How long can the good times roll?

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By: Amber Schiada, Vice President, Director of Research

We’ve been lucky to experience such a booming economy for the past few years in the Bay Area, but this boom is leading to some growing pains. Technology is expanding like gangbusters; people from around the world are migrating here to jump into the industry, high-tech startups and giants alike are expanding into office space, and all the best brunch places seem to have never-ending lines out the door.

All of this economic prosperity is great, but it’s creating a very tight housing market, pushing office rates higher and squeezing out margin-sensitive industries, and ultimately pushing our infrastructure beyond capacity.

So, how much longer can this go on before we reach a breaking point?

Before we look ahead, let’s take a look back at 2014 to see where we ended the year. In San Francisco, 16 leases greater than 100,000 square feet were signed in 2014—all but two by tech companies. This brings us to a running total of 53 large leases signed since 2010.  And because tech is driving much of this, there are concerns that this might not be sustainable, as is typical when one industry anywhere has such a dominant impact on a market (Houston, anyone?).

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All of this demand is driving up pricing. Office rents are up more than 87 percent since the market trough in 2010. If you did a deal five years ago at the bottom of the market, you’re definitely facing some sticker shock if you have a renewal coming up.

Silicon Valley had an equally exciting year. Looking at all of the suburban markets tracked by JLL, Silicon Valley topped the list for leasing transactions greater than 20,000 square feet last quarter. While San Francisco and its lure of an urban, 24-hour lifestyle seems to be attracting all the attention in this cycle, the suburbs are definitely not dead in Silicon Valley.

High-tech companies, for the most part, have no intentions of devising a singular occupancy strategy, and there is no better region in which to study this phenomenon than the Bay Area. LinkedIn, Yelp, and Salesforce are just a few of the big names that have a two-market strategy here, choosing to set up shop in both uber-urban San Francisco and super-suburban Silicon Valley. Not everyone wants to be bussed, and not everyone wants to live in the city.

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It’s clear that Silicon Valley’s office market is on a high-growth trajectory. Average asking rates are about $93 per square foot in Palo Alto, but still haven’t surpassed the peak of $113 per square foot recorded in the dot.com peak. Adjusting for inflation, that’s $154 per square foot, so we definitely have some room to run before the market returns to anywhere near that high.

Right now we are tracking more than 8.0 million square feet of active tenant requirements in Silicon Valley and the Peninsula. And with all of this demand for office space, development is booming. In San Francisco and Silicon Valley combined, about 8.3 million square feet of new projects are under way and about 63 percent of that space is already pre-leased.

An unbelievable 45 million square feet office development is proposed or planned—that we know of today. Many of these planned and proposed projects won’t go up in this cycle, but developers are clearly very excited about the Bay Area.

So, is this a bubble? No. Not yet, anyway. Or, at least not like we saw 15 years ago, and we may never see that kind of devastation in the tech economy again. I’ve heard myself say, “This time is different,” more than I‘d like to admit. But it’s true. We are not in an e-commerce bubble. This time the tech industry is more mature and the products and services reach more people.

Ultimately what makes this time is different is us, the consumer. This time we all have computers in our pockets and can’t imagine life without them. The services, media, and online retail we all love are impossible without the app developers, marketing mavens and most importantly the hardware and network developers that all of this great stuff relies on. Demand for technology and the progression forward of our technology will fuel sustained growth in this industry.

But, no matter if you believe this is a bubble or not, I am certain that the high level of growth we’ve seen in this tech cycle can’t be sustained forever. It will eventually slow down, and that slowdown will have a direct impact on office demand. But I don’t expect a significant slowdown for at least the next 18 months, if not beyond.

Looking ahead by market, San Francisco will likely maintain strong momentum for at least the next year. In 2015 we expect at 1.5 million square feet of positive net absorption with Salesforce and Linkedin driving a large amount of these occupancy gains.

Office rents in San Francisco are expected to increase another 8.0 percent this year. 2017 could be our correction year, but it will be hard to tell until some of these large leases begin to take occupancy and we see how much space they actually occupy. Not because these companies aren’t viable or healthy, but because it will be tough to find the right talent to fill the jobs and all of that office space.

In Silicon Valley, the outlook is very similar. We expect the most rent growth will occur in Redwood City, Menlo Park, Palo Alto, Mountain View and Sunnyvale. Santa Clara will see more activity and North San Jose will likely see some overflow demand. Renovation activity in that area is creating a lot of new opportunities for tenants looking to grow.

The greatest threat to sustained growth will be our local infrastructure issues, namely transportation and housing. The transportation networks seem to be at or over capacity already, so with all of this new construction coming online and the jobs needed to fill those offices, I wonder how we’ll be able to handle it all. And as for housing, we are building lots of it, but not quickly enough to house people affordably.

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