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Sacramento Office Market Report

4th Quarter 2023

Posted In — Market Research | Market Report

MARKET DRIVERS

Sacramento’s office vacancy rate rose to 11.6% in 4Q23. This figure was up 10-bps QOQ
compared to 11.5% in 3Q23, and up 110-bps YOY from 10.7% in 4Q22. In the face of economic
uncertainty, the presence of excess office space and restrained demand poses challenges.
Nevertheless, prospects for future residential conversions emerge as a hopeful avenue to
alleviate elevated vacancy rates.

The average asking lease rate grew slightly to $2.19/SF in 4Q23, a 0.5% increase from the
$2.18/SF views last quarter and in 4Q22.

The availability rate climbed to 15.4%, an increase of 1,050-bps YOY and 550-bps QOQ. This
climb over the year can be attributed to tenants looking to downsize as work from home
policies continue in the market.

Total leasing activity for the year increased from 2.4M SF in 2022 to 2.7M SF in 2023. Sublease
activity is also up; from 78.2k SF in all of 2022, to 127.1k SF for the year in 2023. Although
these numbers are up for the year, the availability rate rising demonstrates that there is
excess product on the market due to vacated properties that have not found new tenants,
and that companies who are able to receive financing for new leases are electing for smaller
spaces through subleases.

Interest rate hikes have taken their toll on investors as well. This can be seen by the significant
decline in year-to-date total sales volume, from 2.7M SF in 2022 to 1.9M SF in 2023, representing
a decrease of approximately 818.2k SF. Sales are down for the market, but investors are still
purchasing Class-A properties and have taken chances on office to multi-family conversion
opportunities.

In 4Q23, direct net absorption reached -119.3k SF, contributing to a year-to-date total of -922.5k
SF in 2023, marking a significant decline from the 304.5k SF net absorption throughout all
of 2022. This further confirms that tenants were being hurt by the tight lending practices of
2023 despite the increase in leasing activity.

ECONOMIC REVIEW

The Sacramento County unemployment rate increased 10-bps from 4.3% to 4.4% over the last quarter. This is up 90-bps from the 3.5% seen in the final quarter of 2022. California’s unemployment rate also saw an uptick from 4.6% to 4.9% over the past quarter.
The Sacramento-Arden-Arcade-Roseville MSA’s Professional Business Sector lost 2.0k jobs since last quarter, but only 800 jobs since this time last year. The 1.3% drop from 153.1k SF to 151.1k SF over the past quarter is not insignificant, but it doesn’t fall outside the trends seen throughout the California and National markets.

NEAR-TERM OUTLOOK

Sacramento is undergoing a wave of office-to-residential conversions, exemplified by the proposed redevelopment of a 1970s single-story office building at 5250 Date Ave. into 18 apartments. Additionally, Sutter Capital Group’s acquisition of the three-story Ticon III office building at 2730 Stockton Blvd., near Aggie Square, signals a potential office-to-multifamily conversion following UC Davis’s departure. These projects align with the broader transformation in the Sacramento office market, highlighted by the conversion of CalPERS-owned 1800 Third St. into a mixed-use space by Heller Pacific. This shift, backed by the city’s updated memorandum of understanding, reflects a dynamic change in Sacramento’s real estate landscape.

Despite these opportunities the Sacramento office market faces challenges, including pricing barriers and a 30% cumulative year-to-year decline in commercial real estate investment volume. Buyers are exercising caution, awaiting favorable price points. The impending wave of debt maturities and potential distress in the office market are additional concerns. The impact of WeWork’s Chapter 11 bankruptcy filing further adds complexity, with repercussions expected to vary across locations, potentially presenting opportunities for value investing and discounted asset prices. As the Sacramento office market undergoes significant changes, it remains a dynamic environment with both challenges and potential opportunities.

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