The 2010 4th Quarter 2010 San Francisco Office Market: Nascent Signs of Improvement

• The quarter ended with city-wide vacancy of 17.4% after beginning at 17.7%, a positive decrease.  Available space eased into 13.2 million square feet from 13.6 million, another small drop. Net absorption did increase 57%--but it was an underwhelming change from 102,68  to 161,981 square feet.  2010 still managed to end with an almost 60% increase in absorption compared to 2009, from negative 1,100,000sf to negative 700,000 square feet. Still negative, but in a positive direction.
• Asking rental rates rose again in 4th quarter, Class A buildings to $34.36, a 2% increase, and Class B to $28.27, a 2.6% increase.  Real rental rates, however, spiked 20-35% over the year in certain SOMA properties with iconic tenants and locations. A prestigious address on Montgomery and California Streets? Practically usurped by tech tenants on Townsend and South Park in SOMA. In fact, many Class B buildings in that submarket have surpassed Class A building rates North of Market and beyond. Click the map illustrating this dislocated pricing.
• Impressive leasing activity, approximately 1.6 million square feet, was led by CNET’s 282,400 sf renewal at 235 2nd Street. Hills Plaza landed both Wharton School of Business, moving into 34,700 sf at 2 Harrison, and Google, expanding another 63,600 square feet at 345 Spear. KKR Financial Corp; Adaptive Path; Eventbrite; Aliph; Macy’s.com; Berry, Appleman & Leiden; and Federated Media are indicative of larger-sized tenants inking transactions in the quarter. However, companies under 15,000 sf, usually tech firms, still drive the market. See the attached ­G & E report for more details on vacancy, rental rates, and leasing transaction.  
• Sales of buildings in the quarter rocketed, especially in December, partially because Proposition N passed in the November election to increase transfer taxes .5%-1% on properties over $5 million selling after 12/17.  Two North of Market transactions were Hudson Pacific’s purchase of 222 Kearny/180 Sutter and Principal Global Investors/Lincoln Property’s acquisition of 655 Montgomery.  Hudson Pacific also took down 1455 Market Street (in a joint venture with Bank of America/Strada Investment Group) in the Civic Center submarket.
• Sales velocity South of Market was off the charts: Hudson Pacific bought 51% (the office portion) of Rincon Center in a joint venture with Beacon Capital Partners. New Urban Properties scooped up 144-54 and 156-60 Second Street. TMG Partners/ Rockwood Capital bought 680 Folsom and 50 Hawthorne Street. 340 Brannan sold to TA Associates and 625 Third Street to PMI Properties. After purchasing 303 2nd Street in September, Kilroy Realty added 100 First Street to end their year on a high note. 500 Terry Francois, soon to be sold again, found Lionstone Group its latest owner, a group that also bought 298 Utah in September. PMI bought 625 3rd Street, while the 77 Federal Street warehouses sold to SF Rents. Continental Development’s 155 Fifth Street got a joint venture boost from TMG Partners.  
• Sale of the Quarter and the Year: Salesforce.com, one of America’s largest technology companies currently headquartered at One Market and occupying at least 750,000 square feet in its various locations, announced a game-changing purchase of 14 acres in Mission Bay for $278 million from Alexandria Real Estate Equities. Approved for up to 2 million square feet of offices, the coveted land is slated to be the company’s future global headquarters. Overnight, Mission Bay went from a biotech hub surrounded by residential development to a biotech hub with an office concentration surrounded by residential development.  Where will all the other biotech and office tenants craving Mission Bay go now?

For Early 2011 (and Beyond):

• Savvy tech (and other) tenants expand location horizons quickly, not only because inventory is scarce around the Ballpark and Caltrain but also because of better rents and more concessions elsewhere in town.  Landlords vie heavily to draw a name, hub tenant that will magnetize others to their building. 
• Even with economic stability and job creation, companies continue to re-think, downsize, and return space as they become more and more efficient, employing fewer to do more in less space per person.
• Pier 70, the 25-acre Port of San Francisco-controlled site contiguous to Mission Bay to the south, is the next phoenix rising as major developers prepare bid packages and designs for a new neighborhood. 
• Aggressive actions by lenders electing foreclosure over workout bring a few more sale properties to market. Witness 500 Sansome, a 150,000 sf building, and the three-building 888 Brannan portfolio of 539,600sf, both recently taken back by Wells Fargo. This will only partially sate the property-hungry. Off-market deals still proliferate.
• Endings and beginnings blur.  2011 momentum is expected to out-perform 2010, but outside forces could always interfere.  The City is at the mercy of a new mayoral election this year, and the power of national politics and the economy can never be discounted.

Please do not hesitate to contact me for details on leasing and sales activity or any other information about the market that may interest you.

Janine Watson, SIOR, LEED® AP
Vice President
Grubb & Ellis Company
One Bush Street, Suite 800
San Francisco, CA  94104
(415) 477-9285  (d)
(415) 956-5996  (f)
janine.watson@grubb-ellis.com

CA Lic #: 00779011.