Starboard Commercial Real Estate

Hans Hansson | April 23, 2007

If recent vacancy rates hold true, San Francisco is absorbing office space faster than anticipated in 2007. Current vacancy rates in San Francisco now stand at six percent, the lowest vacancy rate since 2000 during the high of the dot com boom. What makes this scary for tenants is that the vacancy rate stood at ten percent as late as November 2006.

This rapid drop has created a 20 to 25 percent rental increase in downtown Class A office rents since November. I recently re-toured with a tenant that we began showing large spaces to in September of last year. At that time we still were finding high 20's to low 30's rental rates for decent Class A and Class B plus space. We re-toured our short list at the end of December and found rates slightly higher in the low 30's to mid 30's. We made our final re-tour of the building last week and found rental rates quotes as high as low 50's for the same spaces.

So what is really going on? It is a combination of things. First, large tenants are very much aware of these price increases and the tightness of the office market anticipated through 2007 and 2008. They are stepping up and making deals now. This has created a frenzy, which in turn has lead to higher prices. Second, we have new owners in town. Equity Office one of the largest national owners of real estate sold their portfolio to Blackstone Group. Next, Blackstone sold their San Francisco part of their Equity portfolio to Morgan Stanley, making Morgan Stanley the largest owner of commercial real estate in San Francisco ahead of Shorenstein Companies and Boston Properties.

For over twenty years Shorenstein held the title of largest landlord, in the last year that title has changed three times. These new owners are buying because they fully understand that San Francisco and the Bay Area are in short supply of Class A office space which means higher rental rates in the future. What they also know is that by having fewer owners control the majority of the available space they can also dictate prices. These very floors being quoted in the low 50's have been on the market for over a year in many cases, yet prices are skyrocketing.

The other issue that is causing rental rate hikes in the double-digit figures is the lack of quality view space in these Class A office buildings. During the bust years firms such as my own firm, Starboard, were successful in securing view space at now bargain prices. What were left over in vacancies were large blocks of less desirable lower floor space with limited views and light. This has created a major price differential between upper floors and lower floors of the Class A office product. The spread could be in the twenty to thirty dollar ranges.

Class B and C office tenants are also feeling the squeeze as Class A rents skyrocket. Class A tenants not willing to pay these new office prices are now competing for Class B space. In turn this forces Class B tenants to look at Class C office and so on.

Non-Profits for instance are truly feeling the squeeze as rental rates are now topping high teens and low twenties in most South of Market and Civic Center locations.

There is help on the way as new office projects are being announced almost weekly since the beginning of the year. But with the first new buildings not scheduled till late 2008 and if your lease is coming up beforehand, be prepared to pay at least twenty to thirty percent higher rents than you may have been paying if you signed your lease three to five years ago.
Posted 12 years, 9 months ago on April 23, 2007
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