San Francisco’s Office Market Favored Life Sciences in Q1 – What is a Ground Lease?
News, Office, San Francisco, West, #MarketUpdate, CommercialEdge
San Francisco’s office market continued at a sluggish pace through the first quarter. Vacancy failed to improve, with most large deals being subleases. Most development activity is concentrated in the southern portion of the metro, especially in South San Francisco, as traditional office users have put expansion plans on hold. Meanwhile, the continued growth of life sciences has led to a race by developers to capitalize on this need.
Life sciences dominate development
As of March, San Francisco had 7.8 million square feet of office space under construction across 39 properties, representing 5.1 percent of existing stock—almost triple the national average of 1.8 percent. The metro’s pipeline as a percentage of existing stock grew by 150 basis points year-over-year.
The impact of the life sciences industry on the office market brought San Francisco in line with other metros where this sector is thriving, such as Boston (5.5 percent of stock underway) or San Diego (5.3 percent). Compared to other gateway markets, San Francisco’s office construction pipeline stood at the top. It was followed by Miami (3.3 percent), Manhattan (2.0 percent), Chicago (1.2 percent) and Los Angeles (0.9 percent).
The largest development underway was Kilroy Oyster Point’s three-building second phase, dubbed Gravitate, which broke ground last year. The $940 million project, developed by Kilroy Realty Corp., will offer 750,000 square feet of office space in South San Francisco and is expected to come online in 2024.
Construction starts during the first quarter amounted to 1 million square feet of rentable office space across three properties—all of them are marketed as offices for the life sciences sector. These three projects were also among the top five largest developments underway in the market.
The largest of these was Lane Partners’ first phase of Southline, comprising 715,000 square feet of office space across two buildings, in South San Francisco. In January, the developer received a $373 million financing package for the project, which is estimated to have a total cost of $1 billion and comprise approximately 3 million square feet of office space once fully completed.
The third property that broke ground during the first quarter was Longfellow Real Estate Partners’ Avia Labs at Millbrae Station, a 315,000-square-foot property set to comprise lab and office space and to achieve LEED Gold and Fitwel certifications. In March, the developer received a $310 million construction loan for Avia Labs, from Otera Capital.
The South San Francisco submarket had by far the largest share of the construction pipeline, with 3.7 million square feet underway as of March. It was followed by Redwood City (1 million square feet), San Francisco-SOMA (840,000 square feet) and Burlingame (700,000 square feet).
Office vacancy still struggled
San Francisco’s office vacancy stood at 19.1 percent as of March, down only 10 basis points month-over-month. The market’s rate was 240 basis points higher than the national average. With return-to-office sentiment still wavering, along with companies downsizing or pausing expansion plans, the metro’s vacancy remains the highest among gateway markets, except Chicago, which was on equal footing (19.1 percent). It was followed by Phoenix (18.2 percent), Manhattan (16.5 percent), Los Angeles (14.7 percent) and Miami (11.9 percent).
Despite sluggish leasing activity, with most large deals being subleases, the average listing rate of stabilized assets stood at $66.1 as of March, up 4.9 percent year-over-year and among the most expensive in the U.S. The national rate was $38.2, and only Manhattan recorded a higher rate, at $74.2.
Both sales volume and average prices dropped
Eight properties changed hands during the first quarter in San Francisco, generating $316.4 million in sales. Sales volume dropped by 38.6 percent from 2022’s first quarter. The average price per square foot of stood at $520 in March, significantly above the national average of $195, but down 33 percent year-over-year.
Despite a decline in prices, San Francisco remained among the most expensive metros in the U.S., exceeded only by Manhattan ($1,002 per square foot on average), The Bay Area—comprising the East and South Bay ($604) and Boston ($555).
The largest sale of the first quarter occurred in the South Financial District submarket—The Sobrato Organization purchased the 156,512-square-foot One Harrison from Gap, for $80 million, or $511 per square foot.
Another notable sale was of the newly constructed, 56,000-square-foot Southbridge Plaza, at 345 Fourth St. in the SOMA submarket. Taipei Economic and Cultural Office acquired the property for $52.8 million, or $880 per square foot, from Tarsadia Investments. The new owner will occupy the entirety of the office space.
Morgan Stanley closed on the most expensive transaction on a per-square-foot basis. The company acquired a medical office building at 321 Middlefield Road in Menlo Park, for $68 million, or $1,404 per square foot. The seller was Pollock Financial Group.
More coworking providers appear
San Francisco had flexibile office space accounting for 1.8 percent of its entire office inventory, standing slightly above the 1.7 percent national value. The largest flexible office markets, represented as a share of total office space, were Brooklyn (5.2 percent), Miami (3.3 percent) and Manhattan (2.8 percent).
The growing demand for more flexible space in the market continues to attract more providers, as well as prompt existing ones to expand their portfolio. In January, Pacific Workplaces opened its second location in San Francisco—the new location measures 10,798 square feet at 2001 Van Ness Ave., in Pacific Heights.
Last month, AvantSpace announced plans to open a 10,000-square-foot coworking space in San Rafael, at 835 5th Ave., within a 12,976-square-foot historic building.
Convene opened its first coworking spot in the market in November last year, at 100 Stockton St., in the North Financial District. The 65,000-square-foot location is within a 265,000-square-foot building that is currently undergoing a mixed-use renovation and is set to open in the second half of the year.
CommercialEdge covers 8M+ property records in the United States. View the latest CommercialEdge national monthly office report here. We included properties of 25,000+ square feet in our research.
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First quarter office market fundamentals continue to highlight San Francisco’s strong life science sector.
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In the simplest form, a ground lease is a long-term net lease (usually 49 years or 99 years) of land including any improvements on the said land. Assets that can be subject to a ground lease include but are not limited to, vacant land, office buildings, and large residential buildings.
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