The State of the Peninsula Commercial Real Estate Market at the Close of 2011

| January 22, 2012 | 1 Comment

We will be releasing our 4th Quarter 2011 Market report in the next day or so. I have just completed the narrative for the Office Market portion of the report, which you can preview below– and you may also be interested in my recent post on the Top SF Peninsula Commercial Real Estate Stories of 2011.

Preview of my market overview is below:

It would be hard to view 2011 as anything but the strongest year for the local commercial real estate markets in quite some time.  Perhaps, though, there will be an asterisk in the record books.   A combination of intense leasing activity from select large users and an unprecedented acceleration of a few particularly desirable submarkets has driven the markets into positive territory.  What remains to be seen is if the activity seen in these certain segments equate to a broader market improvement.

The office vacancy rate for the Greater Peninsula plunged over the course of 2011 from 16.22% to its current 11.44%– the lowest rate seen since early 2008.  Looking just at San Mateo County shows a similarly dramatic improvement from 17.61% to 12.47%.

While the market downturn during the recent recession was defined by an exceptional lack of leasing activity, the recovery to date has been driven by extraordinary levels of absorption.  Gross absorption, a measure of all leasing activity with a market area, surpassed 7.3 million square feet for the Peninsula, nearly double the 2010 total and 23% better than the level seen in 2007, the peak of the last market cycle.

This impressive absorption, however, may not look quite as dramatic under closer scrutiny. Much of this unprecedented activity has been driven by an unusually high number of large users taking down very sizable blocks of space.   2011 saw a total of 19 lease transactions of 50,000 square feet or greater on the Peninsula, compared to only 8 in the prior year.   The largest office leases seen in both Santa Clara and San Mateo counties in years, in fact, both occurred in 2011 and played an enormous role in this record year.

Headline-grabbing leases by the likes of Facebook, Sony and Google accounted for a disproportionately high share of the activity for the year, but there were a sizable number of other transactions of importance in the market in 2011.   Noteworthy transactions included DreamWorks’ 193,000 square foot lease at Pacific Shores in Redwood City. Perfect Worlds’ 100,000 square foot relocation to Redwood Shores and Box.net’s 90,000 square foot Class A office lease in Los Altos.

The growth in average asking rates over the course of 2011 was an impressive 12%, with rents closing the year at $3.19 FS for Peninsula office space.  Despite this aggressive one-year spurt, rents are still well below the peaks of 2008, when average asking rates peaked at $3.64 FS with a comparable vacancy rate to the current quarter.  Taken by itself, San Mateo County also showed strong rent growth, closing the year at $2.95 FS.  Without the boost provided by the Palo Alto and Mountain View markets (where rents have far surpassed the 2007 peak), the gap between current rents and the top of the last cycle is even more dramatic.

The aggressive market gains seen in highly desirable core markets such as downtown Palo Alto and Mountain View has been one of the focal points in the market recovery over the past 18 months.  In perhaps a sign that the multi-tenant market recovery is spreading beyond the rail corridor, Redwood Shores has emerged as the large submarket with the most dramatic improvement to date in this market cycle.  Vacancies in this Class A-dominated market have dipped to just 6.5%, and rents in some individual buildings have risen by as much as 60% in just over a year.

At the close of 2010, we predicted that 2011 would bring a shortage of space to handle the needs of larger users on the Peninsula.  While supply has drastically tightened in this segment of the market, demand has similarly dwindled.  Our internal tracking of major users currently in the market suggests that activity will fall off drastically in the coming year.  Further rent growth likely depends on the awaited return of the mid-size user to the market.

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