L-R: Scott Pritchett, Woodmont Real Estate Services, President of Commercial Operations, BOMA member and panel moderator; LaToya Ross, Hudson Pacific Properties, Inc., Senior Property Manager and BOMA SV Programs Committee Chair; Michelle Piazza, TMG Partners, Senior Property Manager and BOMA SV 2023 President; Mark Christierson, CBRE Executive Vice President and Office Market Panelist; James Chung, The Econic Company Founder and Retail Market Panelist; Gene Williams, Valbridge Property Advisors, Managing Director and Capital Markets Panelist.

Scott Pritchett, CPM^®, welcomed the luncheon crowd of approximately 130 property managers and building service providers with some opening remarks, which included a reminder that despite current headwinds, California is still the 5^th largest economy in the world by GDP “even if we are in a recession that isn’t being called a recession yet.” He pointed out that while the Bay Area still receives more venture capital funding than any other U.S. region, overall venture funding fell dramatically in 2022 – to $445 billion, compared with $681 billion in 2021. Pritchett declared that he was in the camp that some form of remote and hybrid work will become permanent.

Retail specialist James Chung started his overview of Silicon Valley’s and San Francisco Peninsula’s retail market by pointing out how resilient retail has proven, and it’s evident in some of the numbers. For example, even if the Peninsula’s retail vacancy rate is currently 5.5%, compared with its usual range under 3%, it is still lower than the national average for retail vacancy, currently at 5.7%. The South Bay retail market is tight at 4.5%, and the past 12 months there was a 2.9% growth in retail rental rates in the submarket. The Peninsula did not fare as well with rents in the recent 12-month period, which dipped 3.9%. Chung said that since 2007 there has been very little new inventory added to both submarkets, the consequence of which has put significant pressure on existing inventory and therefore, high rates of occupancy.

Humorously, Chung cited “revenge spending” by consumers coming out of the pandemic as one reason why the region’s retail real estate has outperformed other markets in the U.S., adding that for the past few years there has been a significant flight to quality (space) by retail tenants and occupiers.

Other trends of note include that the pool (demand side) of larger format retail tenants has waned, but that it is the opposite for second generation restaurant space—meaning former restaurants with stoves, ovens, refrigeration and related operating infrastructure, which has soared and is getting a lot of attention from restauranteurs. Moreover, he asserted, that there has been, and there will be less discussion around ‘creative repurposing’ of what formerly was considered surplus retail space.

Mark Christierson’s office market presentation began with the core data points on vacancy, and namely that Silicon Valley’s office vacancy rate ended 2022 at 14% (not bad compared with other U.S. markets) while R&D space had a vacancy rate of 10%, which historically is considered at equilibrium between landlords and tenants. Overall, however, Christierson described the current environment as one of concessionary – where tenants have greater purchasing power and landlords have to make concessions to get leases signed. Regarding tech company layoffs, one of his slides listed the major tech companies based locally, as well as in Seattle, Los Angeles and Pittsburgh, that have a Bay Area tech presence. That slide asserts there have been 9,541 positions eliminated in the Bay Area – a fraction (2%+/-) of the nearly half million information technology workers in the Bay Area as of 2021.

As for the hybrid/remote conversation, he pointed out that office workers have greater flexibility to work remotely whereas many lab-based professionals are more inclined to work in their offices, where their testing, diagnostic and assembly equipment is located.

That said, one of the slides he showed featured the U.S. Back to Work Barometer by Kastle Systems, the card swipe company, which showed the San Jose metro (it includes other core valley cities such as Sunnyvale, Santa Clara, Cupertino) ranked 7^th out of the 10 metros Kastle tracks, with 47% office occupancy as of Jan. 25 this year. Austin topped the list at 68% while San Francisco was at the bottom, with 41% office occupancy that week in late January.

One of the dynamics of 2022 was the false start early in the year, which led the brokerage community and perhaps landlords to think “we’re back” after the pandemic’s leasing lull, yet the year ended with a dud, and not a single lease over 100,000 square feet was signed during the fourth quarter. That was the first time that had happened in five years, he said. As for 2023, with a base office and R&D inventory of 100 million square feet and only about 2.5 million square feet of new office space set for delivery this year, Christierson thinks the market will easily absorb the new space. One of the reasons for the region’s relative stability in the office and R&D sectors, Christierson pointed out, is that almost a quarter of the space – 25 million square feet, is either leased or owned by Apple and Google’s parent company, Alphabet.

On trending topics and where the office/R&D markets go next, according to the CBRE veteran of 23 years, tenants want best-in-class space (recently updated or new construction), quality finishes, flexible and efficient floorplans, view space and a mix of collaborative and private offices. Office occupiers are also demanding proximity to restaurants, proximity to housing as well as public transportation and EV charging facilities in their buildings. Common spaces, including training rooms, outdoor areas, workout facilities and conferencing centers are other features that will attract tenants to one building over another.

Christierson also believes that hybrid work is here to stay and that local tech companies are striving to be ‘agile’ with their occupancy strategies and commitments, and will likely continue the trend of executing short-term renewals when leases come due.

Gene Williams’ presentation featured a few nationally-focused comments as well as perspective on local market conditions. He said that his company, Valbridge, is expecting an overall 10% to 20% decline in office valuations and that will vary significantly by market and from city to city. He cited CoStar data that predicts office rents and sale pricing will be flat for the next 2-3 years. Williams also cited Silicon Valley industrial rents, which at $440-per-square-foot (psf), are among the highest in the nation. Industrial rents locally increased year-over-year by 12%, which is actually on par with many markets across the U.S.

When he spoke about capital market trends, Williams noted that loan rates have essentially doubled in the last year and are now in the low-to-mid 6% range – and potentially could go to 8% if the Fed keeps raising the core interest rate. In fact, interest-only borrowers will suffer the most with rates already in the 8+% range, he said. The veteran appraiser also asserted that loan funds and bridge loans are beginning to take the place of commercial banks and permanent loans. However, there is a “wall of capital” waiting for prices to stabilize and to be invested.

Some of that money could end up invested in discounted San Francisco office buildings—if and when they do go on sale. Noting that there have been significant office property defaults in Los Angeles and the East Coast, Williams shared that a colleague of his – a capital markets broker in San Francisco, told him that a few office buildings in the city that were recently valued at $900-$1,000 psf are now worth closer to $250-$300 psf. His outlook for the remainder of 2023 was honest: “There are too many variables to predict what is going to happen the rest of this year.”

The phrase, Transit-Oriented Development (TOD) burst into our lexicon in the 1990s, as urban planners sought solutions for some of our most-pressing challenges, and namely, the chronic shortage of housing and long commutes with clogged freeways and congested side-street traffic. Higher density housing that is closer to employment centers has evolved into one of the most common development proposals across municipalities throughout California, often despite community opposition.

Against this backdrop we are pleased to announce that we have been awarded the management (both multifamily and commercial) of Gateway @ Millbrae Station, a transit-oriented development by Republic Urban Properties that has been called the largest multi-modal mixed-use development west of the Mississippi River.

Located on Millbrae Avenue on the San Francisco Peninsula, the new community with offices, shops and restaurants offers a Caltrain and BART stop, it is one block off Highway 101 and is ideally situated within one mile of San Francisco International Airport. Gateway @ Millbrae Station is also served by bus and ride-sharing services.

Multifamily Market Roundup

After a 10-year (or so) upcycle in Northern California’s market rate housing – single-family and multifamily, the Federal Reserve’s efforts to tame inflation by the most aggressive series of Fed Funds rate hikes since the early 1980s has brought the housing market down to more traditional levels of activity in all the major metrics, including sales, and rental rate growth.

The softening rental market follows an unprecedented run for the apartment industry that was put into motion by the pandemic. Pent-up demand for housing exploded in the months after the introduction of Covid-19 vaccines in late 2020 and a surge in apartments lifted rents 25% over two years. That represents a national data point from the listing website Apartment List. In California, law prohibits rental rate hikes of more than 10% annually but it’s a fair estimate to say that rents in Northern California increased 15% to 20% from mid-2020 to mid-2022.

Nationwide, Apartment List reports that renters with new leases in January this year paid on average 3.5% lower than they would have in August of 2022, and for the first time in five years rents declined for six consecutive months across the U.S.

Northern California, however, has rarely followed national trends as it relates to real estate and the current times are not much of an exception. Notwithstanding the number of tech companies in our region that have announced layoffs, the broader perspective indicates employers have not reduced their workforces dramatically and employment remains high. As such, Woodmont’s portfolio of multifamily communities maintains a healthy 95% occupancy level, and while the market has cooled, the company expects rental rates will increase, on average, 4% this year.

What will change a bit more dramatically is capital budget deployment, which translates into fewer owners opting for large scale renovations this year or next. For example, that big clubhouse remodeling project may be deferred a year or two, yet all multifamily owners will still invest in regular maintenance programs. The reason is not only the current cost of money, but the cost of construction – especially labor, which has driven improvements and ground-up construction substantially upward.

For example, in our conversations with multifamily developers, we have been told what used to be a $300-per-foot construction budget for new apartment communities is now running $400-$500 per foot, to the degree that some projects don’t make financial sense to start now. If developers have already broken ground and completed infrastructure, they will move forward. However, most likely they will not start construction in the current environment.

Notably, the development community has not stopped seeking out multifamily development deals. Yet again, the current approach seems to be “get the deal permit ready” rather than break ground.