San Francisco Real Estate Office Research & Forecast Report - 2Q2011

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RESEARCH & FORECAST REPORTSAn FrAnciSco

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From Recovery to Rapid Expansion

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The San Francisco office market is beyond the recovery phase of the market cycle and well into the expansion period. Absorption growth, low vacancy, and a lack of new supply have combined to drive rents and encourage new and existing owners to kick off redevelopment plans.

During the second quarter of 2011, the city experienced 560,121 square feet of positive net absorp-tion, which brought the year–to-date total to 1,047,151 square feet. The growth during the quarter pushed the vacancy rate down to 13.6 percent from 14.2.

Despite tenant expansions, job gains were anemic. The unemployment rate has been declining largely due to a dwindling labor force, not from an increase in hiring. At 8.4 percent in April, San Francisco’s unemployment rate is slightly below the U.S. rate at 9.0 percent and well below the over-all State of California’s rate at 11.4 percent.

Nearly 1.7 million square feet of lease transactions took place during the quarter, which is on par with the city’s historical average. The success of the technology sector is still driving the local economy, as small to mid-size technology firms accounted for more than 44 percent of the market’s total ac-tivity. Leasing activity from finance and insurance companies is also beginning to gain traction, and represents nearly 23 percent of the total transaction volume.

Strong leasing activity and continued tenant demand pressured increases in rents across the board. The non-weighted average effective rent for Class A space increased 8.1 percent during the quarter to $36.92 per square foot. The weighted average for the same category surged 15.8 percent to $40.85 per square foot during the same period. Several larger lease transactions with high price tags at 1 Maritime Plaza and One Market Street explain the difference between the two.

High investment sale prices and a high volume of trades allowed for the San Francisco investment market to experience impressive growth during the second quarter of 2011. Based on closed

rent increASeS

Several larger lease transactions with high price tags at 1 Maritime Plaza and one Market Street during the quarter explain the dramatic difference between weighted and non weighted rents.

MArket indicAtorS

updAteAbsorption and Vacancy rates

Q2 2011 2011

VAcAncy

net AbSorption

conStruction weighted rentAl rAte

non weighted rentAl rAte

SAleS VoluMe

SAle priceS

Q2 2011 | office

1Q '11 overall

2Q '11 Direct

2Q '11 Sublease

2Q '11 overall

% Change

*Financial District: Class A $35.03 $43.15 $24.18 $41.72 19.1%

$33.76 $38.12 $24.06 $36.95 9.4%

*All Markets: Class A $35.28 $42.35 $24.79 $40.85 15.8%

$34.15 $38.08 $24.55 $36.92 8.1%

*All Markets: Class B $29.41 $30.74 $31.57 $30.75 4.6%

$29.04 $31.80 $31.26 $31.78 9.4%

*All Markets: Class C $29.88 $33.83 $20.45 $32.96 10.3%

$24.73 $29.82 $20.45 $28.48 0.0%

-10%

-5%

0%

5%

10%

15%

20%

-400,000

-200,000

0

200,000

400,000

600,000

800,000

-20%

-15%

-800,000

-600,000

2Q '04

3Q '04

4Q '04

1Q '05

2Q '05

3Q '05

4Q '05

1Q '06

2Q '06

3Q '06

4Q '06

1Q '07

2Q '07

3Q '07

4Q '07

1Q '08

2Q '08

3Q '08

4Q '08

1Q '09

2Q '09

3Q '09

4Q '09

1Q '10

2Q '10

3Q '10

4Q '10

1Q '11

2Q '11

Net Absorption Vacancy

*weighted average rents

transactions, buildings in escrow, and active investment offerings, it is expected that San Francisco’s investment volume will exceed $2 billion in 2011.

Looking ahead, many owners and developers are dusting off plans that were shelved during the last economic downturn. San Francisco is now well into the expansion segment of the office market cycle, as Shorenstein, GLL Properties, Tishman Speyer, and SKS Investments move forward with projects that will add a total of 1.1 million square feet to the city’s supply.

AbSorption

Largely driven by well-funded technology firms either entering the San Francisco market for the first time or expanding an existing footprint, the city experienced 560,121 square feet of positive absorption during the quarter, which brought the year to date total to 1,047,151 square feet.

The absorption was driven by organic growth from several small to mid-sized companies, mainly in the tech sector, taking on more space. Examples include Zinio, who took another floor of 15,608 square feet at 114 Sansome Street, ngMoco, who expanded into 12,277 square feet at 475 Brannan Street, and Yelp, who took an

additional 9,801 square feet at 706 Mission Street.

In addition to organic growth there were 69,000 square feet of new tenants. Newcomers to the market included Grass Valley, who took 13,907 square feet at 475 Brannan, Cloudera, who took 10,440 square feet at 433 California and Meebo, who took 9,593 square feet at 101 Montgomery Street. Dewey LeBoef, a law firm, returned to the city after a brief relocation to Silicon Valley and occupied 19,844 square feet at One Montgomery tower.

VAcAncyAbsorption growth during the quarter shed .6 percentage from the city’s overall vacancy dropping it to 13.6 percent from 14.2 percent.

Vacancy rates varied between submarkets. The SOMA East submarket, the preferred location of the technology sector, dipped to 9.8 percent. Historically when vacancy drops below 10 percent, rents surge.

With little vacant subease space to turn to, rents for direct space will increase dramatically. Vacant sublease space provides an economic option for tenants with flexible lease terms, and

The success of the technology sector is still driving the local economy, as small to mid-size technology firms accounted for more than 44 percent of the market’s total activity. This is evidenced by the activity in SOMA East, the preferred address of the technology sector. During the quarter, the submarket’s vacancy dipped below the 10 percent mark, (historically the trigger for rents to surge) to 9.8 percent.

updAte lease and investment transactions

SigniFicAnt leASeS Q2 2011

property AddreSS tenAnt Size type dAte Signed clASS

1355 Market Street Twitter 200,000 New April-11 B

1 Maritime Plaza Farallon Capital 63,246 Renewal May-11 A

1 Maritime Plaza Pisces 63,000 Renewal May-11 A

Two Embarcadero Center Cornerstone Research 42,291 Sublease Jun-11 A

1 Maritime Plaza Offit Hall Capital Management 43,692 Renewal Apr-11 A

101 2nd Street Moss Adams 28,577 New Jun-11 A

50 Beale Street Vertical Response 28,121 New Jun-11 A

425 Market Street Regus Business Center 27,506 Renewal April-11 A

SigniFicAnt SAleS Q2 2011

property AddreSS Seller buyer SQ. Ft. SAle dAte clASS SAle price price per SF

101-121 Spear Street Beacon Capital Partners Hudson Pacific 547,964 May-11 A $189,000,000 $344.91

499 Illinois Street* Shorenstein Properties jv. SKS Investments Alexandria RE Equities 453,256 Apr-11 A $293,000,000 $646.43

500 Terry Francois Boulevard The Lionstone Group Sobrato/TMG Partners 291,000 May-11 A $95,050,000 $326.63

350 Rhode Island Street Paladin Realty Partners Tishman Speyer 135,509 Apr-11 A $42,000,000 $309.94

250 Montgomery Street Argonaut Private Equity McMorgan & Co. 118,538 Jun-11 A $37,050,000 $312.56

275 Sacramento Street Vornado Realty Trust Open TV Corp 77,200 Apr-11 A $36,800,000 $476.68

NORTHWESTNORTHEAST

AIR-PORT

SOUTHEAST

SOUTHWEST

Yerba Buena

South Financial District

Soma East

p. 2 | collierS internAtionAl

research & forecast report | Q2 2011 | oFFice | San FranciSco

*Primarily Medical Office Building

inVeStMent SAleS MArket

investment sales activity will be strong through the second half of 2011 as an equilibrium between buyers and sellers begins to appear. the rapidly improving market fundamentals will continue to encourage an aggressive bidding environment for most downtown assets.

existing properties Absorption new Supply

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DOWNTOWN MARKET:

A 171 52,333,099 6,937,846 13.3% 349,740 0.7% 7,287,586 45,045,513 13.9% 15.1% 295,628 658,809 - - 288,000 5,938,520

B 291 25,523,686 3,693,706 14.5% 51,525 0.2% 3,745,231 21,778,455 14.7% 17.1% 198,030 412,546 - - - -

C 143 7,778,573 586,580 7.5% 1,760 0.0% 588,340 7,190,233 7.6% 7.1% 66,463 (24,204) - - - -

Total 605 85,635,358 11,218,132 13.1% 403,025 0.5% 11,621,157 74,014,201 13.6% 14.9% 560,121 1,047,151 - - 288,000 5,938,520

FINANCIAL DISTRICT:

A 105 40,236,611 4,309,725 10.7% 347,957 0.9% 4,657,682 35,578,929 11.6% 13.1% 228,128 630,306 - - 67,000 4,198,000

B 79 8,060,719 1,088,395 13.5% 9,808 0.1% 1,098,203 6,962,516 13.6% 14.1% 23,069 (16,065) - - - -

C 43 1,896,298 136,620 7.2% - 0.0% 136,620 1,759,678 7.2% 8.6% 25,594 11,629 - - - -

Total 227 50,193,628 5,534,740 11.0% 357,765 0.7% 5,892,505 44,301,123 11.7% 13.1% 276,791 625,870 - - 67,000 4,198,000

- - -

SUBMARKETS:

North Financial 118 26,783,376 3,403,658 12.7% 254,207 0.9% 3,657,865 23,125,511 13.7% 15.1% 197,071 350,715 - - - 469,000

South Financial 109 23,410,252 2,131,082 9.1% 103,558 0.4% 2,234,640 21,175,612 9.5% 10.9% 79,720 275,155 - - 67,000 3,729,000

Total 227 50,193,628 5,534,740 11.0% 357,765 0.7% 5,892,505 44,301,123 11.7% 13.1% 276,791 625,870 - - 67,000 4,198,000

Union Square 57 3,839,477 283,565 7.4% 1,783 0.0% 285,348 3,554,129 7.4% 11.2% 36,808 66,742 - - -

Yerba Buena 32 4,072,149 963,719 23.7% - 0.0% 963,719 3,108,430 23.7% 26.5% (10,267) 12,827 - - - 140,000

SOMA West 30 2,748,771 774,558 28.2% 1,760 0.1% 776,318 1,972,453 28.2% 24.0% 22,134 61,664 - - - -

SOMA East 53 5,125,653 471,510 9.2% 33,000 0.6% 504,510 4,621,143 9.8% 13.8% 144,903 98,193 - - - 870,000

Civic Center/Mid-Market 49 6,433,923 1,605,861 25.0% - 0.0% 1,605,861 4,828,062 25.0% 25.6% 5,001 16,949 - - 221,000

Jackson Square 41 2,429,895 203,874 8.4% - 0.0% 203,874 2,226,021 8.4% 10.4% 8,435 42,028 - - - -

North Waterfront 51 3,957,245 410,871 10.4% 8,717 0.2% 419,588 3,537,657 10.6% 8.1% 16,538 24,469 - - - -

Van Ness Corridor 26 1,608,591 279,621 17.4% - 0.0% 279,621 1,328,970 17.4% 18.6% 7,909 6,577 - - - -

Potrero West 14 1,410,391 66,722 4.7% - 0.0% 66,722 1,343,669 4.7% 10.9% 34,848 58,964 - - - -

Potrero East 11 1,040,544 73,604 7.1% - 0.0% 73,604 966,940 7.1% 10.9% 17,021 29,380 - - - -

Mission Bay 14 2,775,091 549,487 19.8% - 0.0% 549,487 2,225,604 19.8% 20.9% - 3,488 - - - 730,520

Total 605 85,635,358 11,218,132 13.1% 403,025 0.5% 11,621,157 74,014,201 13.6% 14.7% 560,121 1,047,151 - - 288,000 5,938,520 Total 605 85,635,358 11,218,132 13.1% 403,025 0.5% 11,621,157 74,014,201 13.6% 14.7% 560,121 1,047,151 288,000 5,938,520

-

QUARTERLY COMPARISON AND TOTALS

Q1 - 11 605 85,540,175 11,577,224 13.5% 598,912 0.7% 12,176,136 73,364,039 14.2% 14.7% 487,030 487,030 - - 288,000 5,938,520

Q4 -10 605 85,442,720 11,702,139 13.7% 877,621 1.0% 12,579,760 72,862,960 14.7% 14.8% 245,229 240,287 210,000 320,000 288,000 5,938,520

Q3 -10 605 85,442,720 11,540,647 13.5% 1,074,342 1.3% 12,614,989 72,827,731 14.8% 15.0% 200,072 (4,942) - 182,073 277,000 6,383,520

Q2 -10 605 85,442,720 11,668,426 13.7% 1,146,635 1.3% 12,815,061 72,627,659 15.0% 14.6% (292,962) (205,014) - 182,073 320,000 6,383,520

Q1 - 10 605 85,442,720 11,389,438 13.3% 1,110,636 1.3% 12,500,074 72,942,646 14.6% 14.6% 87,948 87,948 - 182,073 320,000 6,383,520

research & forecast report | Q2 2011 | oFFice | San FranciSco

collierS internAtionAl | p. 3

San FranciSco:

Alan D. CollenetteManaging Director 50 California Street 19th Floor San Francisco, CA 94111tel +1 415 788 7850FAX +1 415 433 7844

MArketing:

Sonia Roll Regional Marketing Manager [email protected] +1 415 288 7836

512 offices in 61 countries on 6 continentsUnited States: 125Canada: 38Latin America: 18Asia Pacific: 214EMEA: 117(Europe, Middle East, and Africa)

• $1.5 billion in annual revenue

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when in large supply, it can decrease overall rents. However sublease vacancy has diminished rapidly, and currently stands at 0.5 percent, 37.5 percent drop from last quarter’s 0.8 percent, and the lowest point since Q3 2000.

rentS

With supply dwindling, rental rates saw a dramatic shift during the quarter. The overall average non weighted net effective rental rate for Class A office space increased 8.1 percent to $36.92 per square foot. The average net effective rent for direct Class A office space specifically in the Financial District increased 9.4 percent to $38.12 per square foot

A slough of larger-sized renewals drove the dramatic increase in average effective rental rates, as renewals and large tenants typically demand a higher rent than a new lease. Out of the 15 transactions that commanded rental rates greater than $50 per square foot during the quarter, ten were renewals. The average non weighted net effective rental rate for renewals in Class A office space was $44.64 per square foot, compared to $32.96 per square foot for new leases in Class A space.

Average effective rents for Class A office space in the North Financial District increased 6.9 percent to $36.80 per square foot during the quarter. The increase was largely influenced by several renewals that took place at One Maritime Plaza that were greater than $50 per square foot. Similarly, the average effective rent for Class A office space in the South Financial District increased 14.0 percent to $37.24 per square foot during the quarter, due to a significant number of large renewals at One Market.

Looking forward, tenant demand will further tighten market conditions. We expect the market will experience a total of 1.75 million square feet of absorption growth by year end, an all time high since the 3 million square feet of tenant growth recorded in 2000. Currently there is a

total of 140 tenants in the market with 3.69 million square feet of office space requirements. While it is highly unlikely that 100 percent of these tenants will fulfill their stated space needs, it does provide an indicator that there will be healthy leasing activity for the remainder of the year. As a result, Class A non-weighted rental rates will likely increase further by 5-10 percent by year end, for a total increase of 13 to 18 percent year over year.

inVeStMentS

Strong market rent growth along with more than 1 million square feet of positive absorption through the second quarter has encouraged aggressive underwriting by investors and a competitive bidding process for most assets. The South of Market submarket continues to surprise the investment community as the best buildings with “brick and timber” office space are commanding pricing above $400 per square foot.

Remarkably, since the market bottomed in December 2009, the average price for a typical Class A building has risen by 50 to 70 percent. For example, 250 Montgomery Street traded for $177 per square foot at the end of 2009, and it recently closed for $313 per square foot, a 77 percent increase.

High Investment sale prices and a high volume of trades allowed for the San Francisco Investment market to experience impressive growth through the first two quarters of 2011. Based on closed transactions, buildings in escrow, and active investment offerings, it is expected that investment volume in San Francisco will exceed $2 billion in 2011.

Several more deals are expected to close through the end of 2011 as the San Francisco market continues to show strength. However, the abundance of new offerings currently on the market could potentially temper pricing expectations as a balance between supply and demand is approached.

research & forecast report | Q2 2011 | oFFice | San FranciSco