THE PENINSULA OFFICE market reported an average direct asking lease rate of $5.92/SF full service. This is a change of $6.12/SF from the 1st quarter of 2022 and $6.07/SF from a year ago. Leasing activity stood at 370,822 SF for the quarter. Class A Offices accounted for 156,887 SF of the leasing activity, reflecting some tenants’ willingness to pay for higher quality space. Many employers continue to work towards getting employees back into the office. For some, this means high quality space in Class A buildings with amenities. For others, this means quality space in convenient locations and a lower price point. In either case, buildings with newly improved suites ready for occupancy are leasing much quicker than second generation office spaces.
DIRECT OFFICE VACANCY on the Peninsula rose to 12.4%, year-over-year by 30 basis points (bps). Quarter-over-quarter direct office vacancy rose by 80 bps. Sublease vacancy rose by 20 bps to 1.6% from 1.4% quarter-over-quarter, but is still 80 bps lower than the second quarter of 2021. The lack of a dramatic increase in sublease vacancy indicates a relatively healthy market. The Year-to-date net absorption for the Peninsula is positive 312,191 SF. This quarter, net absorption is negative 152,583 SF. This is the first quarter since Q1 of 2021 that the Peninsula has had negative net absorption. The negative net absorption is primarily attributed to some larger tenants “right-sizing” and leasing less space than they had previously occupied.
OFFICE SALES remain strong with approximately 99,851 SF trading. The majority of these office sales are driven by the Life Science market with investors converting office space into lab space. This trend continues and will reduce the office inventory on the peninsula, as the conversions are completed. Sales activity dropped quarter-over-quarter, most likely due to the rise in
interest rates and inflation, along with reduced tenant leasing demand. There are still plenty of investment opportunities within the market, but with the recent increase of interest rates and stricter underwriting criteria, buyers may reassess pricing while sellers have not yet reduced their prices. Despite this, a 43,083 square foot office building located at 200 Middlefield Rd. in Menlo Park, was purchased by Ellis Partners for $62.7 million ($1,455 /sf).
THE SAN MATEO COUNTY development pipeline remains strong with over 1.5M SF of office space under construction. Kidder Mathews expects speculative construction activity to slow down, as both materials and labor costs have risen. Many construction projects have delayed delivery due to the ongoing slowdown in the supply chain and availability of labor. Current ongoing projects include Stockbridge Capital’s Bay Meadows Station 1 & 5 totaling 433,000 SF of office space. They are slated for delivery in late 2022 and are fully leased as of last quarter.
DESPITE INFLATION and economic uncertainty, there is an abundance of capital available and interested in the office market. As a hedge against inflation, there may be an increase in demand to purchase property as an investment opportunity. On the other hand, this economic uncertainty may slow down the market as both buyers and sellers adjust to the rising interest rates.
SAN MATEO’S unemployment rate continues to drop and currently sits at 2.1% as of April—120 bps lower than the start of the year. This can be felt county wide as traffic on the freeway and on Cal Train have increased—specifically on Tuesdays through Thursdays as many offices are currently adopting the hybrid work model.
AVAILABILITY OF MATERIALS and costs for tenant improvements is impacting lease negotiations by taking longer for occupancy and with higher rents and/or longer terms being required. Due to the hybrid work model, many employers are assessing the amount of space they will require. This will be an on-going issue for the foreseeable future. Continuing conversions of office buildings to life science is displacing several office tenants, which is driving some of the current leasing activity. Once the conversions have been finished the properties will be removed from the Office inventory, which will be reflected with a lower vacancy rate in future quarters.
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