Silicon Valley’s office/R&D markets still dominant in 2018 — growth driven by tech sector
Cushman & Wakefield’s year-end office and R&D market reports for Silicon Valley revealed a strong annual performance for both sectors overall in 2018. As one of the world’s most dominant and innovative tech markets, these two real estate sectors combined to hit 2.5 million square feet of positive net absorption, or occupancy growth, across the valley in 2018. After a soft first half plagued by deep occupancy losses, the R&D sector quickly shifted course in the second half with red-hot growth. Meanwhile, with gains in all four quarters, the office market had one of its strongest occupancy showings on record.
The office sector achieved 1.8 million square feet of occupancy growth in 2018, nearly doubling its growth totals for both 2017 (960,000 square feet) and 2016 (973,000 square feet).
“Putting this robust figure into perspective, this market has averaged just a slightly higher 2.1 million square feet of growth per annum over the past 10 years, a decade that also included record levels of absorption,” said Julie Leiker, Cushman & Wakefield’s market director for Silicon Valley.
Leiker added, “Meanwhile, after incurring 1.8 million square feet of occupancy loss in the first six months of 2018, the R&D market soared in the final six months of the year with 2.5 million square feet of occupancy growth — both the third and fourth quarters each exceeded 1 million square feet of growth. In all, the R&D market recorded 710,000 square feet of annual net growth.”
While net absorption typically indicates the true growth of the market, gross absorption (or leasing) represents the activity within the market.
In 2018, office gross leasing activity was a solid 13.4 million square feet, on par with 2015 as one of the strongest gross figures in the last 20 years. Meanwhile, R&D leasing activity surged once again in the fourth quarter at 4.9 million square feet, bringing its annual 2018 figure to 15.1 million square feet, on par with the 10-year annual average of 15.2 million square feet.
“And a fair portion of this activity still has yet to be occupied, boding well ahead,” said Gregory Davies, senior vice president with Cushman & Wakefield in San Jose.
Davies added, “Large new deals and or expansions were plentiful in the fourth quarter, and occurred across many different submarkets in the region.”
According to the Cushman & Wakefield, LinkedIn leased a three-building campus totaling 410,000 square feet in Sunnyvale. Lucid Motors expanded by 305,000 square feet in Newark. Proofpoint leased two buildings in Sunnyvale totaling 242,000 square feet. ARM renewed and expanded into 155,000 square feet in North San Jose. Alibaba expanded (and renewed) into a total of 166,300 square feet in Sunnyvale, growing from just 35,000 square feet. Google took another Mountain View building totaling 151,000 square feet. ServiceNow expanded by 130,000 square feet in Santa Clara. Tesla added another 110,000 square feet in Fremont. WePay preleased an 119,000 square feet building under construction in Palo Alto. Micro Focus leased 112,000 square feet in Santa Clara. WeWork leased 75,000 square feet in Downtown San Jose. Meanwhile, after leasing 472,000 square feet last quarter, Roku expanded within the Coleman Highline project in the San Jose Airport with a 103,000 square feet lease. Adding to the strong leasing velocity in the fourth quarter, another trend emerged according to the report, user sales. Google acquired a total of 1.5 million square feet in the fourth quarter, while the County of Santa Clara purchased four vacant buildings in South San Jose totaling 440,000 square feet.
Silicon Valley office vacancy slid into single digits to 9.8 percent during the fourth quarter 2018, declining from 10 percent in the third quarter. This figure is also well below its rate of 10.9 percent a year ago. As well, R&D vacancy also slid into single digits to 9.6 percent during the fourth quarter, down from 10.3 percent in the third quarter.
Drew Arvay, managing director with Cushman & Wakefield in San Jose, said, “Single-digit vacancy is typically a milestone as it indicates market health and strength; however, even with improving vacancy figures, sublease space still remains a considerable component of the market — more so on the office side of the equation — and something we are monitoring closely.”
He continued, “Per our data, vacant office sublease space now accounts for nearly a third [30.5 percent] of all vacant office space, up from 26.3 percent in the third quarter and double its 10-year average of 15.5 percent. In the R&D sector, sublease as a percentage of all vacant R&D space dropped slightly to 19.7 percent, down from 20.3 percent in the third quarter. An improvement, but still relatively high.”
Leiker also added, “If the economy steams ahead, we fully expect sublease inventory to drop, however.”
The average asking rent for all office space increased a nickel in the fourth quarter to $4.56 per square foot on a monthly full service basis, up from $4.52 per square foot in the third quarter. Despite strong activity, office rents have remained relatively flat overall, largely due to the significant role of sublease space. Meanwhile, R&D asking rents also moved upward to $2.42 per square foot on a monthly triple-net basis, an increase from $2.33 per square foot the prior quarter. Sublease space, almost always a factor to tempering rent growth, dropped below 20 percent for R&D fueling an uptick in rents. R&D rents have now risen 9.5 percent year-over-year from $2.21 per square foot.
Arvay noted, “Although sublease space represents close to 25 percent of total availability combined in the office/R&D sectors, single digit overall vacancy plus demand could help increase upward pressure on rents.”
New construction continues to advance and revolutionize the Silicon Valley landscape and importantly help fuel growth and demand for today’s modern and expanding companies. Per the report, there was 5.8 million square feet of new office/R&D product under construction at the close of 2018, split by office at 3.8 million square feet and R&D at 2 million square feet.
Arvay said, “Notably, 2.9 million square feet or more than 75 percent of the office development is already preleased, whereas the remaining 900,000 square feet may hit our vacancy stats in 2019 unless preleased prior to completion.” He continued, “The R&D sector however tells an even more positive tale. New R&D product under construction in Silicon Valley consists of 1.1 million square feet of build-to-suits and 900,000 square feet of speculative product. However, with 100 percent of all speculative R&D space preleased, the combination of build-to-suit and spec construction (2.0 million square feet) is completely committed. On the coattails of this success, several developers are evaluating the start of their next phase.”
The report also discussed the Capital Markets sector, with investors certainly keen to the leasing trends boosting the Silicon Valley office and R&D sectors. They have also remained flexible in their pursuits.
Eric Fox, executive managing director with the firm’s capital markets in San Jose, said, “With a backdrop of major expansions by technology tenants throughout the Bay Area, investor optimism for tech-driven real estate has been strong. Treasury rates have bounced around, but for the most part, real estate debt has remained low priced and plentiful. With record pricing on the western side of Silicon Valley and the San Francisco Peninsula, value-add opportunities have been more readily available in the eastern submarkets. The in-fill suburban markets have been notable for transactions with mixed profiles — partially value-add with a component of stability and in-place income.”
Fox noted, “As downtown San Jose has emerged as a transit and tech hub, investors remain focused on the developing transit corridor along the eastern Bayshore [San Jose through Oakland].”
Leiker projected, “Technology tenants continue to dominate the growth statistics in both leasing and user purchases. Based on our tenant tracking, there are currently a total of 10.5 million square feet in active requirements geared to the office/R&D markets as corporate employers continue to search for space to house their increasing employment base. Taking into account our robust demand tracking, impressive gross leasing activity [not yet occupied], and the fact that most new construction is already spoken for, we remain optimistic for Silicon Valley looking ahead into 2019.”
