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Category: CRE News (49)

Aug

National CRE News: US Banks Tightening CRE Lending Standards

Source: CoStar News
By: Mark Heschmeyer
Dated Posted: August 10, 2016

Second quarter bank earnings results and early third quarter lending numbers clearly show U.S.-based banks have tightened their underwriting standards for CRE loans as they face increased scrutiny of their commercial real estate lending from bank examiners.

In fact, loan officers at domestic banks reported that the current standards are tighter now than they have been on average since 2005, according to the latest Senior Loan Officer Opinion Survey from the Federal Reserve.

The tighter underwriting is showing up in shortened interest-only periods and lower loan-to-value (LTV) ratios as well.

However, underwriting standards are not being tightened for all CRE loans evenly. In particular, a significant number of bankers reported tightening standards for multifamily and construction and land development loans, but only a moderate number reported tightening standards for office, retail and industrial property loans (classified as nonfarm nonresidential properties.)

The return of tightened lending standards comes even as banks generally indicate that they experienced stronger demand for all major types of CRE loans during the second quarter on balance.

A modest number of bankers reported stronger demand for loans secured by multifamily properties, and moderate number reported stronger demand for construction and land development loans and loans secured by nonfarm nonresidential properties, according to the Federal Reserve.

US Banks Tighten Standards, Foreign Banks Far Less

While U.S. domestic banks uniformely reported tightening their CRE loan underwriting, foreign-based banks with U.S. branches reported leaving CRE lending standards basically unchanged. However, only a modest net fraction of these banks reported experiencing stronger demand for such loans.

Those underwriting differences are showing up in CRE loan growth numbers.

Foreign banks grew their CRE loan portfolios 7% from the end of June 2016 through July 27. The largest jump came in construction and land development loans up 8.5%; and office, retail and industrial property loans grew by 6.9%. Multifamily loans were up 3%.

U.S.-based banks on the other hand, grew their CRE loan portfolios by just 0.8% in the same period, according to the Federal Reserve.

Construction and land development loans were up 1.2%; multifamily up 1.1%; and loans for nonfarm nonresidential properties were up 0.6%. In general, small U.S. banks (those with less than $20 billion in assets) were more willing to lend for construction and development projects and on nonfarm nonresidential properties. Larger banks ($20 billion or more) grew their multifamily portfolios more than smaller banks.

CRE lending to small businesses reflected by loan amounts of less than $1 million was down slightly and has been falling steadily over the last year.

Domestic banks reported $1.836 trillion in CRE loans on their books at July 27. Foreign banks reported $61.2 billion.

Banks Responding to Federal Scrutiny

At the end of 2015, federal bank regulators became increasingly concerned that aggressive competition among banks for commercial real estate lending was rapidly eroding underwriting standards and raising the risk-exposure level for lenders. Regulators issued a warning that it would be looking more closely at CRE lending in examining banks’ books this year, and reiterated that stance again this summer.

As federal regulators noted, at the end of 2015 406 banks had grown their CRE loan portfolios by more than 50% in one yera than the prior three years. More than 180 of those banks had more than doubled their CRE portfolios during the past three years.

“We’re taking a look at what regulators are saying and we’re comparing it to what’s actually happening on the ground and we are most likely going to pull our foot off the gas pedal a little bit in the second half with regard to loan growth,” John Kanas, chairman, president and CEO BankUnited Inc., told shareholders in his second quarter’s earnings conference call.

Kanas added that he expected to see other banks react the same way over the next six months, some may pullback even more.

“Looking at the pace we were on in construction lending, and where that might take us in out-years, we just felt like it was prudent and certainly consistent with regulatory guidance to slow down the onboarding of new construction loans,” said Kessel Stelling, chairman and CEO of Synovus Financial.

High Valuations also Prompting Caution

Market dynamics too are also playing a part in the tighter underwriting, according to James Herbert, chairman and CEO of First Republic Bank.

“What happens is, as buildings are being purchased at higher prices, our lending rate, our advanced rates tend to look like they’re declining on loan-to-value. But in fact they are the same amount based on cash flow coverage, and so basically you’re getting an apparently increasingly conservative loan-to-value ratio,” Herbert said in his earnings call. “We actually underwrite pretty much entirely to cash flow coverage.”

First Republic said it continues to watch New York’s multifamily and luxury single-family market carefully.

“Our LTVs in New York are the lowest of anywhere in our marketplace,” he said. “The average LTV in New York is possibly — on multifamily — is possibly sub-55.”

This week, REIT and CMBS lending analysts at Morgan Stanley Research, noted in a report that banks will be justifiably more cautious with CRE lending over the next quarter or two as the industry adjusts to the increased regulatory scrutiny and peak CRE valuations.

“We aren’t necessarily positive with our outlook for 2017, but we see enough signs that lending conservatism may be coming back into the market,” wrote Ken Zerbe, lead author of the Morgan Stanley report on CRE lending.

On the positive side, prices have stabilized compared to earlier this year, Morgan Stanley analyst noted. This implies that the near-term risk of higher-credit losses is low.

Banks too are coming into this tightening credit cycle in a far better underwriting position than they were ahead of the 2007 financial crisis, which could meaningfully mitigate potential losses.

“Our expectation is that banks will be justifiably cautious with CRE lending over the next quarter or two as the industry adjusts to the increased regulatory scrutiny and peak CRE valuations,” the Morgan Stanley report noted. “BKU, for example, has cited ‘overzealous competition’ for why it plans to pull back on lending in 2H16. Yet with valuations having collapsed at several of the larger (and presumably more conservative) CRE lenders such as BKU, SBNY, and NYCB, each down 13% – 22% YTD, what is being priced into the shares seems to be a much more severe and prolonged downturn in the CRE market, which we do not necessarily expect — particularly if regulatory pressure ultimately drives smaller banks to pull back lending and allows the resurgence of the CMBS market as credit spreads increase and terms improve.”

As for their outlook for 2017, the Morgan Stanley analysts noted, “We remain concerned about the near-term outlook for commercial real estate lending given aggressive competition, yet property prices are stable and we are starting to see signs that rationality is creeping back into the market. We see enough signs that lending conservatism may be coming back into the market that we don’t think an outright negative view is warranted.”

Link to article: CRE Lending Standards Tighten

Jul

National CRE News: Q2 Office Sector Maintains Steady Leasing Activity

Even as rent growth slows and sales stall, office leasing sustains momentum

Source: CoStar News
By: Randyl Drummer
Dated Posted: July 27, 2016

he U.S. office market continued its steady momentum in the second quarter, recording 39.4 million square feet of net absorption in the first six months of 2016, nearly equaling the 40.2 million square feet absorbed during the record-setting first half of last year.

The U.S. office vacancy rate ticked down another 15 basis points to 10.6% in the second quarter of 2016, well below the long-term historical vacancy rate of 11.3%. CoStar analysts expect the office vacancy rate to continue trending lower before bottoming out at around 10.2% in 2018, about the same as lowest point of the last real estate cycle.

“Basically, we expect to have two more years of occupancy recovery in the office market,” noted Walter Page, CoStar’s director of office research, who presented the Mid-Year 2016 Office Review and Forecast along with Hans Nordby, managing director for CoStar Portfolio Strategy and CoStar senior real estate economist Paul Leonard.

Several markets showed marked improvement at mid-year, including ones that were previously struggling, such as Phoenix, which posted positive absorption of 3.4 million square feet.

In Seattle, which has enjoyed a particularly strong run, Amazon’s ongoing expansion helped drive 3.1 million square feet in net absorption. Even Washington DC saw a welcome return of strength in the second quarter after several years of flat demand growth. The D.C. office market absorbed a respectable 2.3 million square feet over the last four quarters.

“Finally, we’re starting to see some momentum in the D.C. marketplace, which should allow the vacancy numbers to start inching downward,” said Page.

There were several notable exceptions. The energy sector slowdown and corporate relocations related to the completion of several pending build-to-suit projects played a role in Houston and Dallas, which recorded absorption declines of 2.4 million and 3.7 million square feet, respectively, since mid-year 2015. San Francisco, Raleigh, Boston and San Diego also logged declines due to a variety of factors.

But for the most part, the vast majority of office submarkets — 66% — saw their office vacancy decline in the second quarter, and more than half of all U.S. office submarkets have a lower vacancy rate than during the previous market peak in 2006-2007.

Demand for High Quality Space Resulting in Limited Supply

In a theme seen in many markets across the country, the supply of available space in newer, higher-quality office buildings is becoming increasingly limited. With relatively little new development in the pipeline based on historical levels, only about 81 million square feet of space is available today in buildings constructed over the last 10 years.

That total is less than half the 167 million square feet of vacant newer space that was available in 2007, according to CoStar’s analysis.

“While there are some exceptions where plenty of high quality, new office space remains available, such as Houston and Washington, DC, for the most part we’re really tight on nice, new space,” noted Page.

As evidence, Page noted that the vacancy rate for 4- and 5-Star office properties remained unchanged at 11.7%, despite the fact that 90% of the new office space added to the market falls into that category.

Suburban office markets also continued to see increasing activity as large blocks of high-quality space become harder to find — and more expensive — in most major markets, with the exception of Los Angeles, Seattle, Chicago and Atlanta, where large blocks of downtown space remain readily available.

“Part of the story is that it’s now the suburbs’ turn in the cycle, and part of it is that the CBDs were so successful earlier in the recovery cycle that there’s no place left to grow,” Nordby said.

As investors begin to focus on which markets are the most recession-resistant in the later innings of the recovery, certain niches such as medical office space stand out, Nordby said.

Demand growth is nearly twice as strong for medical office as for regular office, and over the long term, medical office has grown at about 1.3% annual rate compared to 0.7% for the broader office market, Page said. The medical office sector, which has never had negative demand growth, even during the two recessionary periods since 2000, had a midyear vacancy rate of 8% compared to the broader market’s 10.6%.

Office construction stayed flat in the second quarter at about 130 million square feet under way, due in part of a large decline in Houston. But building activity is still slightly above its long-term average of 125 million square feet, with increased construction in D.C. and Atlanta, among other metros.

Some Cautionary Yellow Flags

While leasing and absorption levels remain robust and construction still well below historic levels, the U.S. office market did see some cautionary flags in the second quarter, including a big slowdown in office sales activity and the beginning of a slowdown in rent growth.

CoStar is projecting office rent growth will likely finish the year at an average of 3.4% and decelerate to the low 3% range over the next year. As with all trends, there will likely be a few exceptions, including the Nashville, Atlanta and Florida markets, where lower rents earlier in the cycle have limited construction. Also, rent growth in CBDs is expected to continue to outpace suburban markets.

Meanwhile, reflecting declines across all the property types, the volume of office sales completed in the first half of 2016 declined compared to the same period one year earlier, according to preliminary CoStar data.

“It’s a worry,” Nordby said. “A decrease in transaction volume generally portends a decrease or at least a flattening in prices.”

And in another historical sign of softening demand, rising levels of surplus space placed on the sublease market by tenants, is rising in a few markets. In Houston, the contraction of large energy tenants has caused sublet space to balloon to more than 3.5% of total inventory. Companies such as Shell, ConocoPhillips, and BP have each put 500,000 square feet on the sublet market in recent quarters.

Jul

SF CRE News: Blackstone Acquires 555 & 575 Market Street

Source: BisNow News
By: Aswin Mannepalli
Date Posted: July 1, 2016

Blackstone has completed its acquisition of the 753k SF office properties at 555 and 575 Market St from John Hancock Real Estate. The company plans a major upgrade of the facilities lead by Equity Office, Blackstone’s wholly owned real estate affiliate, and hopes to relocate its Northern California headquarters there. The selling price was not disclosed.

The two buildings are 93% leased and count Uber, TIBCO Software, PNC Bank and Bank of San Francisco as clients.

“Beyond the strength of the tenant base in Market Center, the project’s timeless architecture, excellent views, irreplaceable central location and close proximity to public transportation were all positive factors affecting the acquisition,” said Equity Office Western Region managing director Frank Campbell. The new owner is planning to upgrade both buildings, placing an emphasis on improving common areas, adding more retail and fitness offerings, and sustainability. To attract companies looking for creative offices, Equity Office also plans to build new tenant suites.

Link to article: Blackstone

Jun

Bay Area CRE News: Tesla’s Real Estate Portfolio Grows

Source: BisNow News
By: Aswin Mannepalli
Date Posted: June 14, 2016

Tesla is gobbling up Bay Area real estate as it aims to build 1 million cars by 2020. The automotive company is closing in on Apple and Google as one of the major real estate holders in the region.

While Tesla officially declares 6.6M SF of commercial space, the San Francisco Chronicle reports the real number is closer to 8.3M SF. The first number only takes into account holdings such as the 5.4M SF factory and 350k SF headquarters. The 8.3M SF figure, however, adds all stores, service centers and 1M SF in facilities that will come online soon. Analysts expect the company to keep growing rapidly to meet production targets. It remains to be seen if the company will grow in the Bay Area or move east as it did when it built the Gigafactory in Reno. Electric car companies such as Tesla competitor Faraday Future also have pursued Bay Area space for their expansion plans. [SFC]

Link to Bisnow Article: Tesla Major CRE Player

Link to SF Chronicle Article: Tesla’s CRE Empire

Jun

National CRE News: Commercial Real Estate Prices are Booming says Goldman Sachs

Source: BisNow
By: Erik Dolan-Vecchio
Date Posted: June 7, 2016

Prices in the commercial real estate market are booming due to strong construction while the residential real estate market sluggishly comes back to life, says Goldman Sachs.

The investment banking behemoth recently completed a study highlighting the differences between the commercial and residential real estate markets, finding the drop-off in construction was less severe on the commercial side—it fell 1.6% while residential construction declined 2.8%. This has allowed prices to recover faster for commercial real estate, HousingWire reports. In fact, commercial real estate’s quickening pace has some regulators worried. Boston Fed president Eric Rosengren says keeping rates too low for too long may have encouraged excessive risk-taking, leading to unsustainable gains in commercial real estate.

Link to article: CRE Prices Climb

Read more at HousingWire: CRE Hits Historical Peak

May

National CRE News: Industrial Real Estate Renaissance

Source: Bisnow
By: Aswin Mannepalli
Date Posted: May 26, 2016

Online retail economics is changing the face of industrial real estate. With consumers demanding quicker and quicker delivery of online purchases (i.e. Amazon’s two-hour delivery in the Bay Area), the future demand for distributional warehouse space with modern infrastructure and design is transforming.

Click here to read the 6 Ways the Supply Chain is Changing Industrial Real Estate

Apr

National CRE News: Office Market Sending Mixed Signals

Most Markets Continue to Enjoy Steady Growth in Demand and Rental Rates, Although Rate of Increases Beginning to Moderate

Source: CoStar News
By: Randyl Drummer
Date Posted: April 21, 2016

The U.S. office market appears to be at the stage in the real estate cycle that analysts often describe as a turning point or tipping point. Overall, the U.S. office market continued to post solid fundamentals during the first quarter, including very strong net absorption, while traces of a slowdown in demand appeared in some markets.

“We are seeing mixed signals in the marketplace, although our expectation is the office market will continue to do fairly well for the next few years,” said CoStar Director of Office Research Walter Page, who presented the First Quarter 2016 State of the U.S. Office Market Review and Forecast findings to CoStar subscribers this week. “The biggest mixed signals are really related to net absorption and sales volumes.”

Total net absorption of 11 million square feet of office space in the first quarter was about the same as first-quarter 2015, a leveling off from the upward trend of recent quarters. On the other hand, net space taken by occupiers over the past four quarters exceeds the similar trailing period ending in 2015’s first quarter by nearly 11% at 98 million square feet, noted Page, who presented the findings this week, along with Hans Nordby, managing director of CoStar Portfolio Strategy, and Aaron Jodka, senior manager, Market Analytics.

“All in all, it’s still a very good picture, but the market is clearly not growing as rapidly as before,” added Page. “Our expectation is that going forward, we’re going to see a continuing decline in net absorption, principally because we’re headed for that demographic cliff of retiring baby boomers.”

Office-using employment, a key metric for office demand, continued to outperform the broader job market, especially in the nation’s tech markets, as well as South Florida, Dallas and other pockets of growth and recovery from the housing bust following the Great Recession. Conditions for office job growth should remain strong for the next two years before gradually slowing through 2020, Nordby said.

Despite signs of slowing, solid absorption and occupancy levels continue to be enabled by the moderate pace of new office construction and deliveries in most markets. The 127 million square feet of office space under construction in the first quarter was up only slightly from the same period last year.

Link to article: Office Market Mixed Signals

Apr

San Francisco CRE News: 2016 First Quarter Office Statistics

San Francisco’s Office Vacancy Decreases to 6.8%

The San Francisco Office market ended the first quarter 2016 with a vacancy rate of 6.8%. The vacancy rate was down over the previous quarter, with net absorption totaling positive 887,196 square feet in the first quarter. Vacant sublease space increased in the quarter, ending the quarter at 1,412,643 square feet. Rental rates ended the first quarter at $52.43, an increase over the previous quarter. A total of two buildings delivered to the market in the quarter totaling 480,000 square feet, with 5,352,288 square feet still under construction at the end of the quarter.

Absorption
Net absorption for the overall San Francisco office market was positive 887,196 square feet in the first quarter 2016. That compares to positive 680,988 square feet in the fourth quarter
2015, negative (297,950) square feet in the third quarter 2015, and positive 1,332,620 square feet in the second quarter 2015.

The Class-A office market recorded net absorption of positive 669,332 square feet in the first quarter 2016, compared to positive 689,681 square feet in the fourth quarter 2015, negative (25,939) in the third quarter 2015, and positive 825,531 in the second quarter 2015.

The Class-B office market recorded net absorption of positive 248,697 square feet in the first quarter 2016, com- pared to negative (39,232) square feet in the fourth quarter
2015, negative (216,768) in the third quarter 2015, and positive 555,278 in the second quarter 2015.

The Class-C office market recorded net absorption of negative (30,833) square feet in the first quarter 2016 com- pared to positive 30,539 square feet in the fourth quarter
2015, negative (55,243) in the third quarter 2015, and negative (48,189) in the second quarter 2015.

Net absorption for San Francisco’s central business district was positive 660,981 square feet in the first quarter 2016. That compares to positive 163,176 square feet in the fourth quarter
2015, negative (267,529) in the third quarter 2015, and positive 387,476 in the second quarter 2015.

Net absorption for the suburban markets was positive 226,215 square feet in the first quarter 2016. That compares to positive 517,812 square feet in fourth quarter 2015, negative (30,421) in the third quarter 2015, and positive 945,144 in the second quarter 2015.

Vacancy
The office vacancy rate in the San Francisco market area decreased to 6.8% at the end of the first quarter 2016. The vacancy rate was 7.0% at the end of the fourth quarter 2015,
6.6% at the end of the third quarter 2015, and 6.4% at the end of the second quarter 2015.

Class-A projects reported a vacancy rate of 7.7% at the end of the first quarter 2016, 8.0% at the end of the fourth quarter 2015, remained the same at 7.4% at the end of the third quarter 2015 compared to the previous quarter.

Class-B projects reported a vacancy rate of 6.7% at the end of the first quarter 2016, 7.1% at the end of the fourth quarter 2015, 6.7% at the end of the third quarter 2015, and
6.3% at the end of the second quarter 2015.

Class-C projects reported a vacancy rate of 3.8% at the end of the first quarter 2016, 3.7% at the end of fourth quarter 2015, 3.9% at the end of the third quarter 2015, and 3.6% at the end of the second quarter 2015.

The overall vacancy rate in San Francisco’s central business district at the end of the first quarter 2016 decreased to 6.3%. The vacancy rate was 7.0% at the end of the fourth quarter 2015, 6.0% at the end of the third quarter 2015, and 5.8% at the end of the second quarter 2015.

The vacancy rate in the suburban markets increased to 7.5% in the first quarter 2016. The vacancy rate was 7.1% at the end of the fourth quarter 2015, 7.5% at the end of the third quarter 2015, and 7.4% at the end of the second quarter 2015.

Sublease Vacancy
The amount of vacant sublease space in the San Francisco market increased to 1,412,643 square feet by the end of the first quarter 2016, from 1,352,132 square feet at the end of the fourth quarter 2015. There was 1,275,923 square feet vacant at the end of the third quarter 2015 and 1,102,001 square feet at the end of the second quarter 2015.

San Francisco’s Class-A projects reported vacant sublease space of 998,469 square feet at the end of first quarter 2016, up from the 967,996 square feet reported at the end of the fourth quarter 2015. There were 857,982 square feet of sub- lease space vacant at the end of the third quarter 2015, and 748,203 square feet at the end of the second quarter 2015.

Class-B projects reported vacant sublease space of 333,325 square feet at the end of the first quarter 2016, up from the 329,958 square feet reported at the end of the fourth quarter 2015. At the end of the third quarter 2015 there were 342,020 square feet, and at the end of the second quarter 2015 there were 298,324 square feet vacant.

Class-C projects reported increased vacant sublease space from the fourth quarter 2015 to the first quarter 2016. Sublease vacancy went from 54,178 square feet to 80,849 square feet during that time. There was 75,921 square feet at the end of the third quarter 2015, and 55,474 square feet at the end of the second quarter 2015.

Sublease vacancy in San Francisco’s central business district stood at 673,271 square feet at the end of the first quarter 2016. It was 595,812 square feet at the end of the fourth quar- ter 2015, 543,796 square feet at the end of the third quarter 2015, and 491,777 square feet at the end of the second quarter 2015.

Sublease vacancy in the suburban markets ended the first quarter 2016 at 739,372 square feet. At the end of the fourth quarter 2015 sublease vacancy was 756,320 square feet, was 732,127 square feet at the end of the third quarter 2015, and was 610,224 square feet at the end of the second quarter
2015.

Rental Rates
The average quoted asking rental rate for available office space, all classes, was $52.43 per square foot per year at the end of the first quarter 2016 in the San Francisco market area. This represented a 1.1% increase in quoted rental rates from the end of the fourth quarter 2015, when rents were reported at
$51.84 per square foot.

The average quoted rate within the Class-A sector was $54.11 at the end of the first quarter 2016, while Class-B rates stood at $51.77, and Class-C rates at $46.73. At the end of the fourth quarter 2015, Class-A rates were $53.77 per square foot, Class-B rates were $50.94, and Class-C rates were $45.57.

The average quoted asking rental rate in San Francisco’s CBD was $57.99 at the end of the first quarter 2016, and $50.36 in the suburban markets. In the fourth quarter 2015, quoted rates were $58.19 in the CBD and $49.47 in the suburbs.

Inventory
Total office inventory in the San Francisco market area amounted to 165,448,464 square feet in 3,843 buildings as of the end of the first quarter 2016. The Class-A office sector consisted of 77,319,980 square feet in 304 projects. There were 1,437 Class-B buildings totaling 64,146,043 square feet, and the Class-C sector consisted of 23,982,441 square feet in 2,102 buildings. Within the Office market there were 209 owner- occupied buildings accounting for 18,858,040 square feet of office space.

Sales Activity
Tallying office building sales of 15,000 square feet or larger, San Francisco office sales figures fell during the fourth quarter 2015 in terms of dollar volume compared to the third quarter of 2015.

In the fourth quarter, 14 office transactions closed with a total volume of $1,043,890,500. The 14 buildings totaled 1,634,104 square feet and the average price per square foot equated to $638.82 per square foot. That compares to 13 transactions totaling $1,955,263,000 in the third quarter 2015. The total square footage in the third quarter was 2,904,410 square feet for an average price per square foot of $673.20.

Total office building sales activity in 2015 was down com- pared to 2014. In the twelve months of 2015, the market saw 48 office sales transactions with a total volume of $4,814,873,500. The price per square foot averaged $651.62. In the same twelve months of 2014, the market posted 76 transactions with a total volume of $6,456,094,000. The price per square foot averaged
$544.50.

Cap rates have been lower in 2015, averaging 4.76% compared to the same period in 2014 when they averaged 4.88%. One of the largest transactions that occurred within the last four quarters in the San Francisco market is the sale of 333 Bush St in San Francisco. This 546,182-square-foot office building sold for $378,500,000, or $692.99 per square foot. The property sold on 12/24/2015, at a 3.70% cap rate.

source: CoStar 1st Quarter 2016 San Francisco Office Market Report

Mar

SF CRE News: Increase in Office Sublease Space – Sign of “Tech Wreck” or Corrective Adjustment?

Source: The Registry
By: David Goll
Date Posted: March 30, 2016

While some San Francisco real estate observers worry a sizable increase in office space available for sublease may signify a potential property “tech wreck” in the works, others view an increasing amount of available space as more of a corrective adjustment that’s creating some benefit.

According to a report from Cushman & Wakefield, the amount of office space being subleased in San Francisco, including the Financial District and SOMA, jumped from 1.3 million square feet in the third quarter of 2015 to nearly 1.7 million square feet in the fourth quarter. By the end of February, that number had climbed to 1.9 million square feet. As of March 21, 2016, JLL reports that this type of sublease availability has climbed to 2.28 million square feet in San Francisco.

About half of the space available for sublease is coming from technology companies, according to the JLL and Cushman & Wakefield reports. That translates to 45 of the 138 subleases in San Francisco, or close to 1.1 million square feet. And while 41 percent of companies gave contracting or consolidation as their reasons for subleasing space, 26 percent cited relocation inside the San Francisco city limits, while 22 percent are moving all or part of their businesses out of the city, according to Cushman.

“We saw the trend begin to intensify in the fourth quarter [of 2015],” said Christina Clark, senior vice president in the San Francisco office of Cresa Corporate Real Estate. “Our clients were starting to evaluate whether they were occupying too much space, what would be the best way to handle and utilize it. Others are wondering if the high costs are going to continue and whether it was worth getting into a seven-year agreement with unfavorable terms.”

As a result, Clark said leasing activity began to slow as companies “pushed the pause button.”

“We have been monitoring this trend since the second quarter of 2015,” said Andrew Nicholls, advisor in Cresa’s San Francisco office. “That’s when we noticed a distinct shift in the market.”

Colin Yasukochi, director of research and analysis in the San Francisco office of CBRE Group, the Los Angeles-based commercial real estate firm, said the subleasing trend became especially notable late last year, coming mainly from the tech sector. The reasons are varied.

“Some are expanding into new offices here in San Francisco, while some just have excess space they don’t need right now,” Yasukochi said. “There’s a variety of reasons. And what we are seeing, especially with high-quality subleased space, is that it’s not staying on the market that long. It frequently is leased within three to six months.”

Yasukochi said he doesn’t regard the current inventory of subleased space—which covers all grades of office space, but mostly A and B—to be an excessive amount.

“If there was, you would see much bigger discounts offered on space being leased directly from landlords, like 30 or 40 percent,” he said. “When the market is healthy, the discounts are not that large. Subleased space is increasing, but we’re not seeing large discounts.”

According to his research, Yasukochi said the amount of subleased space in downtown San Francisco has jumped from 1.1 million square feet in October to 1.7 million square feet in March. Unlike other observers, who predict that figure will grow substantially by year’s end, he is not quite as certain of that outcome.

“It could grow, but this is an evolving situation and that has yet to be determined,” Yasukochi said. “We will see if the supply continues to exceed demand.”

JLL’s figures tell a similar story today. Five of the largest eight sublease spaces are already in some form of discussions for the space to be subleased. Those top five available spaces are Charles Schwab’s 305,502 square feet at 215 Fremont, Dropbox’s two spaces at 185 Berry for a total of 212,000 square feet, Bingham McCutchen’s 98,000 square feet at 3 Embarcadero Center and Yahoo’s 60,000 square feet at 343 Sansome, which was just subleased to Airwave, a drone software platform company. If all these negotiations result in a new tenant, that would drop the available space to 1.6 million square feet, a 30 percent drop from where we are today. One thing to note, however, according to JLL’s report, is that 43 of the 138 available spaces came to the market in the last month, a 45 percent jump in absolute number of spaces. Some of this space includes nearly 25,000 square feet from Medium at 760 Market, nearly 34,000 square feet from Zenefits at 303 2nd Street, 18,000 square feet from Riverbed at 680 Folsom and 11,000 square feet from Box at 100 1st Street.

Asking lease rates for Class A office space downtown being offered directly from landlords averages about $76 per square foot annually, a figure which grew 14 percent in the fourth quarter of 2015, Yasukochi said. Though it would depend on the condition of the space being subleased by another tenant, asking lease rates would likely be about $65 per square foot annually this spring, he added.

“If it’s in good shape and there’s lots of interest in it,” Yasukochi said of space at those rent levels, which are reflective of the 10 to 15 percent discounts being offered.

Drew Arvay, senior vice president in the San Jose office of Cushman & Wakefield, said he’s aware of the glut of space available for sublease in San Francisco, but said it’s a different dynamic in Silicon Valley—or cities in Santa Clara, San Mateo and southern Alameda counties. It even goes by a different name.

“We call it shadow space,” Arvay said. “There are instances where companies are seeking to sublease space, but it often is on a short-term basis.”

On the other hand, Arvay said some of the Valley’s largest tech giants that occupy millions of square feet of office space might keep a few hundred thousand square feet empty for anything from storage to future productive use when they expand operations again.

“How companies are using space has really shifted in recent years,” he said. “We went from private offices and hallways to cubicles. The cubicles started out averaging 250 to 275 square feet of space per person, but then shrunk to 160 square feet. Now, cubes are disappearing and being replaced with even smaller work pods or benches, or shared space.”

But Silicon Valley companies are offsetting the downsized workplace trend by continuing to hire employees by the thousands, so they are reluctant to shrink their office footprints too substantially. Arvay said Gensler, the San Francisco-based architecture, design and planning firm, has dubbed Silicon Valley companies as the most efficient users of work space.

“That’s not to say we are immune from having surplus space that could be available for subleasing, but this is still a different situation from downtown San Francisco,” he said.

He added there is another dynamic at work in Silicon Valley and elsewhere in the corporate world over the past three years since Yahoo Inc. CEO Marissa Mayer famously ended her company’s popular work-from-home policy for employees.

“Employers have discovered innovation is born of collaboration, of employees talking to one another during the work day, talking over lunch,” Arvay said. “The money they used to save on renting space by having employees work in their pajamas from home was being lost by a decrease in developing innovative ideas.”

Both Clark and Yasukochi said they see another potential storm cloud on the horizon for San Francisco employers: the possible decrease in VC funding, mainly affecting the tech sector.

“We are hearing that while companies are still getting funded, some are getting less funding or having trouble getting another round of funding,” Clark said. “VC funding is critical, so we are watching that very closely. That trend really started accelerating in the fourth quarter, making tenants seriously consider whether they need so much space.”

Link to article: Sublease Conundrum