Owner Appetite Remains Hearty for Tech-Driven Real Estate
SAN JOSE, Calif., April 22, 2019 – Cushman & Wakefield’s latest market reports for Silicon Valley’s Office and R&D sectors revealed a sluggish start to 2019, after having combined for a robust 2.85 million square feet (msf) of occupancy growth in 2018—largely stemming from the office sector. While the office market did continue its growth trend reporting another 269,000 sf of positive net absorption in the first quarter, the R&D sector finished with a negative 265,000 sf, leading to a virtual wash between the two sectors. Notably, both sectors maintain very healthy single-digit vacancies coupled with rent growth, while demand remains strong.
“Historically, the early part of the year can start slow in the Silicon Valley commercial real estate market and that is exactly what happened in 2019,” said Julie Leiker, Cushman & Wakefield’s Market Director for Silicon Valley. She added, “Not unexpectedly, the performance of Silicon Valley’s R&D sector in the first quarter was lackluster when compared to its substantial second-half growth trends of 2018. That said, R&D vacancy is still under 10.0%, the percentage of sublease space is dropping to now 17.6% of market availability, and asking rents continue to climb.”
The report noted that the addition of the 546,000-sf HPE Campus in the Stanford Research Park was a significant contributor to the level of R&D occupancy loss in the first quarter.
Leiker added, “Meanwhile, office vacancy continues to dip further into single-digit territory now at 9.3%, down from 9.6% at year-end 2018. However, sublease space in this sector rose yet again, now accounting for nearly a third (32.4%) of total office availability.”
According to the report, the most significant new office sublease put on the market was a block of 162,000 square feet (sf) from 8X8 at Coleman Highline. And though not yet included in vacancy statistics, the report identified another sublease block now being marketed, Splunk is subleasing 150,000 sf at Santana Row in West San Jose—the brand new 300,000-sf building is still under construction and will be ready for occupancy in November 2019.
Gregory Davies, Senior Vice President with Cushman & Wakefield in San Jose, said, “Typically the first quarter of a year can be on the slower side with activity picking up in the second and third quarters—which we expect to occur this year as there are, in fact, expectations that several large deals have already or are about to be signed.” He added, “Furthermore, we are currently tracking a very robust 11.8 msf of active office/R&D tenant requirements, which is up from the 10.5 msf last quarter. We feel this increase in demand will transition to activity in coming quarters.”
Average asking rents for both Silicon Valley’s office and R&D markets continued to climb during the first quarter. Office rents rose to $4.64 per square foot on a monthly full service basis (psf), up ten cents from $4.54 psf in the fourth quarter. R&D rents grew to $2.54 psf on a monthly triple net basis, a strong increase from the fourth quarter level of $2.41 psf. R&D rents have grown by a whopping 16.5% year-over-year, from $2.18 psf.
Drew Arvay, Managing Director with Cushman & Wakefield in San Jose, said, “Despite strong activity, office rents have remained relatively flat with slight upticks in select markets. This is largely due to the fact that sublease space has continued to represent a significant portion of total availability which forces direct space to compete with aggressive sublease rents. The end result is high volumes of leasing at more modest rent growth.”
Arvay added, “Sublease space has begun to dwindle in the R&D sector—previously accounting for well over 20% of market availability last year, has since fallen to 17%. This trend will reduce the effect that low price sublease space has had on overall market pricing, much like we’re seeing in the office sector. Notably, the northern Silicon Valley cities continue to outperform all other market averages with Palo Alto at $6.88 psf, Menlo Park at $4.63 psf and Mountain View at $4.32 psf for R&D space.
New construction continues to advance the Silicon Valley real estate landscape, in terms of design and functionality as well as activity. It also remains a market focal point. The report shows new office product under construction currently totals 4.4 msf, all being built on a speculative basis, and with 3.2 msf or nearly three-fourths already pre-leased. Meanwhile, new R&D product under construction totals 2.9 msf, split into 1.8 msf of build-to-suit and 1.1 msf of speculative product. Fifty percent of the speculative R&D space is pre-leased, leaving just 530,000 sf currently unaccounted for in that sector. Of the total 7.3 msf under construction across both office/R&D sectors, 5.57 msf or 76% (more than three-fourths) is already committed.
Eric Fox, Executive Managing Director with the firm’s Capital Markets in San Jose, said, “Capital markets activity in Silicon Valley held strong through the first quarter of 2019, as investor optimism and appetite for tech-driven real estate remains hearty. Historical pricing highs have been shattered on the western side of the Valley and the Peninsula, particularly in areas that are served by CalTrain. Of note, the first quarter also saw a surge in activity particularly in the North San Jose submarket.”
He continued, “Treasury rates have settled significantly lower at the end of the quarter versus their peak in late 2018, and accordingly real estate debt has remained low priced and plentiful.”
Notably, there were also two user sales cracking the top R&D sale transactions, including Roche Molecular Systems acquiring their existing 312,000-sf campus in Santa Clara, while another riveting user transaction was Intuitive Surgical’s purchase of a 47,000-sf building in Sunnyvale building for $640/sf, “a high watermark for R&D user sales in Sunnyvale,” says Fox.
Leiker concluded, “Certainly a key indicator for the commercial real estate sector is job growth. And while such growth has slowed compared to a few years ago, due to the fact the market appears beyond typical full employment, the San Jose Metro statistical area continues to add jobs. Year-over-year, the San Jose MSA added 24,200 non-farm positions, while unemployment has tumbled to a mere 2.5%, compared to the national figure of 3.8%.”
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Silicon Valley Office Report
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