California’s commercial real estate market (including office, retail and apartment properties) performs on various levels across the state based on that region’s:
- labor market;
- demographic makeup (educational attainment and income level to name a few); and
- construction activity.
For instance, San Francisco has an extremely low vacancy rate on top of quickly growing commercial rents. That’s due to the region’s:
- strong labor market (fueled by the tech industry);
- high income levels (again, fueled primarily by the tech industry); and
- little construction activity, which is greatly hindered by archaic zoning regulations.
This high-demand, low-inventory, bad-zoning situation has created a bubble in San Francisco not just for commercial real estate, but residential, as well. Read on for a glimpse into the commercial markets in other California metro areas. All data is courtesy of REIS.
The office vacancy rate varies widely across California. Both the top and bottom vacancy rates in the nation can be found in California, at:
- 12.6% in San Francisco; and
- 23.6% in San Bernardino/Riverside.
Contrast this with the average nationwide vacancy rate of 16.8%.
Effective rent (the rent paid by tenants minus any concessions provided by the landlord) in the office sector showed positive growth in Q2 2014. Four of the nation’s ten metro areas with the highest year-over-year rent growth were found in California. In Q2 2014, effective rent was up over the past 12 months by:
- 6.4% in San Jose;
- 5.1% in San Francisco;
- 3.2% in Los Angeles; and
- 3.1% in San Diego.
The national 12-month average change in effective rent was 2.5%.
California retail vacancy rates were (relatively) low during Q2 2014, with six of the ten lowest vacancy rates in the nation found in our state’s metro areas. The vacancy rate for retail properties in Q2 2014 was:
- 3.5% in San Francisco;
- 4.5% in San Jose;
- 5.3% in Orange County;
- 5.8% in Los Angeles;
- 6.2% in Oakland-East Bay; and
- 6.3% in San Diego.
Each of these metro areas have vacancy rates well below the national average of 10.4%.
Effective rent growth occurred over the past 12 months at a rate of:
- 2.9% in San Francisco; and
- 2.7% in San Diego.
Nationwide, the average growth in effective rents was 1.8% over the past 12 months.
All bubbles must pop. For example, let’s return to San Francisco’s market. Office rents rose by 5% over a year earlier in Q2 2014 — well above the rate of consumer price inflation (CPI) experienced in San Francisco during that time, which was 2.4%. Retail rents rose in a more stable manor at 2.9% over a year before (though still above the rate of inflation).
Rents tend to move with the CPI. That is, they move at a steady pace of 2-3% a year, absent extra market factors. In fact, long-term non-residential lease agreements often contain a provision tying changes in rent to the CPI (say, three percent per annum). This covers the negative effect inflation has on the landlord’s rental income.
Thus, the ballooning office rents experienced not just in San Francisco but across much of the state are unsustainable. People (and businesses) can only pay so much as their reported earnings allow. Expect the rise in rents to subside in the next year, more in line with CPI.