Savills Studley Report San Francisco office sector Q2 2018

Savills Studley Research San Francisco

SUMMARYMarket HighlightsFACEBOOK BOOSTS QUARTERLY VOLUME

Facebook’s lease for the entirety of Park Bay Tower boosted second quarter activity, pushing it to nearly 3.0 million square feet (msf). Tenants have leased more than 10 msf in the four most recent quarters.

AVAILABILITY DROPS

San Francisco’s overall availability dropped by 160 basis points to 10% in the second quarter of 2018. The Class A availability rate posted a sharp decrease in the quarter, dropping by 210 basis points to 8.9%.

RENT RISES

The average total asking rent rose by 1.5% to $66.87. Class A rent averaged $69.15, a 1.3% quarter-on-quarter increase.

SALES DROP

Office property sales during the last six months (through May 2018) totaled $1.7 billion, falling sharply compared to the previous six-month total of $2.5 billion.

"Facebook’s aggressive lease of the

entirety of Park Tower at Transbay leaves

the market with essentially no new

space options until early 2022. Changes

in the economy and in development

restrictions could change conditions well

before then, though."

Savills Studley Research

02

Savills Studley Report | San Francisco

Employees In, Employers Out?

The movement of businesses and people from San Francisco to lower cost areas such as Seattle, Phoenix and Denver is well documented. Nevertheless, many people are evidently still hoping to make San Francisco their new home. According to Glassdoor’s Metro Movers study, the city topped the country, with the most job applicants from other markets. Based on 668,000 applicants, San Francisco topped the list, capturing 12.4% of U.S. jobs seekers looking to relocate for work, followed by New York City (8.4%) and San Jose (8.4%). Conversely, more than half of job seekers in Providence, Rhode Island (home to several colleges) are applying to jobs in other areas.

Job applicants may be lured to San Francisco, but evidently not enough are actually relocating to solve the shortage of qualified workers that many area employers face. As local firms struggle to fill empty positions and to find adequate office space, San Francisco is also one of the top cities that companies are moving from. Some firms are leaving the region entirely, others are opening up additional branches in markets such as Denver, Phoenix or Seattle. Some firms have been offering their employees incentives to "de-locate" from the Bay Area.

Demand for talent and office space in San Francisco remains elevated, despite soaring business and living costs. The market heads into the second half of 2018 with an availability rate hovering around 10% and much lower vacancy rates. The last six quarters have brought a flurry of activity as tech firms made aggressive moves to lease up any available big blocks of quality space. Leasing velocity and vacancy rates are comparable to 1999 and 2000 and exceed the level of activity attained in the 2007 and 2008 rally.

IPOs have hit their stride, following some weakness in late 2017. Cloud-storage firm Dropbox met some success, raising just under $1 billion in a recent IPO. Of note Salesforce was among the big investors, snatching 4.9 million share. Follows big dropoffs in pricing for Snap Inc and Blue Apron Holdings. Companies not opting for public markets can find ample private equity.

Lull in Development Activity

It is difficult to see how the pace of leasing achieved in the last two years can be maintained. Facebook’s second-quarter

Source: Bureau of Labor Statistics^

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

-10%

-5%

0%

5%

10%

15%

0.00

0.10

0.20

0.30

0.40

0.50Millions

SFO. Office Emp. SFO. (% Annual Change) U.S. (% Annual Change)

Office-Using Employment Trends

$69.15$67.67

$63.51$64.27

$20

$30

$40

$50

$60

$70

$80

Q2'18Q1'18Q4'17Q3'17Q2'17

Rental Rate Trends

Class A Class B&C

Asking Rent Trends ($/sf)

8.9%

12.7%11.9%11.3%

5%

8%

10%

13%

15%

Q2'18Q1'18Q4'17Q3'17Q2'17

Availability Rate Trends

Class A Class B&C

Availability Rate Trends

savills-studley.com/research 03

Q2 2018

Tenant Sq Feet Address Market AreaFacebook 730,000 250 Howard St Financial District SouthCruise Automation 375,000 301, 333 & 345 Brannan St Rincon/South BeachNektar Therapeutics 136,000 360 Third St Yerba BuenaFederal Home Loan Bank 102,288 333 Bush St Financial District NorthWeWork 77,181 353 Sacramento St Financial District NorthAffirm 45,915 550 Kearny St Financial District NorthBlue Shield of California Foundation 28,017 315 Montgomery St Financial District NorthSquare Inc 26,011 1455 Market St SOMABatter Up 16,700 1200 Folsom St SOMAIndustrious 16,381 1700-1750 Montgomery St Waterfront/North Beach

lease for the entirety of Park Tower (181 Fremont) leaves San Francisco’s office market essentially devoid of any new development space for lease. The next building underway, Oceanwide Center will have 1.0 msf of office space but will not be completed until early 2022.

Facebook recently reported that it hired 2,600 employees in the first quarter of 2018 In addition to the 181 Fremont location, Facebook has some employees working out of at least two WeWork centers. Adding to the competition for space, coworking firms are still growing. In addition to heavyweights such as WeWork, local providers such as Canopy and Spaces are adding locations. Other independent operators include Bespoke, TechSpace and Werqwise. Recent analysis from The Instant Group found that the average cost per desk in San Francisco is $1,046, placing it fourth behind Boston, Los Angeles and Seattle.

Sublet Supply on the Increase

Google, recently added 57,299 sf at Hills Plaza (2 Harrison Street) in South Financial District, bringing its lease at the building to just over 400,000 sf. The company is also reportedly in talks with Salesforce to sublet as much as 228,000 sf at Rincon Center. Sublet supply has continued to push higher, hitting 4.0 msf in June for the first time since December of 2009.

Larger tenants with a lease rollover in the next several quarters must be aggressive. There are only four existing buildings offering a contiguous block of 50,000 sf or more. The dearth of space options creates some opportunity for Oakland and San Francisco. Many tech firms are opening up satellite locations in other markets such as Denver, Phoenix and Salt Lake City.

Smaller and mid-sized tenants face challenging conditions as well, but the space shortage is not nearly as acute. On the other hand, there are more than 60 buildings with a block of space between 20,000 sf and 50,000 sf available. Tenants looking for space in Financial District North have the deepest pool of options. There are more than 100 buildings with a block of 10,000 to 20,000 sf. Mid-sized tech firms have remained active. Affirm completed a 46,000-sf lease at 550 Kearny. This is the second location for the fintech company, its headquarters are located at 650 California Street.

Focus on the UpsideIn this climate, buildings with significant

lease rollovers are in high demand. Nearly everyone is focused on the upside right now. Owners with multiple properties can generate upside by moving tenants within their portfolio, particularly considering the lack of big blocks of space. In Yerba Buena, Nektar Therapeutics inked a 136,000-sf lease at 360 Third Street. The 422,214-sf building owned by Kilroy Realty is now 100% leased. Kilroy’s acquisition of the Brannon Street properties has worked out well. Dropbox which previously leased 333 and 345 Brannan Street has leased the entirety of The Exchange in Mission Bay. This cleared a path for Cruise Automation's 375,000-sf lease at 301, 333 and 345 Brannan Street.

Sales Volume Cooling

Investment activity has cooled just a bit, falling to $1.9 billion in total volume in the last six months, down by 29% from the prior six months. Sellers have little reason to buckle if they are not achieving their target

price. Most Bay Area buildings are achieving strong net operating income. Demand is clearly not the issue. There are ample funds looking for assets, including some big local institutional funds. DivcoWest Real Estate Services and CLSTRS, for example, have raised $300 million to buy commercial real estate in gateways and near city cores, including the Bay Area. Office buildings are commanding top dollar. New York-based Northwood Investors paid $300 million ($868.07/sf) for 123 Mission Street.

Looking Forward

The mayor and Supervisor Aaron Peskin have proposed a temporary increase in the development allowance. The ordinance would permit the re-allocation of 1.3 msf that was converted from office to residential use about 10 years ago back to office use. This would enable projects such as Kilroy Realty's Flower Mart and Tishman Speyer's 598 Brannan Street to proceed sooner.

Availability Rate Comparison Rental Rate Comparison

Major Transactions

$74.82

$71.97

$71.43

$66.87

$66.43

$63.13

$62.29

$60.55

$59.31

$57.31

$34.06

$0 $20 $40 $60 $80

Yerba Buena

Financial District South

Rincon/South Beach

San Francisco

Financial District North

Mission Bay/Showplace Square

SOMA

Union Square/Civic Center

Jackson Square

Waterfront/North Beach

US Index

($/sf)

3.3%

5.1%

7.7%

8.8%

9.4%

10.0%

10.6%

11.0%

14.5%

17.9%

23.2%

0% 5% 10% 15% 20% 25%

Mission Bay/Showplace Square

Yerba Buena

Union Square/Civic Center

SOMA

Financial District South

San Francisco

Rincon/South Beach

Financial District North

Jackson Square

US Index

Waterfront/North Beach

(%)

Savills Studley Report | San Francisco

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Map Submarket Total

SF(1000's)

Last12

Months

ThisQuarter

%Change

fromLast Qtr.

YearAgo

5 Yrs Ago

ThisQuarter

ppChange

fromLast Qtr. (1)

YearAgo

ThisQuarter

%Change

fromLast Qtr.

YearAgo

Financial District North 27,915 2,844 3,074 -16.6% 3,531 3,516 11.0% -2.2% 12.7% $66.43 -1.2% $64.96Financial District North - Class A 20,475 1,794 2,209 -13.1% 2,406 2,578 10.8% -1.6% 11.7% $66.68 -1.2% $66.46Financial District South 24,385 3,685 2,286 -19.6% 3,117 2,540 9.4% -2.6% 13.2% $71.97 1.0% $68.22Financial District South - Class A 20,796 3,386 1,582 -33.7% 2,606 2,036 7.6% -3.9% 13.0% $72.66 1.3% $68.80Rincon/South Beach 4,197 850 444 -25.3% 429 499 10.6% -3.6% 10.2% $71.43 2.1% $68.54Rincon/South Beach - Class A 1,544 425 269 48.8% 205 148 17.4% 5.7% 13.3% $75.46 1.3% $69.28Yerba Buena 3,246 676 165 54.2% 345 619 5.1% 1.8% 10.6% $74.82 0.3% $66.68Yerba Buena - Class A 701 227 0 N/A 65 134 0.0% -2.3% 9.3% N/A N/A N/ASOMA 3,772 243 331 0.1% 334 1,235 8.8% 0.1% 8.8% $62.29 -6.8% $71.82SOMA - Class A 1,158 N/A 108 40.4% 99 273 9.3% 2.7% 8.6% $67.85 1.5% $66.36Union Square/Civic Center 3,627 267 280 -17.6% 441 378 7.7% -1.7% 12.2% $60.55 -1.0% $65.26Union Square/Civic Center - Class A 503 0 12 -33.6% 25 31 2.4% -1.2% 4.9% $66.00 0.0% $72.76Jackson Square 1,916 202 277 12.3% 278 199 14.5% 1.6% 14.5% $59.31 -5.5% $63.29Jackson Square - Class A 414 101 N/A N/A N/A 0 N/A N/A N/A N/A N/A N/AWaterfront/North Beach 2,572 126 597 29.9% 263 458 23.2% 5.3% 10.2% $57.31 -0.4% $59.63Waterfront/North Beach - Class A 503 27 88 107.4% 34 207 17.5% 9.1% 6.8% $61.44 -1.5% $58.10Mission Bay/Showplace Square 4,439 1,233 140 -30.6% 334 846 3.2% -1.4% 7.5% $63.13 1.7% $68.47Mission Bay/Showplace Square - Class A 2,676 1,025 25 -66.4% 222 285 0.9% 0.0% 8.3% $77.00 10.2% $69.06San Francisco Total 76,069 10,127 7,594 -13.8% 9,073 10,290 10.0% -1.6% 12.0% $66.87 1.5% $66.55San Francisco Total - Class A 48,769 7,022 4,352 -19.2% 5,749 5,692 8.9% -2.1% 12.0% $69.15 1.3% $67.67

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(1) Percentage point change for availability rates. Unless otherwise noted, all rents quoted throughout this report are average asking gross (full service) rents psf.Submarkets with limited inventory may be subject to larger changes in statistics. Statistics are calculated using both direct and sublease information. Short-term sublet spaces (terms under two years) were excluded. ^Unless otherwise noted, source for data is Savills Studley.The information in this report is obtained from sources deemed reliable, but no representation is made as to the accuracy thereof. Statistics compiled with the support of The CoStar Group. Copyright © 2018 Savills Studley

Savills Studley150 California Street14th Floor San Francisco, CA 94111(415) 421-5900

Branch ManagerSteve Barker - Vice Chairman sbarker@savills-studley.com

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