San Francisco Bay Area Commercial Real Estate - 2013

8/14/2019 San Francisco Bay Area Commercial Real Estate - 2013

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San Francisco Bay AreaCommercial Real Estate

2013 Forecast

Your comprehensive guide to trends impacting the commercial real estate market.


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CAPITAL MARKETS

CORPORATE SERVICES

LAND ACQUISITION & DISPOSITION

PROJECT & DEVELOPMENT SERVICES

PROJECT LEASING

PROPERTY MANAGEMENT

TENANT REPRESENTATION

We are pleased to share with you our San Francisco Bay Area

Commercial Real Estate 2013 Forecast. This report is an annual

review and forecast that summarizes the trends impacting

commercial real estate in each of the major Bay Area markets

covered by Cassidy Turleys 15 regional offices.

This guide offers forward-looking analysis in addition to summaries

of recent activity for office, R&D, industrial, retail, investment and

multi-family real estate throughout the Bay Area. We examine both

leasing and investment trends as well as the underlying economic

fundamentals that drive our marketplace. This report represents

only a fraction of our research capabilities. Working in unison with

our brokerage staff, Cassidy Turley research maintains the regions

largest database of properties, tenants, landlords, buyers, sellers,

availabilities, and deal comparables of all types. Our research

department publishes detailed quarterly snapshots and reports

covering all of our markets and we provide custom analytics for our

clients. Contact your Cassidy Turley broker to get on our research

mailing list to regularly receive research publication notifications.

Discover Cassidy Turley


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CASSIDY TURLEY

Table of Contents

For a digital ebook version of this book, go to www.ctbt.com/Forecast2013

Message from our President 5

Economic Outlook 6

Office and R&D Forecast 10

Warehouse & Manufacturing Forecast 16

Retail Forecast 20

Investment & Multi-Family Forecast 24

Market Data & Forecast 28

Company Overview 34

Credits & Terms 38


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SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2013 FORECAST

To Our Valued Clients,

Over the past year, the Bay Areas economyhas continued to outperform both Californiaand the nation as a whole. During this period,our region has grown its overall employmentbase by approximately 90,000 jobs, placingboth San Jose and San Francisco among

the top employment growth markets in thecountry. Meanwhile, our commercial real estate market hasgenerally thrived. We are now heading into our third consecu-tive year of a recovery that, for some sectors, has put upgrowth numbers in excess of what we saw during the first dotcom boom. And a boom is what it has been for the regionsoffice and R&D sectors.

Through the first nine months of 2012, occupancy in the BayAreas office sector had grown by over 3.7 million square feet.Since 2010, office occupancy has expanded by nearly 14million square feet. In San Francisco weighted average askingrents have increased by 39% since the low-water mark of therecession in 2009. Meanwhile, all of the trade areas alongthe Highway 101 Corridor on the Peninsula have recoveredall of the occupancy lost during the recession and then some.R&D space has also surfed this wave, posting over 5.1 millionsquare feet of positive net absorption since the start of 2011.

Of course, tech users are once again behind the boom, havingaccounted for a whopping 69% of the deals that we havetracked this year. The growth of Apple, Facebook, Google,LinkedIn, Salesforce, Samsung and others has made the BayArea the strongest local economy within the United Statesand fueled one of the strongest growth periods in the historyof our regions commercial real estate market.

But with this recovery period driven almost exclusively by justone sector of the economy, it certainly has not been even, nor

has it been without its challenges. Our tech-driven boom hasprimarily benefited the Bay Areas office and R&D markets.Of course, it has spurred job growth, generated consumerdemand and fueled demand for housing thereby indirectlyhelping all sectors. Yet the recovery has been uneven both interms of product type and geography, with the East and NorthBay seeing only peripheral gains. But those markets have beenbuilding momentum on their own and there are a number ofreasons why we are very optimistic for their performance inthe year ahead.

The past year was one in which we saw the biggest challengeto the economy shift from weak underlying fundamentals topolitical stalemate. However, despite the discord and political

mayhem of the past few months, well gladly swap gridlockin Washington in place of weak fundamentals as the primaryevil. Even if policy concerns have emerged as the greatestheadwinds, the national economy continues to post slow butsure growth. This certainly played out over the final half of2012. Uncertainty over the election became uncertainty overthe fiscal cliff, and is now uncertainty over the debt ceilingand federal spending cuts. All of this uncertainty during thesecond half of the year slowed growth as many space usersput the brakes on planned moves.

Fortunately, as I sat down to write this in early January, therewas cause for optimism. Congress and the President, whilekicking the proverbial can down the road on many issues, didreach a compromise on the most politically charged issueand potentially damaging issuethat of the expiration ofthe Bush-era tax cuts. While most of the massive automaticfederal spending cuts have been postponed and we are certainto see more policy-inspired business uncertainty in the weeks

ahead, we can only hope that Washington is heeding the pleasfor bipartisan moderation in dealing with the fiscal challengesthat face us while at the same time recognizing the need forreal tax and spending reform.

In anticipation of increasing tax rates, the fourth quartersaw a significant jump in activity, with December being thestrongest month in our companys history. Brokerages, banksand title companies were working overtime to finalize all ofthe tax driven, year-end activity. That very well could meanthat the coming year will be one in which we get off to a slowstart. But the building economic momentum that we sawbuilding through December of last year will return quickly.More importantly, the housing market is finally picking up

traction nationally. Although the Bay Areas housing markethas outpaced national trends by a couple of years, the returnof housing appreciation and new home construction nationallywill have massive positive implications for both the nationaland local economies. Housing, which usually accounts forabout one fifth of GDP, has been so far absent in our recoveryand that is one of the reasons why economic improvementhas been so slow and so fragile. It will take a while, but theturnaround underway in this segment of our economy willbegin to register a profound impact on the marketplace by2014. One that will mean that our own local and uneven tech-driven recovery will spread to more sectors and strengthengrowth in the local markets that have, so far, experiencedonly peripheral gains from Tech Boom 2.0. So, East Bay and

Central Valley, your time is nearing.

With that, we are pleased to share with you Cassidy TurleysSan Francisco Bay Area 2013 Forecast Report. We firmlybelieve that in economic environments such as this, ourcommitment to in-depth, forward-looking research is whatsets us apart from our competitors. Research has been andwill continue to be a key ingredient in our value propositionto you, our clients. We are eager to continue working with youand to expand our relationship across our expanded businesslines and geography. Meanwhile, our commitment to marketleading research will never change because we know thatinformation is vital to your decision making process. I hopeyou enjoy this publication and find it useful. As always, if there

is ever anything we can do for you or do better, please do nothesitate to call me.

Best wishes for a prosperous and productive 2013.

C. Michael KammPresidentCassidy Turley


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CASSIDY TURLEY

The economy truly is at a crossroads as we head into2013. But unlike in recent years, when the biggesteconomic threats came from weakened fundamentals of

one type or another, the greatest challenge currently facing theU.S. economy is that of policy uncertainty. As this report wentto press, Congress and President Obama had reached a partialcompromise on the issue of the fiscal cliff. This combinationof tax increases and sharp automatic federal spending cuts

would have removed about $600billion from the U.S. economy in2013. Most economists agreedthat the failure to either reinstatesome of the Bush era tax cutsor temper austerity measureswould have sunk the economyback into recession no laterthan the second quarter of theyear and likely would have sentunemployment back upwardlikely well above the 9.0% level.The lions share of the damage was likely to be caused by theexpiration of the Bush-era tax cuts, which alone would have

removed about $280 billion from the economy. The good newsis that this is where a compromise was met. The tax cutshave been reinstated for all but those who earn more than$400,000 annually ($450,000 for couples), or roughly 98%of the population. The bad news is that negotiations regardingfederal spending cuts were essentially postponed.

While the issue of policy clarity has been with us for some timenow, the specific concerns regarding the fiscal cliff escalatedover the course of December as the deadline drew closer.Business and consumer confidence fell and many of the spaceusers that we work with opted to postpone planned moves inthe face of this uncertainty. While this had a negative impacton the leasing market, it had the opposite impact on commer-

cial real estate investment. Fearful of new taxes in 2013, manysellers rushed to close deals before January, sending quarterlydeal volume up by at least 20%. As we reached the final weekof 2012, the Dow Jones began to tumble and it appeared thatwe were heading towards a self-inflicted recession. Yet, like anerrant college student who waits until the night before examsbefore studying, Congress came through with a last secondminute (well, actually a late) deal that averted the worst ofthe damage. The Dow Jones immediately surged 300 pointsand the S&P 500 closed at its highest level within the lastfive years.

But the challenge of policy clarity is not completely behindus. Within a few weeks, Debt Ceiling II begins and this debatepromises to be even more contentious than the first one. Bythe time the first debt ceiling debate ended in August 2011,the U.S. sovereign credit rating had been lowered and theeconomic recovery nearly stalled. You can rest assuredthat this political battle will result in more headwinds to theeconomy. We believe there is a 75% chance that the ratings

agencies once again downgradeU.S. credit. And we expect thestock market to dip. But we alsodont think the hit will be quite asbad as last years.

We are likely looking at slowgrowth over the next few months.But we are not looking at nega-tive growth, much less even flatgrowth. Certainly, the lack ofpolicy clarity will remain an issuefor now and additional political

discord on top of that wont help. But there are plenty of

economic indicators to be extremely optimistic about. Notthe least of which being a December jobs report that surprisednearly everyonethe economy created over 150,000 newpositions even as gloom was setting in before the fiscal cliffdeal. It may have a bumpy start, but we anticipate 2013 tobe a year in which the economy gradually builds momentum.

Dj vu or Something New?

On the surface, it appears that not much may have changedwith the economy over the course of the past twelve months.Heading into 2012, unemployment was elevated and job

ECONOMIC OUTLOOK

While U.S. job growth has averaged 2.1%

over the past year, San Jose has seen its

employment base grow by 3.5% (31,400

jobs) while San Francisco achieved a growth

rate of 3.4% (32,600 jobs).

0

10

20

30

40

50

60

70

80

90

100

2008 2009 2010 2011 2012

United States Consumer Confidence

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

2007 2008 2009 2010 2011 2012

United States GDP Growth RateAnnual GDP Growth Adjusted by Inflation

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Annual GDP Growth Adjusted by Inflation


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growth weak. The Eurozone was grappling with flat to nega-tive growth and Asia was in the midst of a slowdown. Policyuncertainty ruled the roost and the looming issue of debt hungover the U.S. economy. Fast forward through a contentiouselection cycle and policy uncertainty remains, only with a newname. Little has changed with the European or Asian econo-mies. Meanwhile, though the unemployment rate has fallen

to 7.7% (as of November 2012), the labor force participationrate is now at a 31-year low. Thecombination of baby boomersretiring and discouraged workersdropping out of the labor forcehas driven this metric as muchas job growth over the past fewyears. But while it may seemlike little has changed with theeconomy, there are a few consid-erable differences to consider aswe head into 2013.

Though unemployment remains

problematic, job growth hasactually been picking up. Over the course of 2011, the U.S.economy created just over 1.8 million jobs (roughly 153,000per month). Through November 2012, the U.S. economy hadcreated just under 1.7 million jobs. Though this overall numberreflects monthly gains of 152,000 per month, just below lastyears average, this statistic includes a dismal spring in whichjob gains fell below the six figure mark. Since July 2012,job creation has ranged between 132,000 and 192,000 permonth and the trend throughout the fall had been headingupward. Meanwhile these levels of employment growth areimportant because the economy needs to create approximately125,000 jobs per month simply to keep up with populationgrowth. Throughout most of the downturn, the economy has

struggled to reach this mark.

Meanwhile, the San Francisco and San Jose markets continueto lead all other U.S. metropolitan areas in terms of jobgrowth. While U.S. job growth has averaged 2.1% over thepast year, San Jose has seen its employment base grow by3.5% (31,400 jobs) while San Francisco achieved a growthrate of 3.4% (32,600 jobs). Meanwhile, after years of flat tonegative numbers, the Oakland/East Bay marketplace alsosaw a return to employment growthposting an annual rateof 2.0% (19,400 jobs).

But while employment growth has improved over the pastyear, it is still not where we would like it to be. As is the casewith a number of other indicators, it is better, but not great.For example, the Conference Boards Consumer ConfidenceIndex (CCI) reached 73.7 in November. This is well belowthe historical average of 95.0 but it is the highest level thathas been recorded since February 2008 when it measured

76.4. That reading came before the recession when theeconomy was just dealing with adeclining housing market. Andthe housing market is where wehave not only seen the greatestimprovement over the past year,but it is the greatest cause foroptimism about the economy asa whole going forward.

Housing Finally Returns

The depth of this downturn wasdue to the deleveraging nature ofthis recession and there was noother sector of the economy that

had more deleveraging to do than housing. Fueled by exoticand often toxic loans, housing values grew by 100% or morein some markets from 2002 to 2006. When this bubble beganto burst in 2007, the resulting impact led the nation into itsworst downturn since the Great Depression with the housingmarket struggling to stabilize since then.

United States Unemployment Rate

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2%

4%

6%

8%

10%

12%

2008 2009 2010 2011 2012

400

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0

200

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US Employment GrowthJobs in Thousands

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-800

-600

-400

2008 2009 2010 2011 2012

Housing typically accounts for 15% to 25%

(from average to boom cycles) of total GDP

It typically leads us out of recessions,

but this sector of the economy has been

missing in action over the past six years.

But, this is all about to change.

Decline in SFR Available Inventory

Metropolitan Statistical Area # of Houses for Sale Yearly Change

Boston 10,788 -37.2%

Chicago 34,192 -5.1%

Inland Empire 8,559 -58.8%

Las Vegas 15,106 -25.1%

Los Angeles 12,569 -55.3%

Phoenix 16,601 -11.1%

Portland 7,854 -20.8%

Sacramento 3,660 -66.4%

San Diego 4,168 -53.5%

San Francisco 3,851 -57.6%

San Jose 1,378 -55.7%

Seattle 9,647 -38.8%

Washington DC 11,146 -28.4%

National 198,581 -29.3%


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CASSIDY TURLEY

Housing typically accounts for 15% to 25% (from average toboom cycles) of total GDP. Following the past three recessions(1980, 1991 and 2001), residential investment grew morethan 30% on average during the first two years of recovery.In past cycles, this meant strong rebounds, thanks to millionsof jobs and billions of dollarsin additional economic output.According to the National Asso-

ciation of Home Builders (NAHB),were home construction near itshistoric norm, it would create anadditional three million jobs. Paststudies from this same group havefound that each new home built inthe U.S. creates three new fulltimejobs (from construction to financialservices to retail) and generates$90,000 in tax revenue. Even athalf those numbers, the impact ofhousing is huge, especially whenconsidering the fact that housingstarts have set new records for

lows throughout this downturn. Housing typically leads usout of recessions, but this sector of the economy has beenmissing in action over the past six years. This is all aboutto change.

Over the past 30 years, the United States has averaged1.3 million new households per year. But throughout therecession, this number dropped to just 600,000 per year as

fewer young people left the nest, renters took on roommatesor people otherwise doubled up on housing arrangements.We estimate current pent-up demand for housing to standat approximately 3.5 million units. Most of this demand willland in multifamily product first, and this trend is already well

underway. Most national marketsare currently reporting multifamilyvacancy in the 5% and 6% range.

In the Bay Area this trend hasbeen particularly pronounced withregional vacancy standing at just2.5% as of Q3 2012. Meanwhile,rental rate growth over the past twoyears has approached 30% in bothSan Jose and San Francisco, whileOakland has seen extremely robustgrowth in excess of 20%.

With apartment rents growing ata rapid clip in most markets andsingle-family residential pricing stillaveraging 30% below peak pricing

nationally, it is now cheaper to buy in most U.S. markets thanit is to rent. A recent JP Morgan study found this to be thecase in nearly half of all U.S. markets, while surveys by Truliaand others have provided even more aggressive numbers.Meanwhile, JP Morgan analysts also estimate pent-up demandfor single-family residential (SFR) housing units to stand at600,000 units. Against this backdrop, it would only seemnatural that home sales would start to surge. And they have

ECONOMIC OUTLOOK

The perception that the housing market

is rebounding still has not hit the

general public, though it should by late

in the year. This will result in a sharper

pop in demand heading into 2014

Housing will begin to impact GDP by

2014 with quarterly growth levels finally

returning to the 3.0% or range or more.

-4,000 -2,000 0 2,000 4,000 6,000

Manufacturing

Information

Financial Activities

Professional & Business

Education & Health

Leisure & Hospitality

Other Services

Trade, Trans. & Utilities

Construction

Government

Change in Employment by IndustryEast Bay 2011 - Nov. '12

-2,000 0 2,000 4,000 6,000 8,000

Manufacturing

Information



Education & Health


Other Services


Construction

Government

Change in Employment by IndustrySouth Bay 2011 - Nov.'12

-3,000 0 3,000 6,000 9,000 12,000

Manufacturing

Information



Education & Health


Other Services


Construction

Government

Change in Employment by IndustrySan Francisco 2011 - Nov. '12

Percentage of J ob Growthby Region 2011 - Nov. '12

0% 1% 2% 3% 4%

South Bay

San Francisco

Bay Area

East Bay

US

California

LA-Orange County


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Over the course of 2012, residential home sales have postedtheir strongest annual sales gains in three years (when saleswere artificially propped up by a first-time buyer stimulusprogram), with the inventory of available homes fallingsharply. Meanwhile, the inventory of homes for sale nationallyhas dropped substantially. According to RedFin, the availableinventory has dropped in Boston by 37.2%, while the hard-hit Inland Empire has seen SFR availability fall by 58.4%

and Sacramento has recorded a drop of 66.4%. In theBay Area, San Francisco has seen availability fall by 57.6%while San Joses inventory of availablehomes for sale has fallen by 55.7%.Meanwhile, the shadow inventory of REOs,foreclosed and delinquent homes is nowback to 2008 levels.

According to the National Association ofRealtors (NAR), single-family home priceshave improved in 100 out of 134 metrossince the beginning of 2012 (Case-Shillerdata mirrors this trend). Meanwhile,RedFins data indicates that pricing

per square foot metrics have improvedsignificantly even in some of the marketsworst hit by the housing crisis. The LasVegas market has seen pricing jump by10.5%, the Inland Empire booked an annual increase of 9.6%,Sacramento pricing improved by 8.8% while RedFin reportsa whopping increase of 30.0% in the per square foot pricingfor the beleaguered Phoenix marketplace.

Lastly, and perhaps most importantly, new home starts arenow at their highest level since before the financial meltdownof 2008. Additionally, permits remain high, meaning that this

trend will continue, at least for now. The construction sectoraccounted for roughly two million of the more than eight millionjobs lost during the recession. Though it will have a slowstart, 2013 will be a year in which gradually improving housingfundamentals will accelerate. Keep in mind that many whowould have otherwise bought homes during the downturn haveheld off until the market hits bottom. The perception thatthe housing market is rebounding still has not hit the general

public, though it should by late in the year. This will result in asharper pop in SFR demand heading into 2014. Meanwhile,

new home construction will continue toaccelerate. We anticipate that housing willclearly begin to impact GDP by 2014 withquarterly growth levels finally returning tothe 3.0% or greater range. Meanwhile,new home construction could add as manyas one million new jobs to the economy by2015, reinforcing a further virtuous cyclethat will drive economic growth ahead.But perhaps the most important impactof housings return will be improvement inhousehold wealth. Historically, for every

$1 increase in home values, consumerspending typically increases by $0.05.Though consumer spending has largelykept the economy afloat over the past four

years, it has been against a backdrop of declining personalwealth. The return of home pricing appreciation will have asignificant impact on consumer spending, retail and invest-ment in general. The new frugality that has significantlyimpacted retail trends over the past few years will certainlybe with us for a while, but the eventual return of the wealtheffect by 2015/2016 could mean relief for some of theretailers hardest hit by the recession.

The lack of policy clarity

will remain an issue for

now and additional political

discord on top of that wont

help. But there are plenty

of economic indicators to be

extremely optimistic about


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Though the Marin, San Francisco andSan Mateo County markets all recordedoccupancy losses during Q3 2012, onlythe Marin and San Mateo County tradeareas were in negative territory for theyear. Based upon the trending that wesaw in the marketplace and numerousdeals that had either been signed or

that were in the works when this reportwent to press in December, it appearsthat all three of these regions will returnto growth in Q4, though it is unclearwhether these numbers will be enoughto bring both Marin and San MateoCounties out of the red for the year. Thegood news here is that the East Bay,which has largely been sidesteppedby a tech-driven recovery, is finallyshowing strong signs of improvement.While total annual growth numbers for the Oakland market aremodest, both the Pleasanton and Walnut Creek trade areashave posted solid occupancy growth in 2012. In fact, some of

the strongest gains that these markets have seen came duringQ3 2012 when the specter of political uncertainty began toimpact tenant behavior.

As we drew closer to the November 2012 elections, we beganto see many space users postpone or even cancel planned realestate moves due to their concern over the lack of clarity ontaxation policy. Though this trend was limited in its impact,it did generally slow growth across the board. Though there-election of President Obama has given the marketplace abetter sense of the general direction of policy, the issue of thefiscal cliff only prolonged this pause in the action for manyspace users.

While concerns over taxation policy were not enough to derailthe Bay Areas office market in Q3, the regions R&D sector didsee some slowing. For the first time since mid-year 2012, R&Dproduct posted negative growth to the tune of 444,000 squarefeet. While this is a comparatively small number when takingthe regions 192.3 million square foot inventory into account,it does raise some concerns. As of the close of Q3, vacancyfor R&D product throughout the region stood at 14.4%, upslightly from a midyear reading of 14.2%. This remains well

below the 15.7% rate of one year agoand marks a major reduction from thepost-recession peak of 19.0% that wasrecorded in Q1 2010. Even with Q3slosses, the market has seen its overallR&D occupancy increase by over 5.7million square feet since that time,reflecting a 3% overall growth rate.

But the question remains as to whetherthe growth cycle is coming to an end.The short answer is no.

Though occupancy growth turned nega-tive in Q3, the Bay Areas R&D sectorremained in positive territory over thefirst nine months of 2012to the tuneof 832,000 square feet and, basedupon deals signed or in the works asthis report went to press in December,

we anticipate that Q4 2012 totals will be modestly positive.And we should note that about 25% of Q3s occupancy losswas due to older R&D buildings being demolished to make way

for new projects (mostly multifamily) in Santa Clara County.Still, deal activity has slowed and while some of this could beblamed on the issue of political uncertainty, most of it reflectsa deeper trend. Most of Q3s R&D occupancy loss came fromspace users moving to office projects and the biggest chal-lenge ahead for R&D landlords will be how to battle the factthat tech user preferences are increasingly shifting towardsoffice space. This has not been as much of a problem withlife science or non-tech users, but as office space continuesto evolve away from the old model of commodity space tocreative space, it has emerged as a direct competitor to R&D.

The good news is that R&D remains the lower cost alterna-tive ideal incubator option for start-ups and, as office rents

continue to escalate, may be well-positioned for more frugaltenants. The bad news is that this trend will only accelerateas office space continues to change and as the regions R&Dinventory ages. While the current regional average askingrent for office space is $2.80 per square foot (on a monthlyfull service basis), the average rate for R&D currently standsat just $1.33 per square foot (on a monthly triple net basis).Though R&D space is almost always leased on a triple net basiswhich passes expenses on to the tenant (and these can vary

San Mateo County R&D Market 2012 Notable Leases (Through Q3 2012)

Tenant Quarter Total SF Address City Transaction Type

Depomed, Inc. Q1 45,990 1330-1360 O'Brien Dr Menlo Park Renewal

NestGSV Q3 45,866 425 Broadway Ave Redwood City Relocation/Expansion

Global Blood Therapeutics Q3 41,387 400 E. Jamie Ct South San Francisco Relocation/Expansion

Pan Pacific Q1 39,150 1205 Chrysler Dr Menlo Park Relocation/Expansion

Intersect ENT Q2 23,232 1555 Adams Dr Menlo Park Relocation/Expansion

San Mateo County Office Market 2012 Notable Leases (Through Q3 2012)


HeartFlow Q1 102,981 1400 Seaport Blvd Redwood City Sublease

Evernote Q1 87,774 305 Walnut St Redwood City Relocation/Expansion

Success Factors Q2 87,067 Centennial Towers South San Francisco Relocation/Expansion

Wildfire by Google Q1 58,686 1600 Seaport Blvd Redwood City Expansion

Gazillion Entertainment Q1 49,800 475 Concar Dr San Mateo Renewal

In September 2012, Lab 126 signed a

deal for 582,000 square feet of space

at Jay Pauls Moffett Towers project in

Sunnyvale. Lab 126 is the Amazon-

subsidiary responsible for developing the

Kindle device. They will be relocating and

expanding into Building D at Moffett Park

upon its completion (currently scheduled

for February 2013).DEAL

HIGHLIGHT


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CASSIDY TURLEY

2

widely), tenants can still find top quality R&D space at rentswell below like office rents.

Bay Area Office/R&D Forecast

Looking ahead to 2013, we anticipate slower growth duringthe first quarter of 2013 for both office and R&D properties.The wheels of commercial real estate move slowly and thepolitical uncertainty that began with the November electionsonly intensified with the fiscal cliff issue. Though we expectthis to improve now that a partial deal is in place, enough realestate decision makers put the brakes on making moves thatit will impact activity in January and February. But demandfor goods and services still trumps fear of taxes in terms ofwhat motivates businesses to expand their commercial realestate usage and so the regions tech engine has hardly slowed,with a number of major deals inked in Q4 and many teedup for Q1 2013. But the same may not be true for othersectors of the economy and though we do not expect anymajor space givebacks, a Q1 slowdown across the board isalmost inevitable. The good news is that the market shouldbe on track for more accelerated growth by Q2. User space

requirements remain strong. We are currently tracking a totalof 18.1 million square feet of space user needs that could landin office or R&D projects over the next 24 months. Some ofthese are for renewals or relocations that will not result in anyoccupancy growth. Likewise, some of these may never land.But the current deal pipeline is roughly in the same place itwas six months ago and should guarantee positive growth goingforward. The real question may be how long could some ofthese moves be postponed.

We anticipate moderate growth ahead in most trade areas.We are also extremely optimistic about the resurgent housingmarket and its eventual return as an economic driver. Thishas the potential to bring back demand from a number ofkey sectors including the financial services sector, which haslargely been missing in action since 2007. This is not likelyto happen prior to 2014 at the earliest, but we do expect anuptick of demand that will extend beyond the big financialservices players in need of larger blocks of commodity space tosmaller residential real estate firms, title companies, mortgagebrokers and other players that had been squeezed by thehousing crash.

San Francisco Office Outlook and Forecast

As stated earlier, Q3 2012 was the first time in nine consecu-tive quarters that the market recorded occupancy losses,posting negative net absorption of 409,000 square feet ofspace. However, annual numbers remained in the blackthrough Q3 to the tune of over 1.4 million square feet and anannual growth rate (when measured against San Franciscos

total office inventory of 83.6 million square feet) of 1.7% injust nine months. San Francisco does not have a significantR&D presence and so that type of space is a non-factor here.

As this report went to press, office vacancy stood at 9.9%, upfrom the 9.4% rate of Q2 2012, but still significantly reducedfrom the 12.0% rate posted in Q3 2011. Market vacancyhad peaked at 16.4% in Q1 2010 but had been on a sharpdownward trajectory until recently. The market has backfilledover six million square feet of space since that time, postingan astonishing growth rate of 7.3% in just 27 months. Butafter two years of nonstop aggressive growth any slowdown isbound to raise some concerns. The good news is that Q3soccupancy losses are best described as a pause in the action.Market timing was key to much of the decline both in termsof space users postponing planned moves in light of politicaluncertainty and a number of shadow spaces coming vacantas tenants relocated within the marketplace. Likewise, thebiggest deal of Q3 was Twitters lease of 164,000 square feetat Market Square North, but because they wont be movingin until 2015 it has yet to impact statistics. The good newsis that deal activity has picked back up and, as this reportwent to press in December, the market was on track to postoccupancy growth in Q4.

As of Q3, San Franciscos average asking rent stood at $3.62per square foot (on a monthly full service basis), up 19.3% overthe $3.03 reading of a year ago. This metric has improved by37.8% since the markets low-water mark of $2.63 was postedin Q1 2010. Based upon the tenant deals in the marketplacethat we are tracking, we anticipate that the San Franciscooffice market will not only return to growth in the final quarterof 2012, but that it will continue this pattern throughout 2013.While we expect Q1 2013 numbers to be modest, look foroccupancy growth totals to escalate heading into the final halfof the year. The market will likely close 2013 having postedabout 1.6 million square feet of positive net absorption and

Santa Clara County Office Market 2012 Notable Leases (Through Q3 2012)


Lab 126 Q3 581,973 1100-1120 Enterprise Wy Sunnyvale Relocation/Expansion

LinkedIn Q3 557,143 555 Mathilda Ave Sunnyvale Relocation/Expansion

Samsung Info Systems Q3 385,000 625 Clyde Ave Mountain View Relocation/Expansion

Palo Alto Networks Q3 299,784 4301-4401 Great America Pkwy Santa Clara Relocation/Expansion

Arista Corp. Q3 149,608 5453 Great America Pkwy Santa Clara Relocation/Expansion

Santa Clara County R&D Market 2012 Notable Leases (Through Q3 2012)


Synopsys, Inc. Q1 215,824 445-455 N. Mary Ave Sunnyvale Renewal

Barnes & Noble, Inc. Q1 207,857 3400 Hillview Ave Palo Alto Relocation/Expansion

Xerox Q3 202,000 3333 Coyote Hill Rd Palo Alto Renewal

JDS Uniphase Q1 162,934 400, 430, & 460 N. McCarthy Blvd Milpitas Renewal/Expansion

Stanford Hospital & Clinics Q2 155,000 1804 Embarcadero Rd Palo Alto Palo Alto

OFFICE AND R&D FORECAST


13/40


a vacancy rate in the range of 8.7%. New construction willeventually become more of a factor impacting trends, thoughwe dont see much of an impact before 2014. The good newsis that is also when we anticipate the recovery as a whole to geta significant boost from the return of the housing market asan economic driver. Look for rents to continue to post stronggains, though they will likely not approach the double-digitincreases of the past year. Our assumption is that they will

likely increase at a rate of 9.0% to 10.0% in the coming year.

San Mateo County Office/R&D

Outlook and Forecast

2012 has been a challenging yearfor the San Mateo County office andR&D market. The combined inven-tory of 50.5 million square feet ofproduct here includes 31.1 millionsquare feet of office space and 19.4million square feet of R&D space.Total vacancy as of the close of Q3stood at 13.4%, up a full percentage

point from the 12.4% rate bookedat the close of 2011. Through thefirst nine months of 2012, just under357,000 square feet of space hadbeen returned to the marketplacewith both office and R&D propertiesreporting losses.

The office market has been harder hit,accounting for 240,000 square feetof negative net absorption throughQ3 2012. Office vacancy stands at13.9%, up from the 13.6% rate thatwas posted exactly a year ago (Q3

2011). But even with office vacancycreeping upward, the real problemfacing San Mateo County is the lackof available space. Obviously, onthe surface, that statement soundscounter-intuitive to the extreme.But the problem is that while SanMateo County may still have plentyof office space available, it is not theright kind of space. Currently tenantoffice demand on the Peninsula isdominated by tech companies looking for larger blocks ofspace of 10,000 square feet or more. Yet, office suites of10,000 square feet or more account for only about 18% of

the more than 4.2 million square feet of space currently avail-able. Likewise, tech companies are also looking for downtowncreative space ideally situated near public transportation andurban amenities. This type of space is also in short supply.This has resulted in some companies relocating elsewherein the Bay Area as they look (primarily to San Francisco) tomarkets that can accommodate their growth needs.

Despite a year in which growth has been negative, office rentshave grown. The current average asking rate for office spaceof $3.33 per square foot (on a monthly full service basis) isup 5.1% over the $3.16 reading of a year ago. This metric isup 31.9% from the $2.52 low-water rate posted in Q1 2010.

R&D space has also struggled to gain traction in 2012. Asof Q3 2012, vacancy stood at 12.7% compared to 11.9%twelve months prior. Through the first nine months of 2012,the market had posted 117,000 square feet of negative netabsorption. This years lackluster performance comes in starkcontrast to the previous three years when R&D space in SanMateo County had accounted for nearly 2.5 million square feetof growth (2009 2011). The challenge here has not only

been the increasing preference of office space for many techcompanies, but stiff competition from cheaper R&D space in

the neighboring Silicon Valley market.So, it should come as no surprise thatrents have been flat here over thepast year. The current average askingrate of $2.17 per square foot (on amonthly triple net basis) compares toQ3 2011s reading of $2.14. Activityin Q4 has picked up but we anticipateminimal growth at best to close outthe year and not enough to boost thissegment of the market into positiveterritory for the year.

We anticipate growth to return to posi-

tive territory in 2012, though the first

half of the year will likely be sluggish

with some quarters possibly continuing

the trend of negative net absorption.

Still, we anticipate that combined

occupancy growth for office and R&D

properties will reach the 200,000

square foot mark by the close of 2013

and that the current overall vacancy

rate of 13.0% will fall to about 12.8%.

The few rare large blocks of available

space on the market will drive overall

metrics for asking rates up by about5.0%, though the market will be very

competitive for small spaces. Office

growth numbers will be much more

robust by 2014 thanks to a number

of projects expected to deliver to the

marketplace by then which will offer the

large blocks of space that tech users

are currently going elsewhere to find.

Santa Clara County Office/R&D Outlook and Forecast

While San Mateo County faced challenges throughout 2012and San Franciscos office market took a break in Q3, the

Santa Clara office and R&D markets has continued to produceimpressive numbers, albeit unevenly. The combined inventoryhere includes over 201.4 million square feet of space and hadposted just over three million square feet of occupancy growththrough the first nine months of 2012. As of the close of Q32012, this equated to a combined vacancy rate of 13.0%, asubstantial drop from the 14.2% rate posted at the close of2011. That being said, Silicon Valleys office sector has simplybeen on fire, having recorded over 1.8 million square feet ofoccupancy growth through September and with enough Q4deals having been inked as this report went to press to easilyguarantee it will close out 2012 well above the two millionsquare foot mark.

San Mateo Countys largest office

lease through the first nine months of2012 occurred in February. Heartflow

took 103,000 square feet of space at

Shorensteins Pacific Shores Center

Building 9 in Redwood City.DEAL

HIGHLIGHT

In April 2012, the University of

California at Berkeley inked a deal for

93,000 square feet of Class B office

space at the Strada Investment Groups

Berkeley Crossing project. They will be

occupying the Class B space in

January 2013.DEAL

HIGHLIGHT


14/40

CASSIDY TURLEY

4

Silicon Valley office vacancy stood at 13.0% as of Q3,reflecting a significant drop from the 14.3% rate of a year agoand a massive improvement from the 18.9% high-water markposted in Q1 2010. Silicon Valley has posted growth nine outof the ten past quarters, racking up an impressive 5.8 millionsquare feet of positive net absorption for an overall growth rateof 8.8%. Meanwhile, office rents continue to climb, thoughthe rate of increase appears to be slowing. The current average

asking rate of $2.89 per square foot (on a monthly full servicebasis) is 6.8% above last years reading, but the current actualeffective rate of $3.87 per square foot reflects a 19.1%gain from where it stood a year ago. This number was bolsteredby a number of transactions completed at new developmentsthroughout the region. Major corporatecampus moves from tech companiescontinue to fuel this marketplaceand has spurred a new wave ofdevelopment that will increasinglyimpact vacancy and rental rate trendsfrom late 2013 onward.

Silicon Valleys R&D sector has also

outperformed. Through Q3 2012 ithas posted just over one million squarefeet of occupancy growth and this isdespite the fact that nearly one millionsquare feet of old R&D space had beenconverted (demolished, mostly to makeway for new residential projects) over thefirst nine months of the year. This factorhelped to drive negative numbers in Q3,however, our tracking of Q4 deal activityindicates that quarterly net absorptionnumbers will turn positive again to closeout 2012. The current R&D vacancy rate of 14.5% comparesto a reading of 16.2% posted a year ago and a peak vacancy

reading of 19.6% in Q1 2010. The R&D market has backfilledover 5.7 million square feet of previously vacant space in theintervening 27 months, reflecting a robust overall growth rateof 3.4%.

While we expect slower activity during in Q1 2013 for all BayArea markets, Silicon Valley will still lead the way in terms ofgrowth. Office will remain the hotter of the two property types,but R&D will also continue to post positive numbers with both

seeing greater growth towards year-end. We anticipate thattodays combined vacancy rate of 13.0% will drop to about12.5% by the end of 2013 thanks to about three million squarefeet of total occupancy growth, with roughly two thirds of thatoccurring in the regions office properties. Look for rents tocontinue aggressive growth in the 10% to 15% range. It willbe 2014 before new speculative construction makes much ofan impact on either vacancy or rental rate growth.

East Bay Office/R&D Outlook and Forecast

The combined East Bay inventory of office and R&D propertiesis 98.7 million square feet and recorded a vacancy rate of17.3% as of the close of Q3 2012. This reflects some improve-

ment over the 18.0% rate posted as ofthe close of 2011 thanks to the 734,000square feet of occupancy growth thatthe regions markets have experiencedthroughout 2012, much of which hascome later in the year.

In terms of office space, there are threemajor trade areas within the East Bay;Oakland, Walnut Creek and Pleasanton.None of these markets have a hugetech presence, though the Oaklandmarketplace does have a couple of techclusters within the Berkeley, Emeryvilleand Alameda submarkets. As a result,recovery has come here much laterthan elsewhere in the Bay Area. Officetenancy in these trade areas has typicallycome from the government, healthcare,education, personal and businessservices sectors and these have only

recently begun to spring back into expansion mode. Modestimprovement in the overall economy and regional improvementas a whole (many East Bay workers commute to tech jobs inthe Highway 101 Corridor markets but spend their paychecksback home in Alameda or Contra Costa County) has helped tofinally turn things around in these trade areas. The Oaklandoffice market currently has a vacancy rate of 17.2%, up froma Q3 2011 reading of 16.4%, but still below its 17.5% peakin Q2 2011. Through the first nine months of 2012, it hadposted just 37,000 square feet of occupancy growth, but thisreflects an improvement over a lackluster 2011 in which it

East Bay Office Market 2012 Notable Leases (Through Q3 2012)

Tenant Quarter Total SF Address City/Submarket Transaction Type

UC Berkeley Q2 93,000 1608 4th St West Berkeley Expansion

PG&E Q3 80,000 Bishop Ranch 1 San Ramon Relocation/ExpansionSingulex Q3 52,000 1701 Harbor Bay Pkwy S. Alameda Relocation/Expansion

Wendel Rosen Black & Denn Q1 52,000 1111 Broadway City Center - Oakland Renewal

Assoc. Third Party Admin. Q2 49,067 1640 Loop Rd, S. S. Alameda Renewal

East Bay R&D Market 2012 Notable Leases (Through Q3 2012)


Warm Springs Constructors, Inc. Q2 107,000 45401 Research Ave Fremont Relocation/Expansion

Volterra Semiconductor Corp. Q3 73,111 47451-47475 Fremont Blvd Fremont Renewal

Depomed, Inc. Q2 60,416 7999 Gateway Blvd Newark Relocation/Expansion

Solta Medical Q3 51,449 25881 Industrial Blvd (Bldg F) Hayward Renewal

LAM Research Q3 50,900 45757 W. Northport Loop Fremont Relocation/Expansion

OFFICE AND R&D FORECAST

While there have been plenty of large

new R&D leases in Silicon Valley this

year, the biggest deal through Q3

was actually a renewal. Synopsys

re-upped on the 216,000 square feet

of space that it has occupied at Jay

Pauls Crossroads Technology Center

in Sunnyvale since 2000.DEAL

HIGHLIGHT


15/40


lost nearly 150,000 square feet of occupancy. The currentaverage asking rent here of $2.16 per square foot is slightlyabove the $2.10 rate of a year ago, but we have yet to seesubstantial growth returning since the downturn. Rents hadpeaked at $2.39 per square foot in Q4 2008 as the impactof the recession was just being felt. While conditions havebeen choppy in Oakland, the Pleasanton office market hasdemonstrated a much clearer trend line. Vacancy here now

stands at 13.9%, down considerably from its Q3 2011 peakof 18.4%. Recovery here has only just begun to pick upsteam. As of Q3, Pleasanton had recorded four consecutivequarters of strong growth and had posted 716,000 square feetof positive net absorption over the first nine months of 2012.The Walnut Creek office market has followed a similar growthtrend with vacancy falling five of the last six quarters and totaloccupancy growth of 195,000 square feet through Q3. Likeall East Bay office markets, Walnut Creeks current vacancyrate of 14.8% remains elevated, but this is a considerableimprovement over the 17.7% peak posted in Q1 2011.

The East Bays R&D marketplace is mostly centered inAlameda County, where roughly 31.9 million square feet of

product is situated. The Oakland R&D marketplace currentlyhas a vacancy rate of 21.7% and has actually regressed overthe past year. As of Q3 2011 vacancy stood at 20.0%. Thishasnt impacted rents significantly, with asking rates currentlyaveraging $0.88 per square foot (on a monthly triple net basis),compared to $0.82 a year ago. The Pleasanton market ishome to approximately 7.1 million square feet of R&D spaceand the trend here has been more positive. The currentvacancy rate here is 10.8%, down from a Q3 2011 reading of13.5%. This trade area had posted R&D occupancy growth of129,000 square feet through the first nine months of 2012,compared to Oaklands loss of 342,000 square feet. The bigchallenge here is that R&D space in the East Bay has seenlittle benefit from the regions tech sector and has traditionally

been more about quasi-industrial or back-end office usagethan anything else. The current average asking rent for R&Dspace in Pleasanton is $0.91 per square foot, up from $0.85a year ago.

Going forward, we anticipate that the East Bay marketplace willsee continued slow growth for office product and flat growthfor R&D in the Oakland trade area. Both the Walnut Creekand Pleasanton office markets will continue to post moderate

growth while we also anticipate activity to tick up for R&Dspace in Pleasanton. All told, we expect todays combinedoffice and R&D vacancy rate of 17.3% to fall over the course of2013 to about 16.0% by year-end. We expect total occupancygrowth to come in at about 1.2 million square feet, with totalsramping up later in the year.

North Bay Office Outlook and Forecast

The North Bay is the San Francisco Bay Areas smallest traderegion in terms of office product (there are no major R&Dprojects in this marketplace to speak of) and accounts fora total inventory of just over 20 million square feet betweenMarin and Sonoma Counties. In Marin County, we track 9.8million square feet of space, which had a vacancy rate of15.5% as of Q3 2012. Performance has been weak in 2012,with the market in the red in terms of occupancy growth tothe tune of 181,000 square feet. Vacancy had reached aslow as 13.6% in Q4 2011. Despite this setback, the averageasking rent for office space in Marin County currently standsat $2.52 per square foot (on a monthly full service basis)reflecting an increase of 3.3% over where it stood a year ago.

Sonoma County has also struggled with occupancy issues thisyear, having posted negative net absorption of 215,000 squarefeet over the course of 2012. But this all came from oneuser, State Farm, who has pulled out of their existing NorthBay campus and because the project is slated for demolitionit has had no impact on vacancy at all. The current vacancyrate for office space in Sonoma County of 20.4% is actuallydown from the 20.9% rate that had been posted a year ago.Before State Farms departure, Sonoma County had been ona course for modest growth throughout the year, though ourtracking of Q4 activity indicates that both markets will returnto modest growth over the final months of 2012. The currentaverage asking rent for office space in Sonoma County is $1.66per square foot, roughly the same place it was one year ago.

We anticipate a return to very slow growth in Marin Countyfor 2013. Our current forecast calls for this market to close2013 with approximately 60,000 to 90,000 square feet oftotal occupancy growth and a final vacancy rate of roughly14.3%. We expect rents to post a growth rate of roughly 3.0%.Sonoma County should end 2013 with a vacancy rate at, ornear, 17.9%. We expect total occupancy growth in the rangeof 160,000 to 190,000 square feet and for rents to increaseat a pace of about 4.0%.

Marin County Office Market 2012 Notable Leases (Through Q3 2012)


Health Net Q3 52,454 2350 Kerner Blvd San Rafael Renewal

Autodesk Q2 46,766 3950 Civic Center San Rafael RenewalRedwood Trust, Inc Q1 27,292 1 Belvedere Pl Mill Valley Renewal

Meritage Medical Network Q2 22,266 500 Hangar Ave Novato Relocation/Expansion

Willis Lease Finance Corporation Q1 20,534 773 San Marin Dr Novato Renewal/Expansion

Sonoma County Office Market 2012 Notable Leases (Through Q3 2012)


Marmot Mountain, LLC Q2 43,000 5789 State Farm Dr Rohnert Park Relocation/Expansion

Raydiance Q2 41,638 1450 Mcdowell Blvd Petaluma Relocation/Expansion

Sonoma Marin Area Rail Transit Q3 28,000 5401 Old Redwood Hwy Petaluma Relocation/Expansion

Adventist Health Q3 26,200 463 Aviation Blvd Santa Rosa Relocation/Expansion

Clover Stornetta Farms Q1 17,846 1650 Corporate Cir Petaluma Relocation/Expansion


16/40

CASSIDY TURLEY

6

The San Francisco Bay Areas 366 million square footindustrial market posted total vacancy 8.6% as of theclose of Q3 2012, reflecting just under 452,000 square

feet of total occupancy growth through the first nine monthsof the year. The regions industrial marketplace is on trackfor its second consecutive year of growth. Industrial spaceaccounted for 362,000 square feet of positive net absorptionin 2011, but the region had hemorrhaged over 12.9 million

square feet of occupancy between 2008 and 2010. Whileoffice and R&D occupancy levels are back to pre-recessionlevels, the same cannot be said of the regions industrial base.However, the good news for local landlords is that at leastthe industrial sector did not enter intothe recession with already inflatedvacancy levels, as was the case foroffice and R&D properties in manyBay Area markets. But as has beenthe case with those property types,recovery for industrial properties hasalso been uneven both in terms ofproduct type and geography.

Bay Area Manufacturing Outlook

Manufacturing space accounts for147.2 million square feet of theregions industrial inventory. Theregions manufacturing sectorperformed well in Q3 2012, posting932,000 square feet of occupancygrowth and closing the quarter with avacancy rate of 6.9%. Unfortunately,this comes after three consecutivequarters of substantial occupancylosses, including those related to the high profile collapse ofFremont-based solar panel manufacturer Solyndra. Through

the first nine months of the year, manufacturing occupancyin the Bay Area has actually fallen by 37,000 square feet.The good news is that Q4 activity should boost this segmentof the marketplace back into the black for the year, but gainsare likely to be modest at best. Still, despite these lacklusternumbers, the trend has been one of general improvement forthe market as a whole. If you take Solyndra out of the mix,the regions manufacturing base would have posted almost800,000 square feet of growth through the first nine months

of 2012. This would have far surpassed the 343,000 squarefeet of occupancy growth that the market experienced in 2011.The good news is that while many feared that the Solyndrafacility would remain vacant for years, it actually sold veryquickly. Seagate Technology will close on the property inFebruary 2013, at which point the regions manufacturingoccupancy will tick up by about 800,000 square feet.

The East Bay is home to 87.6 million square feet of manu-facturing inventory. Vacancy here stood at 7.9% as of theclose of Q3, up from a 6.7% reading a year ago. It tends tobe the most active marketplace and usually drives growth in

the region, though this trade area hadposted negative net absorption to thetune of 485,000 square feet of spacethrough the first nine months of 2012.This was, of course, due to the impactof Solyndra. The average asking renthas increased 19% over the past yearfrom $0.42 to $0.51 per square foot(on a monthly triple net basis).

Santa Clara County closed Q3with a vacancy rate of 5.2%, downsignificantly from the 6.5% rate of ayear ago. This trade area had posted471,000 square feet of occupancygrowth through the first nine monthsof 2012. This is despite the fact thatnearly 240,000 square feet of previ-ously occupied manufacturing spacewas vacated and demolished to makeway for new residential projects inSan Jose. The trend of conversions

for older industrial properties in San Jose is only expectedto intensify going forward as city planners and developers

contend with a housing shortage, skyrocketing rents and homeprices and little land left to build. More owners will find that,assuming they can rezone and get through the environmentalhurdles, that redevelopment plays into residential housing maybe the best use for older industrial properties bordering onobsolescence. This trend will help to tighten market vacancyfurther. Though tenant activity levels for manufacturing spaceare minimal compared to the warehouse sector, there are not alot of quality options to choose from in the marketplace. This is

INDUSTRIAL FORECAST

San Mateo County Industrial Market 2012 Notable Leases (Through Q3 2012)


Williams Sonoma Q2 194,112 435-440 Valley Dr Brisbane Renewal

SF Chronicle Q1 79,300 240 Valley Dr Brisbane Expansion

Pacific Gourmet Q3 70,335 380 Valley Dr Brisbane Relocation/Expansion

NNR Global Logistics Q2 45,362 550 Eccles Ave South San Francisco Expansion

Metro Air Service Q3 43,500 425 Valley Dr Brisbane Expansion

San Francisco County Industrial Market 2012 Notable Leases (Through Q3 2012)

Tenant Quarter Total SF Address Submarket Transaction Type

KWW Kitchen Cabinets & Bath Q2 32,500 211 Industrial St Bayshore Corridor Relocation/Expansion

Young's Market Company Q2 26,000 3000 3rd St Mission Bay/Dog Patch Relocation/ExpansionSRG Designs, Inc. Q2 25,000 695 Minnesota St Mission Bay/Dog Patch Relocation/Expansion

Thatcher's Gourmet Popcorn Q2 20,000 1225 Minnesota St Mission Bay/Dog Patch Renewal

Roar Wines Q2 20,000 1225 Minnesota St Mission Bay/Dog Patch Relocation/Expansion

The largest industrial deal to be inked

throughout the first nine months of

2012 on the San Francisco Peninsula

was Williams-Sonomas renewal on

194,000 square feet of warehouse space

at CalSTRS Crocker Industrial Park

in Brisbane.DEAL

HIGHLIGHT


17/40


one of the reasons why the ultra-modern Solyndra facility soldso quickly as well as what is driving strong rental rate growth inSanta Clara County. The current average asking rent of $0.68per square foot is up 18% from last years rate.

With just 6.6 million square feet of product, San MateoCounty is the smallest manufacturing market that we breakout statistically. Through the first nine months of 2012 it

had posted 23,000 square feet of negative net absorption.Ongoing deal activity in Q4 will likely bring it back intomodestly positive territory, but just barely. If so, it will bethe first time since 2008 that manufacturing space closes theyear in the black. Despite this negativetrending, current vacancy of 7.6% isstill relatively low. The problem is thatdemand has been equally low. Thecurrent average asking rent of $0.79per square feet has actually dropped5% over the past year.

At the peak of the last cycle in 2007manufacturing vacancy fell as low as

4.7%. The market still has a longway to go before it even comes closeto those numbers, however, we areoptimistic that the ongoing trend ofgradual improvement will escalateheading deeper into 2013. The trend ofon-shoring is real and has been fueledby a mix of factors including rapidlyrising costs in Asia and stagnant wageshere at home. The tech boom has had little impact on localmanufacturing demand so far, but even this may change soon.Apple has announced that they will begin assembling at leastone model of their iPad product line in California. Though thiswill probably land in the Sacramento area, this will be part of

a greater marketing campaign to see if they can successfullycharge more for product clearly branded as made in America.Should it succeed, this could have immense implications formanufacturing jobs and space demand in the future.

Bay Area Warehouse Outlook

Warehouse space accounts for almost 219 million square feetof the Bay Areas 366 million square foot industrial base.Vacancy for this product type stood at 8.7% as of the close

of Q3 2012, compared to a 9.0% as of the close of 2011. Inthe intervening nine months, the marketplace had absorbed511,000 square feet of previously vacant space. As this reportwent to press in December there were a number of deals thathad closed or that were in the works that should further boostthis total in Q4 2012. All told, we anticipate that the BayAreas warehouse sector will close 2012 with total annualoccupancy growth in the range of 800,000 square feet. This

will make it the third year in a row that warehouse propertieshave posted positive annual totals. The market had lost overten million square feet of occupancy between 2007 and 2009.The good news is that 2012 will likely end as being the regions

strongest growth year since 2006. Thebad news is that the combined positivenet absorption of the past three yearsstill equates to just 10% of all theoccupancy lost during the downturn.

The East Bay is home to the regionslargest concentration of warehousespace. The East Bay/Oakland markethas a total inventory base of 74.1

million square feet. It closed Q3 2012with a 9.3% vacancy rate, reflectinga slight decline from the 9.6% rateof one year prior. This trade area hasaccounted for 227,000 square feet ofoccupancy growth through the firstnine months of 2012 and continuesto be one of the most sought afterlocations from tenants who wish to be

close to the Port of Oakland and major transportation hubs.At the peak of the last cycle, vacancy here had fallen aslow as 4.4% (Q3 2006). Though vacancy remains elevatedfrom pre-downturn levels, one of the challenges facingthis trade area is a lack of available modern space. The

average age of warehouse buildings in Alameda County is42 years. Industrial demand is currently being driven bydistribution and logistics users who need warehousing spacethat can handle heavy floor loads and that offer cross-dockingcapabilities, high ceilings for stacking and numerous othermodern amenities. These facilities are in high demand andfetch top rents. Much of what remains vacant in the EastBay/Oakland marketplace is older product. This past year isthe first since the downturn where this market has started

Santa Clara County Warehouse Market 2012 Notable Leases (Through Q3 2012)


DGA Services Q1 149,010 999 Montague Expwy Milpitas Relocation/Expansion

Apple, Inc. Q3 134,160 2940 Mead Ave Santa Clara ExpansionGolden State T's Wholesale Q1 90,000 2070 S. Seventh St South San Jose Renewal

Cepheid Q1 70,627 914 Caribbean Dr Sunnyvale Expansion

Apple, Inc. Q1 54,934 590 Macara Ave Sunnyvale Expansion

Santa Clara County Manufacturing Market 2012 Notable Leases (Through Q3 2012)


Legacy Transportation Services Q1 107,116 2011 Senter Rd South San Jose Expansion

Riverview Systems Group Q1 70,042 1101 Cadillac Ct Milpitas Relocation/Expansion

SMTC Q1 64,800 2302 Trade Zone Blvd North San Jose Renewal

Versgrove Moving Systems Q3 51,600 665 Lenfest Rd North San Jose Relocation

ACTA Health Products Q1 34,040 41320 Boyce Rd Sunnyvale Renewal

We are optimistic that the

ongoing trend of gradual

improvement will escalate

heading deeper into 2013.

The trend of on-shoring is real

and has been fueled by a mix offactors including rapidly rising

costs in Asia and stagnant

wages here at home.


18/40

CASSIDY TURLEY

8

to see rents recovering. The current average asking rate of$0.40 per square foot is up almost 11% over one year ago.

While the East Bay/Oakland marketplace typically sees themost tenant activity in the region, it was the East Bays inlandContra Costa County markets that have posted the most growthin 2012. The East Bay/Pleasantonmarket is home to 17.8 million

square feet of warehouse space. Itclosed Q3 2012 with a vacancy rateof 15.0%, down from a reading of16.3% one year ago. It has posted211,000 square feet of occupancygrowth through the first nine monthsof 2012. The current average askingrent here of $0.57 per square foothas only just begun to stabilize overthe past six months. It is down17% from where it stood a yearago. While we do not expect it tofall any further, the regions still-highvacancy rate will continue to weigh

on rental rate growth.

The East Bay/Walnut Creek tradearea led all other Bay Area ware-house markets in terms of occupancygrowth through the first nine monthsof 2012 with 479,000 square feetof positive net absorption. Vacancyhere has fallen from 17.0% to 13.8% over the past twelvemonths. But like its neighbor to the south, rents are only nowstabilizing and significant rental rate growth is unlikely untilvacancy falls further. The current average asking rent of $0.53per square foot has not budged in the past six months, but ayear ago it stood at $0.58 per square foot.

In 2013, we expect the combined industrial markets of theEast Bay (warehouse and manufacturing in all trade areas)to account for at least 860,000 square feet of positive netabsorption, if not more. We expect the current overall vacancyrate of 9.6% to fall to 9.1% over the course of 2013.

But while the East Bay as a whole grew in 2012, the same wasnot true of the regions second largest marketplace. The Santa

Clara County warehouse market includes 31.2 million squarefeet of inventory and closed Q3 2012 with an overall vacancyrate of 8.8%. While this marks an improvement over the 9.8%rate that was posted a year ago, Santa Clara County lost over454,000 square feet of warehouse occupancy through thefirst nine months of 2012. There is some good news here in

that building conversions have beenthe real culprit. Since the begin-

ning of the year, we have removed653,000 square feet of space fromour statistical tracking. In virtuallyevery case these were buildingsslated to be demolished to makeway for new projects, usually newmultifamily developments though theextension of BART has also playeda role. Though this trend results inlower overall occupancy numbers, itactually has helped to drive vacancyrates down because some of thisinventory was already empty. Thecurrent vacancy rate for warehouse

product in Santa Clara County is8.8%, down from 9.8%. Withoutthese conversions, the market wouldactually be on page for modestgrowth in the 200,000 square footrange. This helps to explain whyrents here are growing. The currentaverage asking rate of $0.49 per

square foot is up 10% over last years reading. With leasingfundamentals continuing to gradually improve and more olderor obsolete industrial properties likely to face the wrecking ballin 2013 and beyond, we see vacancy continuing to tighten andrents continuing to grow.

Looking ahead to 2013, we anticipate that Santa ClaraCountys combined industrial marketplace (warehouse andmanufacturing) will account for at least 250,000 square feetof occupancy growth in 2013 and that it will close the yearwith an overall vacancy rate of 6.2%

San Franciscos 20.3 million square foot industrial marketclosed Q3 2012 with a vacancy rate of 4.8%, down from 5.5%over the past twelve months. Through the first nine months of

East Bay Manufacturing Market 2012 Notable Leases (Through Q3 2012)


Theranos Q1 219,255 7333 Gateway Blvd Newark Relocation/Expansion

Gary Steel Q2 173,600 1699 Grand Ave, W. Oakland Renewal

Dean Refrigeration Q1 130,000 860 81st Ave Oakland Relocation/Expansion

Whole Foods Market Q2 117,008 2000 Atlas Rd. Richmond Relocation/Expansion

Specialized Packaging Solutions Q1 107,199 38505 Cherry St Newark Renewal/Expansion

East Bay Warehouse Market 2012 Notable Leases (Through Q3 2012)


Ceva Logistics Q3 323,254 31353 Huntwood Ave Hayward Relocation/Expansion

RK Logistics Q2 191,483 41707 Christy St Fremont Relocation/ExpansionArchitectural Glass & Aluminum Q3 175,000 6400 Brisa St Livermore Relocation/Expansion

Owens Corning Q3 174,278 201 C St Hayward Renewal

Primary Steel Q2 173,600 1699 W. Grand Ave Oakland Renewal

INDUSTRIAL FORECAST

The East Bays (and the regions)

largest industrial deal of the year was

a relocation/expansion lease. Ceva

Logistics inked a deal for 323,000

square feet of space at Haywards

Huntwood Logistics Center in February.

The third-party logistics provider took

occupancy of the space in November.DEAL

HIGHLIGHT


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2012 it has posted 82,000 square feet of occupancy growthbut some Q4 move-outs will likely put this market into negativeterritory on the year. We also anticipate vacancy as of Q42012 to climb as high as 5.8%. Rents here have remainedunchanged over the past year at $$0.74 per square foot. TheSan Francisco market is dominated by long-term owner/userswith little in the way of availablespace for lease. As a result, this is a

low demand/low activity marketplacethat also has low vacancy and higherpricing. Tenancy here is driven byservice providers who need to belocated here. Looking forward, weanticipate that likely conversionsof existing space to other propertytypes and continued modest levelsof demand should combine to bringvacancy levels back downward. Wealso expect rental rate growth in2013 to ramp up, likely above the5% level.

San Mateo Countys industrialmarket closed Q3 2012 with avacancy rate of 9.6%. One year agoit stood at 9.0%. The market has lost71,000 square feet of occupancythrough the first nine months of2012, but we know of a few Q4 deals in the works that shouldbring those numbers back into positive territory. The currentaverage asking rent here of $0.69 per square foot is down 8%over the past year. While final 2012 growth numbers should bemodestly positive, we anticipate that growth should ratchet upin 2013. We expect the San Mateo marketplace to close 2013with about 160,000 square feet of positive net absorption anda vacancy rate at, or near, 8.6%.

Marin County closed Q3 2012 with an industrial vacancy rateof 7.1%, compared to a reading of 7.3% twelve months ago.This trade area has experienced extremely modest growth ofjust 14,000 square feet through the first nine months of 2012.Deals in the works for Q4 will boost this total slightly, but it willstill likely fall beneath the 50,000 square foot mark. Thoughvacancy levels are relatively low, deal activity and demandhas also been low. Most local deal activity remains focused

on smaller industrial users in need of service-related, lightmanufacturing or basic warehousing (not distribution) space.The current average asking rate for industrial space in MarinCounty is $1.10 per square foot, up 13% over the $0.98 persquare foot reading of one year ago. Rental rate growth hascontinued to take place simply because there are not a lot of

quality options for space users. Whilewe expect growth levels to pick up

here heading into 2013, we still donot think that absorption levels fornext year will grow much above the50,000 square foot mark. Still, weanticipate that Marin Countys indus-trial market will close 2013 with avacancy rate of about 6.2% and thatrents will also continue to grow at amoderate clip.

Unlike Marin County where industrialservice users rule the roost, SonomaCountys industrial marketplaceis much more about warehousing,

particularly in support of the regionsstrong wine industry. As of Q3 2012,vacancy stood at 10.1%, down froma 10.6% reading a year ago. Themarket has recorded nine consecu-tive quarters in which occupancy had

either grown slightly or remained flat. Demand remains tepidand with vacancy still slightly above the 10% mark, rents havealso remained flat. The current average asking rate of $0.64per square foot has budged little since Q1 2010. As this reportwent to press we were aware of a couple of planned tenantmove-outs that could send vacancy as high as 11.2% andbring annual occupancy growth totals into the red by as muchas 220,000 square feet. However, we do expect a return to

modest growth in 2013. We anticipate that Sonoma Countywill close out next year with vacancy at, or near, 10.5%.

Marin Industrial Market 2012 Notable Leases (Through Q3 2012)


EO Products Q2 38,000 90 Windward Wy San Rafael Relocation/Expansion

32Ten Studios Q1 29,982 3210 Kerner Blvd San Rafael Relocation/Expansion

Marin Senior Coordinating Council Q3 9,070 15 Jordan St San Rafael Relocation/Expansion

Tesla Motors Q2 8,000 595 Redwood Hwy Mill Valley Relocation/Expansion

San Francisco Exotic Cars Q2 8,000 15 Jordan St San Rafael Relocation/Expansion

Sonoma Industrial Market 2012 Notable Leases (Through Q3 2012)


Kala Brand Music Company Q1 24,006 1105 Industrial Ave Petaluma Relocation/Expansion

Office Playground Q2 17,456 715 Southpoint Blvd Petaluma Relocation/ExpansionEnphase Energy Q1 15,580 1380 Redwood Wa Petaluma Relocation/Expansion

Moresco Distributing Company Q3 14,550 1460 Cader Ln Petaluma Relocation/Expansion

Three Twins Organic Inc. Q1 7,989 2190 S. Mcdowell Blvd Petaluma Relocation/Expansion

The South Bays largest industrial deal

of the year so far (through Q3) was a

warehouse lease. In the first quarter,

DGA Services inked a deal for 149,000

square feet of space at 999 Montague

Expressway in San Leandro.DEAL

HIGHLIGHT


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CASSIDY TURLEY

0

The 2012 holiday shopping season was well under way asthis report went to press and initial indicators are thatfinal sales will be up at least 3.0% over 2011 totals, but

the final tally could exceed the 4.0% mark. Analyst forecastswere more robust this year than they were in 2010 and 2011but that is due to a number of reasons. This years holiday salesseason includes an extra weekend of selling time while retailerscontinued to push the envelope with further early openings

during the Black Friday weekend. Meanwhile, the numberof major malls that opened on Friday atmidnight increased from roughly 35% toabout 50%. But while these factors werebound to have an incremental impact onretailer sales figures, the primary reason foroptimism was consumer confidence.

Remember that both the 2010 and 2011holiday sales seasons turned out to bepleasant surprises for U.S. retailers. In2010, the economy was still emerging fromthe depths of the recession. Luxury andupscale retailers had seen their same store

comparables hammered, with some chainshaving posted 18 consecutive months ofdeclines in the double-digits. Sales for thissegment of the market had only begun toturn positive in September 2010. Mostimportantly, consumer confidence hadbeen on a lengthy run of declines, reachinga low of 48.6 in that same month. Analystspredicted a weak sales season only tobe shocked when consumer confidencesuddenly began to trend upward andshoppers turned out in force. While mostforecasters predicted annual sales gainsof 2% or less, American consumers drove

annual sales growth by over 4%.

A similar phenomenon took place in 2011, though by thenupscale retailers were doing markedly better. But confidenceslumped following an early year run-up in gas prices and thesummertime discord surrounding the debt ceiling debate andsubsequent downgrade of U.S. credit. By October 2011,consumer confidence had fallen to a low of 40.9 as economistsdebated the possibility of a double-dip recession. Analystspredicted sales increases in the 2.5% to 3.0% range. Yet,once again shoppers came through, fueling an annual increasein holiday sales of just over 4.0%.

But unlike in those past years, consumer confidence was notweak heading into the Holiday season. In fact, it is currentlyon its strongest uptrend in over four years. After hitting alow of 61.3 in August, it jumped to 68.4 in September andhas only been climbing since. By November it had reached apeak of 73.7its highest rate since February 2008. Againstthis backdrop, it only makes sense that projections for 2012sholiday sales would be more robust. This is important because

a strong holiday sales season can directly impact retailerexpansion. Following both the 2010 and2011 holiday sales seasons, retailersboosted their growth plans considerably.

Before the 2010 Christmas season,retailer growth was dominated bydiscounters (ranging from off-priceapparel to warehouse stores and discountgrocers) and low ticket restaurants (fastfood and fast casual). The surprisinglystrong holiday sales season marked theofficial end of the recession for manyretailers. Many chains that had put

expansion on hold now moved to cautiousgrowth mode and with rents off in somemarkets by 40% to 50% from peakpricing, it led to a wave of opportunisticdeals. We track retailer growth plansnationally and saw a 30% surge in newstore plans between September 2010and March 2011. The 2011 holidayshopping season played out in a nearlyidentical manner as surprisingly strongsales figures resulted in another uptickin retailer demand. But this time thesurge accounted to an increase of about15%. The market was already moving

back to more normalized trends, mean-while, as the marketplace had improved

considerably over the previous year opportunistic plays for topproperties were becoming harder to engineer.

With final 2012 holiday sales figures expected to show stronggrowth the question is whether this will translate into a similarsurge in retailer growth plans. Unfortunately, the answer for2013 is likely not. The rapid acceleration of retailer growthplans in 2010 and 2011 were anomalous. While it is notuncommon for demand to increase following a strong holidayshowing, historically this surge has usually been in the 5% to10% range. Additionally, though the retail market has not fullyrecovered from the impact of the downturn, there are fewer

opportunistic plays available for retailers seeking premiumspace. While the Class C marketplace still offers plenty ofopportunities for chains looking for deals, rents for Class Aspace in nearly every major U.S. market (including those stillposting the weakest overall performance) have been on therise as vacancies have fallen. Meanwhile, Class B productin all but the weakest of U.S. marketplaces has also seenconsiderable improvement over the past 30 months. As 2012drew to a close, Class B properties were rebounding in generalas vacancies tightened for Class A space. This was not thecase a year ago. The last reason why we do not expect a repeatof the last two years is indicative of a longer term trend; theincreasing encroachment of e-commerce.

RETAIL FORECAST

Walmart leased 41,000 square

feet of space at San JosesEvergreen Village Center and

opened one of its new smaller

format Walmart neighborhood

stores. The worlds largest

retailer is actively looking for sites

throughout the Bay Area and we

anticipate a number of openings

in 2013. With speculation rife

that Walmart could potentially buy

Fresh & Easy as they exit the U.S.

market, what could be a handful

of openings next year could

potentially turn into an overnight

footprint of more than 20 stores.DEAL

HIGHLIGHT

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80

120

160

200

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Retail E-Commerce Sales

A Seven-Fold Incr ease Since 2000

Gaining roughly 10% annually

Billions of Dollars


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Who is Growing and Why?

We are currently aware of plans from retailers to open as manyas 41,000 new retail storefronts in the U.S. over the next twelvemonths. This compares to a reading of just under 40,000potential storefronts one year ago. Growth remains slow andcautious and has shifted increasingly to retail concepts thatare considered bulletproof when it comes to e-commerce.

Hard goods retailers, with the exception of dollar storesand discounters, remain in conservativegrowth mode at best. Meanwhile, foodrelated or service oriented retail remainsin aggressive growth mode. Restaurantconcepts alone account for 42% of allthe planned growth that we are tracking.Meanwhile, smaller format groceryremains hotdriven by strong demandfrom niche players ranging from discountto upscale and ethnic to organic. Thisholds true nationally as well as region-allyof the top 25 retail leases inkedthroughout the Bay Area this year, smaller

format grocery accounted for five of them.Walmart, Grocery Outlet, Fresh Marketand other players remain extremely activein the marketplace. Though Fresh & Easyhas announced that it will be withdrawingfrom the U.S. market in 2013, demand forits existing Bay Area sites is expected tobe high. Though speculation is rife thatthe chain could sell to either Walmart orALDI, a sale to one of the numerous dollarstore chains in growth mode could be justas likely.

Dollar stores are entering their third

consecutive year of explosive growth andwe are tracking a potential of over 2,000new dollar stores throughout the U.S.over the next year. Dollar General aloneis planning on as many as 625 openingsnationally over the course of 2013. Mean-while, Family Dollar is expected to open atleast 500 new stores while Dollar Tree hasplans for at least 300 new units in 2013.All of these chains are expected to beactive in California this year. We anticipatethat dollar stores alone will account fora minimum of 15 million square feet ofoccupancy growth across all retail building

types in the coming year.

Besides these categories, we continue tosee expansion from fitness/health/spa concepts, drug stores,thrift stores, automotive service, discounters, off-price apparel,pet supplies, sporting goods, hobby stores/arts & crafts,wireless stores (limited growth driven mostly by a few newconcepts) and some banking/check cashing/financial servicesproviders. Ultimately, however, if you want to understand whois growing and why, it all comes down to a few basic trends.

Luxury and upscale retail is back while concepts offering lowprice points (from restaurants to hard goods) have mostly

thrived throughout the downturn. But the middle classconsumer remains in frugal mode and, having downsized,this is taking its toll on mid-price point retailers of all stripes.Those very same hard goods concepts have been doublypinched thanks to e-commerce, though many casual diningchains (with a few exceptions mostly limited to new concepts)also continue to face challenges. Meanwhile, site selectionremains about the sure thing. Higher income demographics

and greater population densities are what most chains arechasing. Likewise, the market remainsbifurcated in terms of class with ClassA and B properties remaining in mostdemand. Meanwhile, all of these trendshave served the Bay Area remarkably wellover the past couple of years.

San Francisco Peninsula Outlook

Our retail division, Terranomics, tracksretail trends across nearly 60 major U.S.marketplaces. As of the close of Q32012, shopping center vacancy within

the San Francisco market stood at just4.0%, placing it second in the nation interms of boasting the tightest vacancy.We should note that these numbers dontinclude freestanding retail or ground floorretail spaces within mixed-use buildings.That would include much of the inventoryof the citys high-end shopping district,Union Square, where we estimate currentvacancy to be below the 4% mark. UnionSquare has continued to see intenseactivity over the past year with pricingaccelerating at a rapid clip. Though toprents here have occasionally surpassed

the $500 per square foot mark forpremium space, this remains well belowsimilar high street rents in New YorkCity where recent top rents for MidtownManhattan (according to the Real EstateBoard of New York) have surpassed the$2,700 per square foot mark. Becauseof this, many retailers who typically lookfirst to Manhattan for flagship locationsare increasingly skipping the Big Appleand looking to the West Coast instead.

Office leasing activity has been brisk inthe citys SoMa district and has continued

to move westward. Meanwhile, a largenumber of multifam

San Francisco Bay Area Commercial Real Estate - 2013

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