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San Francisco Office Rents Rise to New High

Growing Demand, High-Priced New Space Drive Rents Above 2000 Peak
October 2, 2018
In San Francisco’s South Financial District, the Park Tower at Transbay at 250 Howard St. is one of many buildings that has quickly leased before construction was even completed as tenants in the market swooped in on available space.

Asking office rents in San Francisco’s financial district are rising to record levels as technology companies such as Facebook and Google snap up space faster than it can be built, creating demand that's spilling into commercial real estate across the country.

Average Class A office rents in that area set a third-quarter record by topping $81 per square foot for a full-service gross lease that calls for landlords to pay occupancy operating expenses, according to brokerage Cushman & Wakefield's preliminary figures. That would beat the market’s previous peak in 2000 by about 85 cents.

Cushman reports rental growth of about 115 percent over the past eight years in the area. That growth tracks with CoStar data showing cumulative rent growth of about 110 percent from 2010 to 2016, topping the increases in high-demand markets such as New York and downtown Seattle and Chicago's financial district.

"Leasing activity and demand remains strong for downtown office space," said Jesse Gundersheim, a CoStar market economist in San Francisco. "We have over 6 million square feet of leasing activity in the downtown central business district. That puts the downtown core on pace to reach about 8 million square feet in total leasing activity this year, which would be its highest annual total since 2014 and puts it on pace to exceed last year's total of 7.7 million square feet."

Technology companies have driven the increase in rental rates in San Francisco and in tech-heavy cities across the country, said Robert Sammons, senior director of Northern California research for Cushman & Wakefield, the New York City commercial real estate brokerage.

Tech firms are flush with cash and rapidly expanding. Many are opening beach-head locations in cities nationwide as they compete for talent -- and are willing to pay top-dollar to do so.

In addition to the San Francisco and Silicon Valley area, markets where tech is critical to an area's economy include Austin, Texas; Boston and Seattle. In those and other similar markets, office rents in central business districts are up nearly 49 percent on average since 2010, according to a report released last week by Cushman detailing the impact of tech firms on commercial real estate nationwide.

CoStar records show Austin, Boston and Seattle together posted an average of 49 percent rental growth in that time as well.

San Francisco's rents have risen more than anywhere else in the United States from 2010 to this year, jumping about 115 percent, according to Cushman’s report.

According to CoStar Market Analytics, San Francisco's rates are so high that "the market's average asking rent has doubled since bottoming out in 2009, and lies around 63 percent above its prerecession peak."

Atlanta’s price appreciation was the second-fastest, with average rents growing about 65 percent in the eight years since the recession’s end, according to Cushman. That's somewhat higher than the roughly 40 percent to 47 percent CoStar reports for the metropolitan Atlanta and Midtown Atlanta market rental growth in that time.

And while some of the rent growth in these areas and across the United States can be attributed to general economic recovery and growth following the end of the recession, in places like San Francisco, that recovery was intrinsically linked to tech, Sammons said.

Construction on top-of-the-line buildings has flooded San Francisco, according to CoStar. The South Financial District has not hosted this level of construction since 2000, according to CoStar Market Analytics.

It helped drive up average rents as new product commands higher lease rates and owners of older buildings renovate to keep pace and push their rental rates, he said.

Despite the construction, a supply and demand imbalance also contributes to rising rents in the area, Sammons said.

As tech companies grow, they are pre-leasing new space before construction is finished, making the environment competitive for prospective tenants, which drives up rents.

Take, for example, Facebook. The social media giant signed the area's largest deal when it preleased about 763,000 square feet at Park Tower, 250 Howard St., in San Francisco's South Financial District this year while the 43-story office tower was under construction.

The office development pipeline in San Francisco is expected to slow, Sammons said, because of caps on development put in place by the city’s Office Development Annual Limit Program, which took effect in the 1980s. The program allows only 875,000 square feet of large-scale office space to be built in the city per year, though the totals can roll over from year to year.

A lack of development during the recession meant that developers had plenty of room to work under the cap in the years immediately following, but now that allowance is dwindling and setting up a slowing in development, Sammons said.

Large office users in San Francisco, including the biggest tech companies, knew this slowdown was coming, he said, and they have been working to sign large leases before its effects become too serious.

Office owners in nearby California cities such as Oakland could find themselves the beneficiaries of this dynamic as companies look for space in markets that are near Silicon Valley that are not impacted by construction caps and haven’t seen price increases that are as dramatic as in San Francisco.

Molly Armbrister, Denver Market Reporter  CoStar Group   

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