SF Peninsula Commercial Real Estate Third Quarter 2011 Market Update

| October 20, 2011 | 1 Comment

Our 3rd Quarter 2011 Market Report for the SF Peninsula will be released in a few days.  A preview of my write-up on the Office market follows:

Broad market conditions on the SF Peninsula still feature relatively high vacancies and rents far from the levels seen only a few years ago.  The extraordinary activity driven by some of the most dynamic and fast-growing companies in the nation and the highest concentration of Venture investment in the world, however, has driven rents higher in many markets and  created significant pockets where conditions are as strong or stronger than pre-financial crisis peaks.

The Office vacancy rate for San Mateo County continues to decline, though at a less impressive clip than seen over the rest of the year, and closes the Third Quarter at 13.86%.  The greater Peninsula, which adds some of the region’s tightest submarkets, dropped 60 basis points to its current 12.54%.

The pace of activity in the office leasing market has been impressive throughout 2011.  Gross absorption on the greater Peninsula remained very solid in the third quarter at 1.2 million square feet. Overall Gross Absorption in 2011 will almost certainly surpass both 2006 and 2007, the peak years of the last cycle.  Net Absorption did drop off drastically in the third quarter compared to the rest of 2011, checking in at less than 275,000 sf on the greater Peninsula, half the very strong year to date average.

Despite impressive statistical performance of the Peninsula market year-to-date, concerns do persist as to the depth of the recovery.  An unusually high portion of the impressive Gross Absorption seen this year has been concentrated among a small handful of large users.  In at least 4 sizable Peninsula cities, in fact, over half of the Gross Absorption seen to date in 2011 has been accomplished due to a single user.  Consistent with the pattern seen over the course of this year, Sony Corporation’s transaction of 450,505 square feet at Bridgepointe Corporate Center in San Mateo, the largest in San Mateo County, represented 37% of total gross absorption in the 3rd quarter.

The pronounced improvement to the local market does remain concentrated in high end submarkets and property types.  The exceptionally low vacancies in downtown Palo Alto and Mountain View have been widely reported, and continue to push rents in these locations.  On the other side of this equation, however, is the market for second tier, class ‘B’ office space.  Vacancy rates in this broad category remain virtually flat, which, particularly in light of the still high R&D vacancy rate, give reason to question the depth of the market recovery to date.

Thanks in large part to the recent 100,000 sf lease consummated by Perfect World at 100 Redwood Shores Parkway, Redwood Shores has become the tightest sizable submarket on the Peninsula, with the vacancy rate there dropping to 6.5%.  Still, even in this desirable location, vacancies for Class ‘B’ space have remained virtually flat.

It seems almost inevitable that this bifurcated market will come to a close in the near future, as spillover pressure from the tightest market forces more leasing activity into the periphery. Of greater concern is the growing gap between office space absorption and job creation.  Continued anemic job growth would eventually lead to a large influx of destabilizing sublease space, which could quickly reverse the improvements seen over the past two years.

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