MARKET DRIVERS
The office availability rate fell by 30-bps (basis points) from 20.5% in 4Q23 to 20.2% in 1Q24.
The vacancy rate rose from 16.2% in 4Q23 to 16.6% in 1Q24. The contrast between availability and vacancy can be explained by tenants and landlords coming to terms on renewals, taking the properties off the market, while the market continues to be affected by work from home policies.
Average asking lease rates dropped from $4.03/SF FS to $3.96/SF in the past quarter. An oversupply of office spaces, landlords reducing rental rates to stay competitive, and tenants seeking more advantageous terms in lease negotiations are all factors attributed to this decline.
After a rough close to 2023, sales saw a massive increase, from 72.8K SF to 952.8K SF this quarter. This is also higher than the 690.5K SF recorded in 1Q23, and is already nearing the total sales for last year. A reason for this is that these properties are dropping tremendously in price, below where they were 8 years ago in the case of 111 Market St, and investors who bought at these properties’ heights are cutting losses after coming to terms with being unable to get stronger returns on their investments.
Net absorption was -64.9K SF this quarter, which is disappointing when compared to the 854.5K SF viewed in 1Q23, but better than the -518.0K SF last quarter. Although sale transactions are picking up, the persisting work from home policies are keeping lease volume low. As properties change hands for lower prices, these new owners and landlords can be more flexible with asking rates, which would certainly alleviate some of the office vacancy issues.
ECONOMIC OVERVIEW
Unemployment in the San Jose-Sunnyvale-Santa Clara MSA rose 40-bps from 4.0% to 4.4% quarter-over quarter. Likewise, California’s unemployment rate climbed 50-bps, up to 5.6%.
The Professional Business Sector in the San Jose-Sunnyvale-Santa Clara Metropolitan Statistical Area (MSA) saw a small decrease both yearly and quarterly; from 249.4K jobs in 1Q23, to 245.7K last quarter, to 244.4K this quarter.
NEAR-TERM OUTLOOK
Amidst uncertainties in the Silicon Valley office market, there are signs that office sales may soon rise. Real estate investors, though cautious, are showing heightened interest in commercial real estate purchases compared to previous years. Despite the current challenges, such as the retreat of institutional investors from office property purchases, there is a potential for a shift as private capital and occupiers step in to fill the gap. However, challenges persist, such as KBS Real Estate Investment Trust III’s struggle to raise funds to avoid defaulting on a loan tied to a Silicon Valley office portfolio. Nonetheless, amidst these challenges lie opportunities for savvy investors to navigate and potentially capitalize on emerging trends in the market.
The Silicon Valley office market is experiencing notable trends amidst broader shifts in office leasing activity. While there’s a traditional preference for “trophy” office spaces, location is increasingly crucial, with vibrant neighborhoods gaining importance. Silicon Valley stands out as a hot spot for AI companies, driving significant office space demand. The region boasts the highest concentration of AI companies nationally, with San Francisco and Silicon Valley competing for tenants. Despite challenges posed by the pandemic, such as remote work trends, Silicon Valley’s office market remains resilient. Companies in the region tend to lease larger spaces compared to San Francisco, reflecting the area’s appeal for tech and AI firms. This demand contributes to the region’s economic vitality and underscores its status as a leading hub for innovation.
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