Source: San Francisco Business Times
By: Roland Li
Date Posted: May 2, 2016

Boston Properties, San Francisco’s largest office landlord, thinks the country’s hottest office market is cooling.

In an earnings call last week, Doug Linde, president of Boston Properties (NYSE: BXP), said that San Francisco’s office market is seeing fewer space needs from larger tenants, which could indicate a slowdown, while Silicon Valley’s activity is growing.

“I think the big difference between the market then — i.e. in 2014 and 2015 — and today is really the lack of large growth requirements, and by that I mean big tenants over 300,000 square feet,” said Linde, according to a transcript.

Boston Properties, which had 5.8 million square feet of office space in the Bay Area market at 93.8 percent occupancy as of December 2015, is working on some of the largest office projects in the city. Along with minority partner Hines, Boston is building Salesforce Tower, which will be the tallest tower in the city when it opens next spring. Still, Linde cited some pullback.

“San Francisco has slowed from the pace that it was going at in 2014 and 2015. Silicon Valley continues to be very active and actually has been expanding,” he said. There’s a dearth of huge tenants such as Salesforce.com, Stripe and LinkedIn, who all signed huge leases over the past three years, he added.

“So technology is still a vibrant part of the market, it’s still expanding, it’s not quite in the same manner that it was in 2014 and 2015,” said Linde.

Linde’s perspective mirrors the consensus of many real estate brokerages, who have projected a slowdown this year after record leasing activity in the past few years. However, the majority of first quarter reports anticipates that San Francisco will remain one of the country’s most expensive markets. Asking rents are over $70 per square foot, and vacancy is hovering around 5 percent for Class A space.

But some real estate professionals fear that a full downturn could occur. They see a tech bubble, citing startups with unsustainable business models that are committing to huge blocks of space that they likely won’t fill.

Boston Properties, though, says its developments are filling up. Salesforce Tower is now 59 percent occupied, said Linde on the earnings call, and the landlord is in talks with both single-floor and multi-floor tenants. He said that by the end of the second quarter, the company hopes to complete another 100,000 square feet in leases.

In the past quarter, Bain & Co. and Vy Capital have signed leases at Salesforce Tower, underscoring continued demand from non-tech tenants. CBRE Group Inc., the tower’s own broker, is also close to a lease. Boston Properties also completed 535 Mission St. in 2014 and is seeking approvals for a 1.1 million-square-foot project at Fourth and Harrison streets in the Central SoMa district.

However, Boston Properties has also shown caution. Michael Tymoff, Boston Properties’ senior project manager, development, told the Business Times in February that the company has declined to pursue projects because expected returns didn’t match land or construction pricing.

“We are very disciplined, both in our timing and the selectivity of sites,” he said. “While we evaluate every project on its own merits, we currently target 7 percent returns or better for our ground-up office developments.” Tymoff didn’t immediately respond to requests for additional comment on Monday.

Brokerage data also indicates that Linde’s comments on tenant demand may be inaccurate. JLL is tracking over 9.3 million square feet of current demand in San Francisco, including three tenants with requirements over 500,000 square feet.

Brokers have said that Google Inc. (NASDAQ: GOOG), as well as health care and financial services firms are seeking large blocks of space over 300,000 square feet. Amazon.com Inc. (NASDAQ:AMZN)’s Twitch and cloud-computing company Okta, and co-working firm WeWork are also looking for spaces larger than 100,000 square feet, according to multiple sources.

The slowdown this year is in part because the last three years have seen record activity, and the pipeline of new projects, including Salesforce Tower, have rents as high as the triple digits.
“A lot of the growth has already occurred,” said Amber Schiada, director of research for Northern California at brokerage JLL. “If you’re a big company like that, you’re not eager to take on $80 rents or $100 rents.”

There’s also more scrutiny for rising costs. “VCs are really pulling back on expansion on their younger companies, trying to minimize burn rates,” said Schiada, referring to venture capitalists.

New towers in the Transbay district including 181 Fremont St. and Park Tower have signed no tenants, but those buildings also won’t be delivered until late next year or later, said Schiada. Tenants are showing a preference for pre-built space that is ready for occupancy, she said.

Another big public landlord, Kilroy Realty Corp. ( NYSE: KRC), stated last week during its earnings call that San Francisco remained strong, and sublease space was being filled up.

Mike Sanford, Kilroy’s executive vice president of Northern California, said that the company was still seeing strong demand. “Down on the street there’s just more activity, more tenants coming to the buildings, looking for space and then boots on the ground,” said Sanford.

Link to article: Office Slowdown