Tenant, investor demand grows in 2014
By Dave Peterson, Keegan & Coppin Co., Inc./ONCOR International
The Santa Rosa office market remains in transition gaining momentum as the first quarter of 2014 comes to a close.
The past few years have been some of the most challenging for office building owners in decades. While unemployment continues to fall, it appears that most of the jobs have been outside of the office-user type, as there has been very little growth in office demand. Hiring for jobs in the retail, tourism and industrial sector are likely the result of the decreasing unemployment numbers as well as the cause of the increased demand we have recently seen those sectors of the commercial real estate market.
However, since the first of the year, we have seen an increase in tenant demand and office-space tours, likely the result of continuing optimism and rising business confidence. In addition, investor demand for office properties has returned, with the most activity for “value-add” opportunities. We anticipate this increasing interest in the office market to continue through 2014.
The vacancy rate for Santa Rosa office space was 18.2 percent at year-end, up from 16.8 percent in the fourth quarter of 2012. Office rents have remained relatively flat over the past 12 months and continue to vary greatly based on the quality and location of the property. Those rents on a full-service basis per square foot currently are $1.25–$1.35 on the low end and $2–$2.50 for the highest-quality class A properties.
Incentives amid stabilization
Tenant inducements such as free rent and/or turnkey improvement packages are still prevalent in most lease transactions. Many owners continue to desire higher contract rates while providing free rent to effectively reduce the rent in the tenant’s eyes.
Foreclosure sales have decreased substantially over the past six–12 months, and prices are increasing. While from 2009–2012 it was fairly common to find office buildings at 40 percent to 50 percent below replacement value in the $100–$125-per square-foot range, those opportunities are dwindling.
We anticipate continued upward pressure on pricing as property owners are on stronger footing and not as motivated to sell. However, it is feasible that we see a few more bank foreclosures come to the market as loans become due.
Those who financed at the peak of the market and subsequently signed lease transactions at the bottom of the market are likely to find that they are unable to refinance without contributing additional capital or increasing rental income. Banks have fewer troubled properties on their books and appear to be more aggressive in pursuing foreclosure versus renegotiating loans.
New downtown office space
The most significant development to come to the market in the near term is the Museum on the Square project in Downtown Santa Rosa. Hugh Futrell is re-developing the 4 story property with anticipation of construction commencing in the 2nd Quarter and completion around year end. The building is 75 percent preleased with only one floor of office and restaurant/retail space on the ground floor remaining to be leased in this sure to be iconic property. It will be the first office building to be built in Santa Rosa since 2005 and demonstrates the developer’s confidence in the market.
I tend to agree with Mr. Futrell and think we will continue to see improvement across all quality types with reductions in vacancy and increasing rents. The market is showing signs that it is improving and high quality office space availability is limited to only a few options. Companies considering moves should start exploring options in the near term in order to take advantage of the opportunities before the best deals are taken.
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