Mid-year market review: My Office Market update for 2Q ’11

| July 21, 2011 | 1 Comment

Colliers will be releasing its 2Q 2011 Market report for the SF Peninsula shortly.  My article on the Office Market can be found below:

The market recovery continues on the San Francisco Peninsula as we cross the mid point of 2011, and the Bay Area economically outperforms the rest of the nation.   Not only has the vacancy rate shown substantial improvement over the past 18 months, but overall leasing activity has returned to pre-recession levels on the Peninsula.

In San Mateo County, the office vacancy rate now stands at 14.26%– still higher than long-term averages, but the lowest rate since late 2008.  The greater Peninsula (San Mateo County, Palo Alto, Mountain View and Los Altos) has reached 13.14%- an exceptionally strong improvement over the 16.2% rate seen only 6 months ago.

Vacancy can be a very rough measure of conditions of the moment, particularly in a smaller market such as the Peninsula.  Perhaps a better indicator of the re-surging local market is the dramatic increase in the Gross Absorption rate, a measure of all leasing activity in a market.  Year to date, the Peninsula has seen 3.8M square feet of total office leasing activity, surpassing the annual totals for both 2009 and 2010.  The greater Peninsula’s Net absorption for the quarter of 586,225 square feet is the strongest figure in over 5 years.

The incredible market movement in core locations such as downtown Palo Alto and Mountain View continues.  The vacancy rate in downtown Palo Alto has reached an extraordinary 1.96%, and rents have shot up by 25% just over the course of 2011 (currently averaging $6.82 PSF).   These submarkets have become synonymous with the current boom in Peninsula start-up activity.  Many casual market observers will equate the success of these submarkets to a boom in surrounding areas as well.  The expected spill-over phenomenon, however, from these downtown areas to surrounding markets has yet to occur.  Multi-tenant buildings elsewhere in these same cities have yet to see substantial increases in activity or lease rates, and the spread between rents in these secondary locations and the nearby downtown hubs continues to grow.

While large users always make a disproportionate mark on a market such as the Peninsula, the impact of the biggest local players is stronger than ever, accounting for a very substantial percentage of the strong year to date gross absorption.  Google has year to date snapped up over 650,000 square feet in Mountain View alone, and Facebook’s new campus in Menlo Park is one of the largest leases in the area in recent memory.   Other significant transaction on the Peninsula this quarter include SunEdisons’ 120,000 sf lease at the long-vacant 600 Clipper in Belmont Shores, Box.net’s 90,000 sf expansion into Los Altos, and Philips Electronics 65,000 sf Foster City lease.

This dichotomy between the large user market and broader conditions might cause concern to some over the depth of the ongoing recovery.  The vacancy rate for Class ‘B’ office space (a part of the market that would not benefit from the large user insurgence) actually tracked up modestly in 2Q 2011, ending the first half of the year at a very high rate of 18%.   Further cause for concern can be found in the relatively flat trend in Average Asking Rents on the Peninsula.   Despite continued strong performance in certain Class A-dominated markets, the current $2.98 PSF average asking rate is little changed from last quarter and remains relatively flat over the past year.

While there is strong sentiment that the local market has turned a corner and will continue to improve in the second half of 2011, though likely in the same uneven fashion as has been seen to date.  As predicted here last year, space for larger users is now in very short supply on the Peninsula.  Start-ups continue to compete for space in the most desirable core markets and drive rents well beyond those seen at the peak of the last cycle in those locations.  It remains an open question how rapidly the broader market will catch up.

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