By J.K Dineen, Reporter, San Francisco Business Times
Technology leasing may have cooled off a bit in the first half of 2013, but San Francisco’s office building developers are just warming up.
At a time when leasing velocity has slowed to a three-year low, a well-capitalized roster of institutional builders, both local and national, is roaring ahead with the biggest crop of downtown office buildings San Francisco has seen since the boom of the 1980s, which brought towers like 101 California St., 333 Bush St., 123 Mission St. and 50 Fremont St.
Approximately 2 million square feet of new or totally rehabbed office space is under construction, and developers are gearing up to break ground on 2.5 million square feet more, according to Jones Lang LaSalle. Of the six new developments that have broken ground or are expected to this year, five are being developed speculatively. Of the total development pipeline, 1.3 million square feet, or 30 percent, has been preleased.
At 350 Mission St., Kilroy Realty Corp. has started on a 444,000-square-foot building preleased to Salesforce. At 505 Howard St., Tishman Speyer is wrapping up construction on Foundry Square III, a 280,000-square-foot LEED gold mid-rise to be delivered early next year, while Boston Properties has started work on a 307,000-square-foot tower at 535 Mission St. Meanwhile, Jay Paul Co. has obtained a demolition permit at 181 Fremont St., where it will build a 400,000-square-foot tower with 75 residential condos on the top floors.
And at 101 First St., Boston Properties and Hines are going to start excavation this fall on the Transbay Tower, a 1.6 million-square-foot landmark that will be San Francisco’s tallest skyscraper. In the early fourth quarter, Kilroy will start on 333 Brannan St. — a six-story, 180,000-square-foot building meant to be a modern take on the 19th century brick and timber structures popular with technology tenants, said senior vice president Mike Sanford.
“It’s the kind of building you feel comfortable going spec on,” said Sanford.
San Francisco’s leasing market remained slow in the second quarter, logging 131,000 square feet of positive net absorption as growing tech companies prepare to move into the vast amount of space they leased in 2011 and 2012, according to Jones Lang LaSalle.
For the first six months of 2013, tenants took 415,000 square feet more than they gave up. While the trends are positive, leasing is down 40 percent compared with the first half of 2012. In 2011 and 2012, the city saw 23 leases over 100,000 square feet in San Francisco. This year there haven’t been any.
The trend may be in part a result of rising rents. Rents have climbed to an average of $52 a square foot, up 71 percent since 2010, according to CBRE.
“There is a difference between doing a deal in the $30s or $40s and the $50s or $60s,” said Sanford. “When rents are higher, there is going to be more scrutiny so those deals take longer.”
Still plenty of tenants are out looking for space. There is currently 6.5 million square feet of active demand, a 7.7 percent increase from a year ago. San Francisco has added 7,400 jobs since the start of the year and now has an unemployment rate of 5.4 percent.
“It may not be as frothy as the end of last year, when you had companies like Square going from 30,000 to 300,000, but we still see strong demand,” said Mark McGranahan, a managing director with Cushman & Wakefield. “We are starting to see increased demand from law firms and financial institutions.”
McGranahan said that rising construction costs may also be giving pause to some tenants. “The biggest barrier is less about rent, but the capital budget required to move from building A to building B,” he said.
This is also a slow year for lease expirations, with just 950,000 square feet of existing leases over 40,000 square feet rolling over. In contrast, 2014 has 1.5 million square feet of roll over and 2015 will bring 3 million square feet.
To go or to slow?
Still some bullish developers could hit the pause button if leasing doesn’t pick back up. Tishman Speyer has indicated it would probably not break ground on the Foundry Square project until it has a tenant. Both Jay Paul’s 181 Fremont St. and Kilroy’s 333 Brannan St. will likely go this year, but Hines and Boston Properties could take a more cautious approach at the Transbay Tower. The excavation and foundation work will take a year, giving the developers an opportunity to reassess the market before going vertical, said Tony Natsis, a partner with Allen Matkins.
“At any point in time if they don’t think the market is cooperating they could go slower, without stopping construction,” he said. “On the other hand, it’s not a project that needs to hit the market in a particular cycle and they are going to own it forever.”
The deals done in 2011 and 2012 will continue to pay dividends for landlords in the second half of this year, said Julia Georgules, JLL’s research manager for Northern California. Yelp, Autodesk, Airbnb, Square and other startups will move into space leased last year, representing about 650,000 square feet.
In addition to new buildings, 10 major buildings are under renovation including One 10th, 680 Folsom St., 888 Brannan St., 155 Fifth St. and 140 New Montgomery St. Those four buildings represent 1.8 million square feet, 1.2 million square feet of which has been leased.
Jim Collins, vice president of leasing at Shorenstein Properties, said the firm is in negotiations with tenants at One 10th St., a 1970s building behind Twitter’s 1355 Market St. headquarters.
Georgules said any downturn would likely be mild compared with down cycles of 2000 and 2008. Tech companies are making sensible real estate decisions.
“These are companies with such wide user bases, with millions of members,” she said. “For the most part, they are being conservative about space and cautious about the IPO market. The impact of 4.5 million square feet of new inventory is not dire by any means.”