The Other Side of the Coin

| October 12, 2009 | 1 Comment

Last week, I wrote about some modest improvement seen in the office market, based on some components of our just-released 3Q statistics.  Given some movement we’re seeing in some submarkets that I view as leading indicators, I am guardedly optimistic about conditions going forward, at least in the office space segment.

R&D space, I think, is a different story.

Now, “R&D space” has a different meaning then it used to, and is no longer just lab and assembly space.  Low-slung two and even three story buildings that might be filled with nothing but cubicles qualify.  While Colliers and most other firms will define R&D space based on parking ratios and such, the real differentiator is how easily the floorplates divide– as a general rule, R&D buildings have less flexiblity here and therefore end up leasing in larger chunks.  This sort of space makes up a very significant component of the R&D building base, in addition to the old-school assembly facilities, life science-oriented space, etc. 

R&D vacancy for the greater Peninsula stands at 17.4% up from 15.8% last quarter (yes, the office vacancy rate is higher and I consider that a stronger market segment).  Every submarket shows negative absorption, and activity is pretty poor.  South San Francisco, something of a bellweather for this product type, is approaching a 30% vacancy rate.  Asking rates are NOT falling, which tells me the cheap deals that need to happen, arent. 

Building owners and Sublessors with R&D space on the market simply cannot respond easily to where the current market strength–small users– is found, for the very simple reasons that I described above.  The less flexible larger user spaces, while more cost effective to build when user demand is there, are always problematic in tough markets like this.  Absorption will only get pushed by aggressive pricing. 

There are some caveats to this- the 300,000 sf Tesla deal, for example, doesn’t show up in our (or likely any of our competitors) vacancy or net absorption stats because the building they took was meant to be demolished, so–quite appropriately– it wasnt classified as “vacant”.  That would have given Palo Alto positive absorption for the quarter.  But one deal doesn’t make for a recovery, and I think that we’re going to see weakness and continued degradation in this sector through 2010.   I also think we’ll see a lot more daylight between average asking rents for office and R&D space next year.

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