Hardy and Healthy
by Thomas Trowbridge
Northern California's robust economy provides a firm foundation for real estate investment
Last October the "Emerging Trends" survey published by Lend Lease and PricewaterhouseCoopers identified San Francisco as the country's best investment market. The area claimed that distinction for the third consecutive year and local real estate markets throughout Northern California have continued to show strength in 1999, validating this judgment. Single-digit vacancies prevail throughout the region. Rents are firm following substantial increases in recent years.
San Francisco Bay Area
The nine-county Bay Area is home to 6.8 million people. It provides 3.3 million jobs and enjoyed an unemployment rate of approximately 3 percent for the past three years. The economy has added 216,000 jobs during the 1996-98 period, a growth rate of 3 percent a year. The Bay Area is the fourth largest economic region in the country after New York, Chicago and Los Angeles.
The Bay Area's three major metropolitan statistical areas are San Francisco, Oakland and San Jose. For many years, San Francisco has been the headquarters city and financial center. Oakland has been the port city and hub to BART, the region's 100-mile rapid-transit system. San Jose is the major city in Silicon Valley, the leading high-tech employment center in the world and the region's primary growth engine. San Jose surpassed San Francisco in both population and job growth during the 1990s.
Office
In a region devoted to the information economy it is no surprise that the office market is immense. Downtown San Francisco's market, at 40 million square feet, has less than 20 percent of the total space in the Bay Area. Annual rents for Class A space are $43 on average, with top rents exceeding $60 a square foot. Class B space has moved up to $35. The most recent average vacancy reported by brokerage firms is around 3 percent.
A handful of buildings are under construction with substantial early leasing. This follows a 10-year hiatus from new starts. The 1.5 million square feet of new space coming on the market will very likely be fully leased, or nearly so, upon completion.
In addition to three speculative buildings, other projects of note include a new headquarters for the GAP, which will be topping out before the year's end. A proposal for a 900,000-square-foot new campus for Lucas Films was selected in the spring as the reuse for the 23-acre site of Letterman Hospital in the Presidio. Groundbreaking will be in the fall of 2000. This is the first significant commercial development in the Presidio following its conversion from the headquarters of the Sixth Army to a fiscally self-sustaining National Park under the supervision of the Presidio Trust.
Also on the drawing boards is Catellus Development's Mission Bay project that consists of 300 acres along San Francisco's eastern waterfront. Over the next two decades some 7.5 million square feet of office/research and development space will be developed, the cornerstone of which will be a 43-acre molecular research campus for the University of San Francisco, which is expected to break ground shortly.
Down the San Francisco Peninsula is San Mateo County with its very strong and active market of 28 million square feet. The Peninsula market is a high-quality suburban market with rents very comparable to those in San Francisco. Vacancy in 1999 has been in the range of 5 percent, up from 3 percent in the prior two years. Substantially all of the vacancy increase is attributable to the development of a single speculative project, Westport, in Redwood Shores. Westport will contain 1 million square feet of space, of which approximately 25 percent is leased.
The San Francisco International Airport is a significant employer in San Mateo County. United Airlines operates a major hub there and employs 10,000 people. An on-going $2.5 billion expansion will continue to foster growth of office uses for years to come. A 7.5-mile, $1.5 billion extension of the BART line to the airport is also under construction. Completion of both projects is expected in 2001.
Adjacent to San Mateo to the south is Santa Clara County with another 42 million square feet of office space and 140 million square feet of office/R&D space. The office market is about 10 percent vacant. Average annual rents are $33, with the high end in the Palo Alto market, home of the venture capital and investment banking firms that serve Silicon Valley. Rents in this submarket along Sand Hill Road are the highest in Northern California, at $6 a square foot.
The R&D market in Santa Clara County is the largest and most dynamic market in Northern California. Vacancy, which sits at 11 percent, has declined from 12 percent in the first quarter of the year when the effects of the Asian financial crisis were felt in the semiconductor industry. A good indicator of the strength of this market is that R&D rents increased some 8 percent in 1998 while one of the Valley's major industries was in a downturn. Rents of $1.60 to $2 per square foot in the first quarter are expected to firm during the balance of the year, with vacancy falling to 10 percent or less, as the semiconductor industry continues to recover.
The Oakland-East Bay metropolitan area stretches from Richmond and Concord in the north to Hayward and Pleasanton in the south. The market is very diverse, ranging from downtown Oakland's highrise buildings to the suburban office campuses of San Ramon and Pleasanton.
The I-80/I-880 corridor, along the eastern shore of the Bay, contains approximately 21 million square feet of office space. Vacancy is approximately 8 percent. The I-680 corridor farther to the east has another 24 million square feet, with a vacancy rate of approximately 6 percent. Annual rents in these markets are considerably lower than San Francisco, the Peninsula and Silicon Valley, averaging $25 for Class A space. The result of this rent differential is that substantial numbers of major San Francisco employers relocated their back-office operations to the East Bay during the 1990s. This trend continues.
Industrial
The major industrial markets of the Bay Area are summarized in the following table:
Average Market Sq. Ft.
(in millions)Vacancy Rent San Francisco 27 1.7% 76 cents San Mateo 34 2.3% 74 cents Santa Clara 34 5.8% 61 cents East Bay 78 4.2% 43 cents Totals: 173 3.8%
The industrial space market is stable and mature, reflecting the generally strong regional economy. High land costs and building costs in the region inhibit new construction. Most new industrial development is occurring to the east, in Sacramento and the Central Valley.Apartments
Housing is in short supply throughout the region. Vacancies in all the major markets around San Francisco Bay are currently in the 2 percent to 4 percent range. Multifamily housing starts have picked up, from 15,700 in 1995 to 29,000 in 1998.
Again, given the high cost of land and construction, together with a very long lead time required to obtain entitlements, it is difficult to build apartments anywhere in the Bay Area. It is likely that demand for units will remain unsatisfied for the foreseeable future.
The prospects for commercial real estate in the Bay Area are bright. Its interesting topography and favorable climate make it a desirable place to live. Its healthy economy makes it a good place to work. These are the underpinnings of strong demand. The geographic constraints of a bay surrounded by mountains means that developable land is in short supply.
Sacramento
Metropolitan Sacramento's population will exceed 1.7 million in 1999. Job growth over the last 10 years has averaged 2.3 percent a year, 3.5 percent in 1998. Unemployment is less than 4 percent.
In this capital city of the nation's largest state, government employment has historically had an important impact on the regional economy. During the 1990s, however, the concentration of government in the employment base has been reduced from 35 percent to 26 percent. At the same time that state employment rolls were being reduced in California's recession of the mid-decade, and military facilities such as Mather Air Force Base were being closed, a significant number of jobs were added in services and high technology.
While the region's largest employers are health maintenance organizations, with 18,000 employees, the high-technology sector of the economy has been a key factor in the strong employment growth of the past four years. The most significant high-tech companies in the region now include Hewlett Packard (4,000 jobs in Roseville), Intel (3,800 jobs in Folsom) NEC/Packard Bell (3,000 jobs at the site of the former Sacramento Army Depot) Oracle and Apple. In addition, Sacramento has more than 375 smaller high tech related firms, up from 100 in 1993.
Office
The Sacramento office market is a healthy and active one. It is a 33.5 million-square-foot market with 8.6 million square feet downtown and 24.9 million square feet in the suburbs. Vacancies in the summer were reported at 6.3 percent and 9.3 percent, respectively.
Approximately 3 million square feet was under construction in 1999, of which 70 percent was preleased as of June. One million square feet of net absorption is projected for 1999 vs. the 800,000 square feet of 1998. The most active submarkets are Roseville and Folsom.
Industrial
Sacramento has a substantial industrial base - 133 million square feet - for its population. Vacancy reported in the summer was 4.9 percent; 3 million square feet of new space will be added in 1999, half of which will be speculative. West Sacramento and Roseville are the two most active industrial markets.
Apartments
The multifamily market continued to improve in 1998 as overall market vacancy declined to 4.1 percent from 5.2 percent at year's end 1997. Average rents increased approximately 8 percent during the year to a weighted average of just over $1 a square foot. New construction could add as many as 5,000 units in 1999.
This year will be an excellent year for commercial real estate throughout Northern California's metropolitan areas. The outlook for the coming year is favorable for stability and continued growth.
This article first appeared in the September 1999 issue of the California Real Estate Journal.
