MARKET DRIVERS
The office availability rate increased by 140-bps (basis points) to 21.4% in 2Q24. Conversely, the vacancy rate decreased from 16.5% in 1Q24 to 16.3% in 2Q24. 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.
Net absorption was 563K SF this quarter, bouncing back from the negative 258K SF last quarter. In context of the market at large, this indicates that space under construction is being listed as available while the current space on the market is being leased.
Average asking lease rates dropped from $3.96/SF FS to $3.91/SF in the past quarter, the lowest recorded since before the pandemic. A surplus of office space has emerged, prompting landlords to adjust rental rates and offer lease incentives to attract tenants. This, coupled with tenants seeking more favorable lease terms during negotiations, is leading to a downward pressure on rental prices.
Sales volume has not reached the levels they were at pre-pandemic, but it rebounded with 1.3M SF already sold this year, more than all of 2023 combined. The price/SF these properties are selling for are significantly lower than the past, which opens these properties up for leases at lower rates to meet investment requirements. If this trend continues it could greatly alleviate the vacancy and availability problems that have been afflicting the office space.
ECONOMIC OVERVIEW
Unemployment in the San Jose-Sunnyvale-Santa Clara MSA dropped 50-bps to 3.9% quarter-over-quarter. Likewise, California’s unemployment rate dropped 10-bps to 5.2%.
The Professional Business Sector in the San Jose-Sunnyvale-Santa Clara Metropolitan Statistical Area (MSA) saw an increase both yearly and quarterly, reaching 247K this quarter.
NEAR-TERM OUTLOOK
The Silicon Valley office market is in flux, with talent acquisition a top priority. Companies are investing in high-quality workspace to attract and retain employees. Landlords are countering with increased tenant improvement allowances, but the gap between these offerings and renovation expenses persists. While loan delinquencies are rising, private capital is emerging to aid loan workouts, especially with a large volume maturing in a higher interest rate environment. Overall investment activity is muted due to increased borrowing costs, leading to a slowdown in new construction across property types. The Federal Reserve’s delay in interest rate cuts adds to the uncertainty. Companies may postpone leasing decisions and focus on optimizing existing space. This period of adjustment could lead to a new market equilibrium with higher long-term occupancy rates.
A recent Sunnyvale office campus sale reflects a decline in property values compared to pre-pandemic times. This aligns with the national trend of high vacancy rates, although some suburban office buildings in less competitive areas are showing surprising resilience. Notably, these top performers include recently renovated B and C class properties catering to tenants prioritizing affordability over amenities. Whether this trend translates to Silicon Valley remains to be seen.
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