2015 Forecast

San Francisco Bay Area Commercial Real Estate 2015 Forecast

Your comprehensive guide to trends impacting the commercial real estate market. We are pleased to share with you our San Francisco Bay Area Commercial Real Estate 2015 Forecast. This report is an annual review and forecast that summarizes the trends impacting commercial real estate in each of the major Bay Area markets.

This guide offers forward-looking analysis in addition to summaries of recent activity for office, R&D, industrial, retail, investment and multi-family real estate throughout the Bay Area. We examine both leasing and investment trends as well as the underlying economic fundamentals that drive our marketplace. This report represents only a fraction of our research capabilities. Working in unison with our brokerage staff, DTZ research maintains the region’s largest database of properties, tenants, landlords, buyers, sellers, availabilities, and deal comparables of all types. Our research department publishes detailed quarterly snapshots and reports covering all of our markets and we provide custom analytics for our clients. Contact your DTZ broker to get on our research mailing list to regularly receive research publication notifications. Table of Contents

Message from DTZ 5

Company Overview 6

Economic Outlook 10

Commercial Real Estate Outlook 20

Infographics 48

Top Lease Transactions by Market 50

Credits and Terms 55

Challenging the Conventional

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To Our Valued Clients, Heading into 2014 we were confident that it would be a Make no mistake about it. You will still be dealing with the strong year for the Bay Area’s economy, for commercial real same people and the same dedication to excellence that estate in the region and for our firm. And while we thought earned us the moniker “The Challenger Brand,” but as DTZ the bar would be set high, all of us may be a little surprised you will now have access to a global, best-in-class Corporate at just how strong a year it was for the economy, for the Services platform, with broader coverage and depth of region, for commercial real estate, and certainly for us. in-house Facilities Management services. You will have access to expanded Tenant Representation capabilities in We’ve been publishing an annual forecast report of the Bay the Americas as well as Europe and Asia. And our Capital Area for years. Seemingly, ages ago we were one of the Markets platform will expand to Europe and Asia, where strongest players in the region. Just five years ago came our DTZ is dominant in key markets. It is ranked #1 in China for national affiliation with Cassidy Turley and for a number of investment sales transactions with over 50% market share years we published this report as one of the region’s most and is ranked #3 in London and the United Kingdom. This dominant firms, Cassidy Turley BT Commercial. It was also will vastly expand our reach and capabilities whether we as a proud member of one of the fastest growing and most are talking about finding global investment opportunities successful brands in the history of our industry. By last year for you or gaining access to foreign investors. our forecast book was released under the Cassidy Turley banner; the small upstart firm that we had joined just a few This was a decision that we made following a period of years before was now a unified entity known throughout the intensive due diligence. You can be assured that we will industry as “the Challenger Brand.” And now, as we head continue the traditions of Cassidy Turley by maintaining into 2015, we find ourselves once again releasing our annual our roots of superior local service and close personal report, the inaugural edition under our new banner, DTZ. relationships even while we expand our capabilities throughout the world. Our professional’s focus on We know that all of these different brand names may operational excellence and client service, as well as our sound confusing, but the story is actually as simple as it clients’ continued confidence in our people and platform, gets. That story is one of growth and of us building our positioned us for this opportunity to combine with DTZ. capabilities to better serve you, first locally, then nationally Together, the combined companies will create a game- and now globally. We’re still the same people and the same changing organization – for you, our clients, and for the company. But our growth has never been about becoming entire industry. the biggest; it’s been about becoming the best. So while it may be true that we are bigger now, we are more proud of Best wishes for a prosperous and productive 2015! the fact that we are even better now.

By joining forces with DTZ, we have immediately created a top three global commercial real estate services firm. Our combined company now has more than 28,000 employees across more than 265 offices in 50 countries with revenues Mike Kamm of more than $2.9 billion. Whereas Cassidy Turley had a President, US Western Region legacy of strong local market leadership and presence in the U.S., our merger with DTZ gives us full-service capabilities throughout Europe and Asia as well as enhances our domestic Corporate Services and Facilities Management platform. Most importantly, it allows for us to help you, our Gregory Moss Challenging the Conventional clients, more effectively anywhere in the world. Regional Managing Principal, Northern California

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 5 A global leader DTZ is a global leader in commercial real estate services. With beginnings in 1784, our legacy of strong local market leadership today extends to serve clients with progressive, full-service property solutions around the world.

Tenants, occupiers and investors rely on DTZ’s industry-leading advisory, brokerage and management expertise. Our 265 offices in 50 countries offer our clients global reach and the complete range of services on any scale, large or small. We deliver outstanding quality and customized solutions with speed, creativity and effective results.

Our talented team, 28,000 strong, operates in a service culture of exceptional client care. Every one of us is dedicated to creating the best solutions and the most rewarding experiences for our clients everywhere. 265 50 $63B* offices countries transaction volume 28K $2.9B* 3.3B sf employees revenue management portfolio

*(U.S. dollars)

Country coverage DTZ Office Locations DTZ Global Headquarters Australia Malaysia Chicago, Illinois Bahrain Mexico Belgium Netherlands Canada New Zealand China (Hong Kong Norway & Taiwan) Pakistan Croatia Papua New Guinea Czech Republic Poland Denmark Qatar Estonia Romania Fiji Saudi Arabia Finland Singapore France Slovakia Germany South Africa Hungary Spain India Sweden Indonesia Switzerland Italy Thailand Japan Turkey Jordan Ukraine Kazakhstan United Arab Emirates Korea United Kingdom Latvia United States Lithuania Vietnam Luxembourg

6 www.dtz.com A global leader

DTZ is a global leader in commercial real estate services. With beginnings in 1784, our legacy of strong local market leadership today extends to serve clients with progressive, full-service property solutions around the world.

*(U.S. dollars)

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 7

Core services

DTZ powerfully combines specialist real estate brokerage, investment consultancy and leasing agency services with day-to-day property and facilities management for both investors and occupiers across all commercial property types.

Our clients can select from a vast menu of core, comprehensive lifecycle services, from brokerage transactions, investment and portfolio management through integrated facilities management, maintenance and janitorial, energy and sustainability services. We are fully accountable to each project we undertake, from preliminary planning through closeout and beyond.

We take pride in our full-service capabilities throughout the lifecycle of the project or asset, always on time and often beating the budget. Our unbeatable track record of customer satisfaction and our long-term, loyal client partnerships are rooted in our delivery of the right solutions on time, at the right time.

Agency/project leasing Capital markets Energy & sustainability services Landlord representation Debt placement Energy audit and consultancy Office, industrial, retail leasing Investment sales Energy management systems Owner occupier sales Acquisitions/dispositions Green mark and LEED certifications Subleasing services Structured finance Metering management Government services Real estate investment banking Environmental strategy, systems, reporting, procurement and program delivery

Project management Property management Strategic consulting Design and concept planning Accounting and financial reporting Market research Procurement and bid management Building maintenance and engineering Labor strategies and analytics Move management management Portfolio optimization Technical due diligence Contract and vendor management Location and metro planning Value engineering and cost Due diligence Workplace strategy and change consultancy Tenant retention management Transitions and quality control Business and economic incentives

Specialty sectors and services Banking/financial Data centers Energy/oil and gas Government Higher education services Education Food and beverage Healthcare Hospitality

8 www.dtz.com Core services

Agency/project leasing Capital markets Energy & sustainability services Facilities management Global occupier services Investment and asset management Landlord representation Debt placement Energy audit and consultancy Financial planning and management Facilities services Investment management Office, industrial, retail leasing Investment sales Energy management systems Strategic sourcing and vendor Facilities management Asset management Owner occupier sales Acquisitions/dispositions Green mark and LEED certifications management Portfolio administration Fund creation and management Subleasing services Structured finance Metering management Occupational health and safety Project and development services Indirect investing (multi-manager and Government services Real estate investment banking Environmental strategy, systems, Business continuity planning Transaction management REITS) reporting, procurement and Asset and life cycle management Strategic consulting Fund investment strategy program delivery

Project management Property management Strategic consulting Tenant representation Valuation Design and concept planning Accounting and financial reporting Market research Occupancy and exit strategy Appraisal and due diligence Procurement and bid management Building maintenance and engineering Labor strategies and analytics Rent review, renewal and Capital market valuations for funds Move management management Portfolio optimization relocation services IPOs, mergers and acquisitions Technical due diligence Contract and vendor management Location and metro planning Lease restructuring Securitizations Value engineering and cost Due diligence Workplace strategy and change Lease audit and recovery Corporate recovery consultancy Tenant retention management Transaction negotiation and Statutory valuations Transitions and quality control Business and economic incentives management (compensation, tax, litigation)

Specialty sectors and services Banking/financial Data centers Energy/oil and gas Government Higher education Industrial Law firm/professional services Multi-family Public institutions Technology services Education Food and beverage Healthcare Hospitality Land Life sciences Net lease investment services Retail Economic Outlook

Party Like it’s 1999 The November 2014 jobs report was released just a November’s job growth was not limited to lower paying couple of days prior to this report going to press. In it, services positions. Professional and business services the Labor Department reported that 321,000 new jobs added 80,000 new jobs, with particularly strong hiring in were created in that month, making it the strongest month accounting and bookkeeping. Retail employment grew by for employment creation in over two years. Typically 50,000 but not all of it was thanks to increased seasonal any month with job growth above the 200,000 mark is hiring. In fact, car dealerships were at the top of the list considered strong. This metric has only exceeded the in this category when it came to hiring. This is reflective 300,000 threshold six times in the past 120 months. of the fact that new car sales in the U.S. had averaged Consecutive readings above the 300,000 mark or 17.2 million through November, the highest total recorded 300,000+ readings paired with numbers in the high since 2005. Another key positive is that unemployment 200,000 range (the economy has averaged monthly among millennials (ages 25 – 34) has fallen from 7.4% employment growth of 258,000 new positions since to 6.1% over the past year. June), are typically indicative of a booming economy. With the exception of January (+144,000 US Employment Growth Jobs in Thousands jobs), every month in 2014 saw the 600 creation of at least 200,000 jobs, with 400

200 two of them (April and November) 0 -200 coming in above the 300,000 mark.

-400

-600 Perhaps most importantly, November saw a surge in

-800 earnings. Average hourly earnings climbed by a much stronger than usual 0.4%. That being said, overall -1,000 2009 2010 2011 2012 2013 2014 wages are up just 2.1% for the year but this may finally be the turning point. Wage growth has been muted The figure far outpaced predictions (the consensus throughout the Post-Recession era because employers from economists had been at roughly 230,000 jobs) have largely had their pick of job seekers. However, and marked the 50th consecutive month that the U.S. falling unemployment and consistently strong job growth economy has added jobs—a new national record. All told, inevitably puts upward pressure on wages. It appears that the economy created 2.65 million new positions through this past streak of ten consecutive months of 200,000+ the first eleven months of 2014. With the exception of job gains may have helped to turn this corner. This is critical January (+144,000 jobs), every month in 2014 saw the because improving wages inevitably lead to greater levels creation of at least 200,000 jobs, with two of them (April of demand and consumer spending, which in turn, boosts and November) coming in above the 300,000 mark. further job growth reinforcing a virtuous cycle.

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Here is something to consider; the highest level of the full implications of falling gas prices were clear (more job creation reached at the peak of the last economic on that shortly) and it was also before November’s job cycle came in 2005 when the economy experienced creation at boom levels. Ultimately, we expect that Q4 employment growth of roughly 2.51 million. The next 2014 GDP may top the 3% mark. best years were 2006 (2.1 million) and 2004 (1.9 million). This year, the economy has already surpassed those totals Gross Domestic Product We conservatively forecast 2015 GDP growth at 3.1%. with one month left to go. Assuming job creation remains 5.0 strong in December, the economy is on pace to close 2014 4.0 Forecast with roughly 2.9 million jobs, making this past year the 3.0 strongest year for private sector job growth since 1999. 2.0 1.0 And there is every reason to believe that employment 0.0 2010 2011 2012 2013 2014 2015 growth will remain strong in December and heading deep -1.0 -2.0 into 2015. The most recent job openings report from the Labor Department indicated that there were 4.7 million job openings in the U.S. as of September 2014, down In the 1970s, U.S. GDP averaged 3.4%. Throughout the slightly from the 4.9 million metric recorded in August. 1980s and 1990s it averaged 3.2% and 3.4%, respectively. However, the August number was the highest level that In the 2000’s this metric fell to 1.7% thanks to the impact has been recorded since 2001. The September figure of the Great Recession (exclude 2008 and 2009 and was the second highest metric since that time and the the quarterly average for this decade was 2.5%). Yet decrease in that figure between the two months was due the economy has struggled to return to the 3.0% level to increased hiring. of GDP growth that was once considered normal. But current trending seems to suggest we may finally have Some analysts have cited lower gas prices as being one returned to that place. Our conservative forecast for 2015 of the forces driving the latest surge in job numbers. GDP growth is 3.1%, however, we readily admit that the They certainly couldn’t have hurt. But the consensus impact of falling gas prices upon the overall economy could view among economists is that this is a reflection of both significantly increase this total should the current price war pent-up demand and surging economic growth. And, from last for a substantial amount of time. all appearances, barring any unforeseen shocks to the system, this is economic growth that will likely accelerate heading into 2015. Gas Could Drive 2015 Surge As of December 8, 2014 the average price of gasoline GDP Finally Back to “Normal” across the U.S. stood at $2.65 per gallon. Gas prices had peaked at $3.69 per gallon on June 26, 2014. This reflects Following a dismal first quarter that saw GDP decline for a reduction of $1.04 per gallon from peak values. The price the first time since in three years (gross domestic product of gas had been steadily falling throughout the summer shrunk by -2.1% in Q1), 2014 may end up being remembered months, but escalated in October following a move by Saudi as the year in which GDP levels finally returned to what producers to cut the price of oil by an additional $2 per was once considered “normal.” Rebounding strongly from barrel to the U.S. only. It was at this point that speculation the “polar vortex quarter,” Q2 growth came in at a robust began to arise that Saudi oil producers were reacting to 4.6%. This strong performance was backed-up by an the existing glut of supply by targeting those they held increase of 5% for Q3. In early November our economist most responsible for it; U.S. shale oil producers. These forecast Q4 growth of 2.6%, however, this was before suspicions were more or less confirmed on Thanksgiving

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 11 Economic Outlook

Day when at OPEC’s latest meeting in Vienna, Saudi oil $28.8 billion of savings through the first week of December producers opted not to cut production though there was 2014. We forecast this out through April 2015 based on apparently some significant pressure on them from other the -2.0% rate of weekly declines that had been in place members of OPEC to do so. Cutting production would have throughout most of October and November. Based upon helped to reduce supply and eventually raise prices. The the assumption of a -2% weekly decline in pricing, the reasoning behind the strategy is quite simple; Saudi oil is average price per gallon of gasoline would reach $1.99 per much cheaper to extract, costing an average of $15 and $25 gallon by March 24, 2015. At that point, the total savings per barrel historically. Fracking and other new technologies to U.S. consumers would be $80.9 billion (from the peak have helped to radically boost U.S. energy production, but on June 26, 2014). If prices were to continue to fall at that it has cost more to produce oil using these methods. The rate through the end of April 2015, the average price of industry norms have historically averaged between $25 and gasoline would be just $1.78 per gallon and total savings $50 per barrel. The logic of the Saudi strategy is simple; to the American consumer would be $104.7 billion. they can still make a profit off of $2 per gallon gasoline, but American shale oil producers will increasingly struggle if $2.00 Gas by March 2015? At current rate of declines, gasoline will cost $2 per gallon by late March pricing falls below the $2.25 per gallon mark. $3.75 $120

$100 And all signs indicate that gas pricing will likely hit the $2.00 $3.25

per gallon mark sooner rather than later (some markets are $80 $2.75 already there, but we are referring to the national average). $60 The pace of declining gasoline prices had averaged about $2.25 $40 -2% throughout October and November as the trade war US Average Price / Gallon $1.75 Cumulative Savings Billions $20 developed. However, following the Thanksgiving OPEC 0 0 0 0 0 1 1 1 $1.25 0 0 0 0 $0 0 1 2 6 7 8 9 9 1 2 3 4

meeting where Saudi intentions became clear, the pace of / / / / / / / / / / / 1 / 1 2 1 8 1 1 0 2 0 2 0 1 5 2 7 5 4 4 / 0 9 9 3 9 / / / / / 1 / 1 / / / / 1 / 4 1 falling prices has escalated. The current national average 1 1 1 4 5 1 1 1 1 1 5 4 4 5 4 4 4 5 4 price of $2.65 per gallon reflects a whopping decline of Cumulative Savings to Consumers US Avg Price Gasoline -3.6% in just one week. (current pricing vs. peak) (per gallon)

We doubt that gas prices will go far below the $2.00 per gallonDID national average,YOU but all indications are that this is where they are heading. Additionally, with the spike in the GASOLINE rateKNOW of pricing declines since Thanksgiving,? this timetable may be speeding up considerably. At a -4% weekly drop, the price of gas would be $2.00 per gallon by late January DIESEL 1 withbarrel cumulative of crude savings oil toholds consumers 42 gallons. (as of January 26, OTHER PRODUCTS 2015) of roughly $54.5 billion. JET FUEL LIQUIFIED PETROLEUM GASES 1 barrel of crude oil creates HEAVY FUEL OIL Just how much could this impact the economy in 2015? OTHER DISTILLATES 19 gallons of gasoline. A lot, particularly if the price war is long and drawn out, which we expect it to be. For one thing, the U.S. shale oil industry has become much more efficient at extracting We calculated the savings to the American consumer. oil using new technologies. Some analysts peg the cost of Over the course of 2013, the U.S. consumed an average of production now at closer to $20 to $35 per barrel, which 368.5 million gallons of gasoline per day. When measured means that Saudi oil producers may have to lower gas against the peak pricing of late June, this equates roughly to

12 www.dtz.com DTZ 2015 FORECAST prices further and keep them low longer than they may the U.S. over the course of Q3 2014 equaled $78 billion, have initially expected when they launched this trade war. or just 55% of that total. All retail sales (including auto Likewise, there is a clear U.S. foreign policy imperative to and gas) for Q3 2014 totaled $1.185 trillion or just under supporting U.S. shale oil production simply because what ten times that total. Assuming these numbers hold true, this really is about is U.S. energy independence. Earlier this $143 billion gas dividend would break down to an this year the U.S. stopped importing oil from East Africa, additional $447 per person in the U.S. (based on latest once its fourth largest supplier. Why? Because U.S. oil census estimate of just over 319 million). production has increased by 80% since 2008. Domestic Is retail where most of this money will go? Consumer output totaled roughly five million barrels per day in 2008; spending will almost certainly see the lion’s share of it now exceeds nine million barrels. This increase alone the benefit. However, as the savings grow and become is greater than the output of almost every OPEC country more seemingly permanent, look for consumers to start combined. And so while we think cheap gas will hurt the reallocating their personal budgets and spending greater weakest U.S. players and will absolutely drive a trend of portions of these dollars paying down debt, increasing consolidation in the industry, the damage may not end up savings and making more large purchases (including new being as deep as the Saudis hope. In fact, the big winners homes). But businesses will also see a bonus from this trend may turn out to be Chevron and other domestic players (at least those outside of the energy sector); particularly on top of the food chain that, for the most part, are sitting those involved in transportation. Trucking, distribution on huge cash reserves and may find themselves able to and logistics firms are already seeing strong gains to their cheaply acquire start-ups, upstarts and a whole lot of bottom lines. Meanwhile, airlines (which have yet to pass competition. any of these savings on to consumers) are reaching their Ultimately, the stage has been set for a protracted price highest levels of profitability in over 20 years. war that, unless the Saudis blink, very well could last at Throughout the Post-Recession era, the overall economy least the first half of 2015, if not longer. Let’s assume that has struggled to return to “normal” growth levels. For gas pricing stabilizes at a national average of $2.00 per each of the past few years we have forecast improvement, gallon by the middle of March 2015 and it stays there. but with a caveat of likely headwinds. In 2014 it was the By the end of June, the cumulative savings to the U.S. weather. In both 2012 and 2013 it was politics and policy. consumer will have topped $143 billion. How much exactly Go back to 2010 and 2011 it was the still struggling housing is $143 billion in the grand scheme of things? The total market. In 2015, all indications are that the economy amount of all e-commerce sale transactions conducted in

Where Are We in the Cycle? Length of Expansion Average Quarterly GDP Average Monthly Job Growth Recession Recovery/Expansion Period Following Recession Growth During Expansion During Expansion (000s) 1948 Q1 1950 – Q1 1953 13 qtrs 7.4% 182 1953 Q3 1954 – Q2 1957 12 qtrs 4.1% 115 1957 Q3 1958 – Q1 1960 7 qtrs 6.7% 165 1960 Q2 1961 – Q3 1969 34 qtrs 5.1% 169 1969 Q1 1971 – Q3 1973 11 qtrs 5.3% 198 1973 Q2 1975 – Q4 1979 19 qtrs 3.5% 239 1980 Q4 1980 – Q2 1981 3 qtrs 4.4% 145 1981 Q1 1983 – Q2 1990 30 qtrs 4.4% 233 1990 Q2 1991 – Q4 2000 39 qtrs History is not 3.8% 203 2001 Q4 2001 – Q4 2007 25 qtrs on our side 2.7% 83 2007 Q3 2009 – current 20 qtrs+ 2.2% 119 Average (48-01) 19.3 qtrs 4.8% 173.3

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 13 Economic Outlook

was on pace for the strongest growth year of the Post- In the case of timing, it comes down to the belief that Recession era before even taking into account the potential historically, over the last 50 years or so, we have averaged (and we feel likely) impact of a protracted gas price war. a recession once every five to seven years. We are now Take this into account and for the first time in years we are technically in the fifth year of an expansion, therefore “we not talking about potential headwinds inhibiting growth, must be due.” but likely tailwinds accelerating it. Actually, if you go back to the late 1940s, we have technically averaged a recession every 19.3 quarters. That equates to Risks Ahead? once every 4.8 years, so if your method of divining the next The economy is never without its risks. Though the economic rough patch is the calendar, time is definitely not gasoline price war will likely be a huge boon to the overall on our side. Of course, none of these downturns were as economy, there is a school of thought that frets it could deep or as damaging as the last one and most have tended cause a crash in energy sector stocks that might then to last no more than a few quarters. spread. We don’t see that as likely. Regardless, while it is true that something has caused a recession, on average, once every 4.8 years for the past 60+ years, the key word in that phrase is “something.” Black swans are unforeseen events that Recessions don’t just happen out of mid-air. In fact, they come along and do great damage. The nearly always are visible in advance. Certainly, there is always the risk of the “black swan.” Black swans are proper strategy for black swans is to be unforeseen events that come along and do great damage. aware of, and to limit, your liabilities. For example, no one could have guessed on the morning of 9/10/01 that a terrible event would happen the next day that would cause immense damage to the economy. Yet, the The Dow Jones Industrial Average recently hit its highest 2001 recession (which 9/11 helped to worsen) was already level ever when trading closed on December 5, 2014 at playing out thanks to the first tech wreck. The dot.com 17,956 points. But the impact of falling oil prices brought crash had begun in late 2000, but many economists had it back down from its peak shortly thereafter and, as warned of a bubble in the tech sector as early as 18 months this report went to press, it was unclear if these were out. The black swan of 9/11 only deepened and lengthened just normal market fluctuations or the beginning of that downturn, but it didn’t actually cause it. something greater. The NASDAQ Composite Index has And here is the good news; black swans are now likely the followed a similar trend; it reached as high as 4,792 points greatest risk that the U.S. economy faces, in other words, on November 28, 2014 (near, but not quite back to the the unknown or unforeseeable. And this is a baseline record of 5,049 points set on March 10, 2000), but has that is always present. It is also one for which the proper since seen slight declines. Regardless, even if U.S. energy commercial real estate strategy is not to plan for as to do stocks tumble considerably, we don’t see that countering so would mean investing so conservatively as to make the all of the other positive economic signs as of late, or having realization of profit nearly impossible. The proper strategy a significant impact outside of that sector. for black swans is to be aware of, and to limit, your liabilities. The three greatest concerns we continue to hear from This is not to say that another recession is not inevitable. It our clients and people in the marketplace when it comes is. It will eventually happen. It is just that there is nothing to the risk of recession are those of timing, the fear of a in the underlying data that gives us any great concerns tech bubble and the possibility of increased interest rates currently and that all of the current economic indicators are on the economy. the strongest that they have been in years. A quick recap:

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• GDP was 4.6% in Q2, 3.9% in Q3 and (as of not currently showing the signs of a bubble. The historic December) was tracking above 3% for Q4. marketwide P/E average for the S&P 500 over the past 100+ years has been 15.5. That number stood at 41.0 • Current job creation is the strongest that we have seen in fifteen years. during the dot.com meltdown. It reached as high as 70.9 in early 2009 as the economy was collapsing at the front • Job openings, typically a forward indicator, at their end of the Great Recession. As of early December 2014 it highest levels since 2001. stood at just under 20.0. This is only slightly higher than • Gas prices are falling rapidly; consumer spending the historical average, but certainly nothing even close to is on the upswing. suggesting that there is a bubble in place.

• In October, the Conference Board’s Consumer Confidence Index (CCI) reached its highest level PE Ratios Not Alarmingly High (94.0) in eight years and is expected to significantly S&P 500 PE Ratio 80 exceed that in December. The CCI is often a leading Average: 15.5 70 indicator for consumer spending patterns. 2009 Recession Onset: 70.9 60 Tech Bubble Burst: 41.0 • According to the ISM Purchasing Managers Index 50 December 2014: 20.0 (PMI), business confidence in October reached 40 30 its highest level (59.0) in three years. The PMI is a 20 leading indicator of business spending patterns. Any 10

reading above 50.0 typically reflects expansion. 0 1871 1883 1895 1907 1919 1931 1943 1955 1967 1979 1991 2003 12/8/2014

• The National Federation of Independent S&P 500 PE Ratio Historic Average 15.5 Businesses (NFIB) Small Business Survey rose two points in November to 98.1, its highest level since 2007. Interest Rates

• Vehicle sales are expanding at their fastest pace After years of supporting near zero interest rates, most since 2007. analysts believe that this Fed will finally raise this key economic metric in 2015. So far, new Fed Chair Janet Yellen • The tech sector continues to gain momentum has made it a point to broadcast potential moves by the Fed based on both venture capital funding and IPOs, as clearly as possible prior to making them. Short of giving corporate and bank balance sheets are all in fantastic shape by nearly every metric and the list an actual date of increase, Yellen has repeatedly stated goes on and on… that the Fed’s goal is to see long-term employment and wage growth return to acceptable levels and for the target inflation rate to hit at least 2% before making any moves. Stocks Generally Not Overvalued The second concern we hear most in the market is the With all of the strong employment growth of the past few issue of whether or not there is a bubble building in the months, the Fed seemed to add another caveat to that list stock market. Particularly in the Bay Area this remains a in November when New York Fed Head William Dudley great concern simply because no one has forgotten the announced that the potential impact on global markets first tech crash of 2000/2001, nor have the lessons of would be another determining factor behind any moves. the Great Recession (2008/2009) been lost on anyone. The fact is that wage pressures are just beginning to show Most of this concern has to do with the occasional large the signs of life that Chief Yellen had outlined as a major valuation in the marketplace or huge sale. But if you look point on this checklist and so all signs would seem to point at the actual price to earnings (P/E) ratios, the market is towards rates going up in the next few months.

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 15 Economic Outlook

Inﬂation to Determine Fed Rate Hikes… In fact, we believe there is a greater long-term danger if What Inﬂation? interest rates are kept too low too long into the recovery. Y-o-Y % Chg. 3.0% The longer that interest rates remain where they are (essentially near the 0.1% mark depending on the individual 2.5% Fed’s 2% Target rate), the greater the chance that the relationship between 2.0% pricing and the underlying fundamentals of an investment 1.5% type become disconnected. 1.0%

0.5% We cannot emphasize this point more strongly when it 2006 2007 2008 2009 2010 2011 2012 2013 2014 comes to Bay Area commercial real estate. Thanks to its Core CPI Core PCE emergence as one of the strongest local economies in the In a forecast we gave over the summer, we predicted a United States (arguably the strongest large economy) and likely increase by May or June of 2015. However, this its role as a gateway marketplace, Bay Area commercial was before the gas price war erupted. The dividend in real estate has surged in demand over the past few years. savings reaped by businesses and consumers as a result A wave of foreign capital has helped to add fuel to the fire. of the ongoing gas price drop is likely to counter inflation Near zero interest rates certainly haven’t hurt either. The significantly. It will lower the cost of transporting goods, net result has been far too much money chasing far too potentially translating into lower prices for consumers. It properties. This has been great news for sellers who have may even help to reduce upward pressure on employers been able to achieve top pricing for all building types. But in terms of wage growth, thought we don’t see it as cap rates are already at record lows for most property playing a major role in slowing that trend down. Still, it subtypes and continue to drop, with yields for investors is likely to push back the date at which we begin to see falling with them. We don’t believe that there is a pricing the Fed’s target of 2.0% inflation. Regardless, we still bubble in place yet for commercial real estate, but if current anticipate interest rate hikes eventually come into play trends persist we could be looking at one soon. That being for 2015 and, as we see the trend of strong employment said, interest rate hikes later in the year probably won’t growth and increasing upward pressure on wages likely significantly impact local pricing and investment demand negating the deflationary pressures created by falling gas trends immediately but a step towards normalcy wouldn’t prices. However, we anticipate that the intention to raise hurt the market from overheating at this point. interest rates will be as clearly broadcasted by the Fed as soon as possible and that the hikes themselves will be What’s it Mean if Interest Rates Rise? Fed Funds Rate vs. Commercial Property Values minimal and gradual. We believe this will start to happen by the end of Summer 2015. 190 6%

And values 5% 170 Last time Fed climbe d by 8 0% raised rates was over t he ne xt 3 Many fear that the investment community will grind to a halt July 2004 4% 150 years once rates begin to return from the artificially suppressed 3% 130 low levels where the Fed has kept them throughout the 2% 110 1% entire Post-Recession era. We think that those fears are 90 0% Apr Oct Apr Oct Apr Oct Apr Oct Apr Oct overblown. The belief is somehow that near-zero interest 2001 2002 2004 2005 2007 2008 2010 2011 2013 2014

rates have been the only thing keeping the entire engine of Moody's/RCA Commercial Property Price Index Fed Funds Rate the economy going and that the whole house of cards will come crashing down once they climb. That might be true As for concerns that interest rates will negatively impact if we were talking about going from 0 to 12% overnight, but commercial real estate values? It sounds counterintuitive, what we are probably talking about are increases measured but when the Fed starts raising interest rates it is likely to be in basis points… not percentage points. positive news for commercial real estate values. It signals

16 www.dtz.com DTZ 2015 FORECAST that the economy is strong and getting stronger, which recorded in more than a decade and all indications are means stronger rent growth, lower vacancy, better NOI, that these totals will increase in 2015. better debt availability, and property values will generally The reason why this is so critical is because technology go up, even in a climbing interest rate environment. The companies continue to dominate venture capital activity, last time the Fed began raising interest rates in July of with the Bay Area having emerged as the greatest single 2004, commercial real estate values didn’t go down. beneficiary of this trend. They actually increased by 80% over the following three year period. In fact, there is only a very weak correlation Bay Area Venture Capital Trends between rising interest rates and commercial real estate Total Deals and Funding (in Billions) returns. The real correlation, however, is economic 1,400 $20 $18 growth. When GDP goes up, commercial real estate values 1,200 $16 usually go up. The positive impact of stronger growth that 1,000 $14 $12 eventually result in the necessity of interest rate hikes far 800 $10 outweigh the potential negative impact of those rate hikes 600 $8 at this point. 400 $6 $4 200 $2 0 $0 Bay Area Tech Will Continue to Dominate 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 YTD-14

Venture Capital Funding Total Funding Total Deals All of the factors that we have discussed should result The Software industry continues to significantly outpace in continued robust growth in 2015 for the Bay Area’s all other industry sectors in terms of VC funding. Software economy, which as we mentioned before, is already companies accounted for just under $13.5 billion, or nearly arguably the strongest performing local economy for any 41%, of all of the funds raised in the U.S. through the first region of its size in the United States. With the United nine months of 2014. Media and Entertainment companies States economy currently posting the highest levels of raised more than $3.9 billion of VC investments, or nearly global growth, this places our local economy in a unique 12% of all funding. However, it is critical to note that online spot as one of the strongest in the world. media and entertainment companies are what dominated The dominance of the tech industry is what all of this comes activity here. Biotechnology firms ranked third; they down to and nowhere else is this as clearly demonstrated accounted for just under $3.9 billion of funding through Q3 as in trends for venture capital (VC) funding. According (12%). IT Services ranked fourth, accounting for just over to PricewaterhouseCoopers and the National Venture $1.8 billion in activity or 5% of all deal activity. Medical Capital Association’s quarterly MoneyTree report, more Devices and Equipment, Industrial/Energy, Consumer than $33.0 billion of VC funding had been raised by U.S. Products and Services, Retailing/Distribution and other companies through the end of Q3 2014. Through the categories are all reflecting higher levels of venture capital first nine months of 2014, more money had been placed investment, but these four categories (Software, Media than over the entire course of 2013 when roughly $30.0 and Entertainment, Biotechnology and IT Services) have billion of VC funding was raised. Q3 2014 was the sixth been accounting for the lion’s share of activity in 2014. consecutive quarter in which 1,000 or more companies Together, they have driven 70% of all U.S. venture capital raised VC funds. This equated to $9.9 billion invested investment for a combined total of $23.1 billion. And all across more than 1,020 deals. The U.S. will likely close of those sectors are heavily represented in the Bay Area. 2014 with more than $43.0 billion in total venture capital activity, making this the strongest year the market has

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 17 Economic Outlook

U.S. Venture Capital Trends by Region funds were actually raised. Now that the Bay Area has Region Total Deals Total Funding Avg. Deal Size established itself as the epicenter of global venture capital Silicon Valley 333 $4,392.9M $13.19M activity, more companies are opting to locate themselves NY Metro 123 $1,710.0M $13.90M in the region (particularly in San Francisco or Silicon New England 97 $652.0M $6.72M Valley) in order to successfully court VC funding. In other LA/Orange County 76 $581.0M $7.65M words, venture capital activity is now driving growth in SouthWest 27 $527.2M $19.52M the Bay Area’s office and R&D markets both before and Midwest 104 $395.2M $3.80M after companies actually land any actual VC investments. Texas 41 $288.2M $7.03M Northwest 30 $268.9M $8.96M The intensification of this trend will likely only result in San Diego 27 $238.5M $8.83M even greater levels of venture capital pouring into the DC/Metroplex 40 $228.8M $5.72M region in 2015 with the possibility of Bay Area companies Southeast 53 $172.1M $3.25M accounting for 50% of all activity by next year a real one. Colorado 17 $167.2M $9.83M North Central 22 $116.9M $5.32M To a lesser degree, a similar trend has emerged in the IPO South Central 8 $93.1M $11.64M (initial public offering) marketplace, where a Bay Area Philadelphia Metro 19 $62.1M $3.27M address has increasingly become a “must have” for tech Sacramento/N.Cal 2 $17.7M $8.85M companies looking for a successful launch. Upstate NY 3 $0.9M $0.29M AK/HI/PR 1 $0.4M $0.35M Total 1,023 $9,913M $9.69M IPOs on the Rise Thanks largely to the largest initial public offering (IPO) Through the close of Q3 2014, Bay Area companies had ever, the record breaking $22 billion stock launch of accounted for over $15.7 billion (or a whopping 48%) of Chinese e-commerce giant Alibaba, Q3 2014 saw the the $33.0 billion of total venture capital activity recorded most proceeds raised through IPOs in any quarter since in the United States. The Bay Area’s closest competitors 1999. The U.S. IPO market raised $37 billion in Q3, bringing are the New York City Metro and New England, where 2014 totals through the first nine months of the year to companies have respectively raised $3.6 billion (11%) and $70.6 billion. With three months left to go, the market has $2.8 billion (8%) through the first nine months of 2014. already exceeded 2013’s annual total of $54.0 billion by The Los Angeles/Orange County market is a distant fourth 29%. All indications are that the U.S. IPO market will close place, having accounted for just under $1.6 billion or 5% 2014 with as much as $90 billion in total IPO issuances in of all funding through that same timeframe. what will likely be the strongest year for activity since 1999. The trend of Bay Area dominance when it comes to venture capital funding goes back to the first tech boom when dot.coms, software and personal computer companies Chinese e-commerce giant Alibaba, drove activity. However, even during the 1999/2000 peak Q3 2014 saw the most proceeds raised years, the Bay Area typically accounted for just 40% of through IPOs in any quarter since 1999. all deal activity. Especially over the past five years, this percentage has quietly grown from the low to the mid 40% range and now the high 40% range. It has also become a What may be the most important statistic of all is that critical factor for the region’s office market. over half of all IPOs (primarily health care) priced their Venture capital funding typically results in real estate shares below the proposed range. Investors largely balked growth (particularly for start-ups or early stage at initial valuations for 53% of Q3’s IPOs, pricing them companies). But in the past this was always after VC below their initial goals. This fact should help to quell

18 www.dtz.com DTZ 2015 FORECAST investor concerns over the market becoming too frothy. The final tallies for 2014 IPO activity will almost certainly Biotechs have been among the leaders in terms of recent match or exceed the record levels recorded in the late IPO activity, along with smaller private equity firms. And, 1990s. But it is unlikely that 2014 totals will be surpassed of course, then there is Alibaba, whose single issuance in 2015, simply because of the boost in activity that the in September accounted for 77% of all funds raised in Alibaba deal provided this year. Regardless, we anticipate Q3 2014. The tech giant is expected to use its newly 2015 to be another year of extremely robust IPO activity, raised capital for rapid expansion into North American with final tallies far above the historical norm. And we markets. This could have a particularly dramatic impact anticipate that technology companies will remain at the on industrial real estate in the years ahead. Alibaba’s key forefront of IPO issuances, with the Bay Area benefiting competitor is Amazon, which is projected to have a 90 largely from this trend. This will translate into local job million square foot distribution chain in place by 2016 growth and additional commercial real estate demand, (Amazon currently has about 70 million square feet of particularly for office and R&D space. e-commerce fulfillment/distribution space throughout the US). Assuming that Alibaba wants to go head-to-head with Bay Area VS. US IPO Activity Jeff Bezos, we could be looking at an additional 30 to 50 Bay Area Tech/Biotech Advantage 51% million square feet of industrial demand coming from just Technology 43% Financial one well-funded user over the next few years as Alibaba 20% Energy 13% builds up their supply chain capabilities. 41% Health Care 10% Business Services 8% Once again, tech companies are accounting for most of 4% Consumer the action. According to Renaissance Capital, technology 4% Materials 3% companies are the single most active category in terms of Capital Goods 2% IPO issuances, having accounted for nearly $31 billion in Transportation 1% Bay Area activity through the first three quarters of 2014. Bay Area Communications firms accounted for 51% of this activity. The Bay Area has Utilities United States also dominated in healthcare IPOs, the fourth most active category year-to-date, having accounted for 41% of all IPO Lastly, we also anticipate 2015 to be a year of surging activity through the first nine months of 2014. merger and acquisition (M&A) activity. A recent survey from tax and advisory firm KPMG of M&A professionals IPO Proceeds by Sector found that 82% believed that they would close at least one US Total Bay Area Total deal in the coming year, compared to 63% in last year’s Sector # $(B) % of $ # $(B) % of $ survey. The survey found higher numbers in the Bay Area Technology 46 $30.5 43% 12 $15.6 51% where 86% expected to close deals in 2015. IPOs are Financial 24 $14.4 20% 0 $0.0 0% helping to drive this trend, with many firms going on buying Energy 23 $9.3 13% 0 $0.0 0% sprees after successful issuances. The strong IPO market Health Care 83 $7.0 10% 14 $2.7 39% has helped potential buyers stockpile cash for acquisitions. Business Services 8 $2.9 4% 1 $0.2 8% According to KPMG, cash reserves in technology, media Consumer 11 $2.5 4% 0 $0.0 0% and telecommunications companies rose 124% between Materials 7 $2.0 3% 0 $0.0 0%

Capital Goods 7 $1.2 2% 0 $0.0 0% 2008 ($482 billion) and 2013 ($1.1 trillion). These large

Transportation 4 $0.8 1% 0 $0.0 0% cash reserves will drive accelerated M&A activity in 2015.

Communications 1 $0.1 0% 0 $0.0 0% Look for the biggest tech players to continue to get bigger

Utilities 1 $0.1 0% 0 $0.0 0% with most of these forces benefiting the Bay Area’s existing

Total 215 $70.6 27 $18.5 industry giants.

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 19 Commercial Real Estate Overview

Bay Area CRE Moving Beyond Normal range. Whatever the fi nal tally, that average will have been dragged down signifi cantly by Q1’s dismal fi gure. But Q2 The story of commercial real estate in the Post-Recession (+4.6%) posted phenomenal growth. Q3 (+3.9%) was era has evolved over the past few years. In most major also above par and we are currently tracking growth levels metros, it was fi rst a tale of bare bones survival. Then it that may exceed the 3% mark for Q4. Take Q1 out of the slowly morphed into a story of glacially slow recovery. equation and it appears that economic growth hasn’t just “Wait until next year,” became the mantra. The question returned to “normal,” but has moved well beyond it. “when will things return to normal” became just as common as “what is the new ‘normal?’” But ‘normal’ All major economic indicators are pointing towards didn’t come quickly and it certainly didn’t come uniformly. sustaining and accelerating current levels of growth, Recovery wasn’t just slow; it was uneven. And so all of particularly when it comes to employment. And, as we these new storylines emerged; core vs. non-core, Class A stated earlier in our forecast report, while each of the past vs. Class B, CBD vs. Suburban and multifamily vs. offi ce few years had looming issues that could (and generally vs. industrial vs. retail. It was enough so that over the did) act as headwinds mitigating growth, this year’s last 24 months, as one major U.S. market after another falling gas prices are likely to act as tailwinds bolstering gradually returned to metrics that (by any historical it. Certainly we cannot rule out any black swan or other measure) would be considered “normal,” this long-awaited cataclysmic global events that could act as a shock to the for event went almost unnoticed in many places. But the system and not even Al Roker knows yet if 2015 starts with majority of major U.S. metros have now seen their local polar vortex II, but for most major U.S. markets, it appears market fundamentals (vacancy, net absorption, etc.) to that commercial real estate will be moving into high gear. pre-recession norms. The only exception has been rental rate growth, which still lags for a few property types and in a few geographies but has surged for others. All major economic indicators are pointing towards sustaining & accelerating current So what will the story of 2015 be? levels of growth... In recent years, strong late-year performances have led to optimistic forecasts that were eventually derailed by early spoilers. The return of housing predictions of 2013 turned Back to the Boom out to be half correct; pricing rebounded substantially but Of course, many of the trends that we have described for a slew of other factors kept residential development on the national market as a whole are already old hat for the the shelf and helped to mitigate the overall impact of this Bay Area. Throughout the Post-Recession Era period, the trend. Heading into 2014, many economists predicted Bay Area has emerged as arguably the strongest local that this would be the year when we fi nally saw the return major economy in the United States and commercial of the ever elusive (and “normal”) 3% GDP growth rate. real estate trends have reflected that. Recovery for But then came the polar vortex and a dismal Q1 that saw most product types began here and in a handful of other GDP in the red to the tune of -2.1%. But were economists American cities (Boston, Dallas, Houston, New York and really wrong on this one? It is true that we will likely end Washington, DC among them) before anywhere else. The 2014 with an annualized GDP growth rate in the high 2%

20 www.dtz.com DTZ 2015 FORECAST region’s trends continue to outpace what we are seeing in average asking rent peaked a few months later (Q2 2008) the rest of the country by 12 to 24 months, if not more for at $3.13 per square foot (on a monthly full service basis). some property subtypes. Then, the near-financial collapse of September 2008 hit and the freefall began. Bay Area office vacancy peaked at The fact is that there has been no “normal” here in the 17.6% in Q1 2010. Asking rents for office space hit their Post-Recession era. That probably doesn’t come as much lowest recession-era mark three months (Q2 2010) later of a surprise as San Francisco has never had a reputation when the local average dropped to $2.50 per square foot. for normal. Not from its Gold Rush beginnings and the As of Q3 2013, local vacancy stood at 10.5%. Meanwhile, Emperor Norton days through the Beat Generation and the average asking rent has also moved beyond levels Summer of Love or through its emergence as the global posted at the peak of the last cycle. It now stands at $3.29 center of the tech world. Nor has Silicon Valley, from its per square foot. humble start in the garages of modest ranch homes to the dot-com days or through the rise of Apple, Google and a slew of other rising tech giants that are now among the most profitable companies in the world. And it is the tech sector that has been driving boom level growth in the region for going on five years now. It’s just that over the past 18 months or so, that growth has finally spread to nearly every other sector of the local economy and all indications are that growth will accelerate in 2015.

In fact, the issue of commercial real estate returning to where it stood prior to the 2008 downturn is already behind us. Let’s start with the first product type to rebound; multifamily. Bay Area apartment vacancy dropped to a low of just 3.7% in Q3 2006. These numbers started to increase long before the downturn as local development levels ramped up. By the time the recession hit in Q3 The 1.4 million square foot Salesforce Tower (415 Mission 2008, local vacancy stood at 4.1% and the average asking Street) won’t even be completed until January 2017 but has already been the site of the largest office lease in San rent stood at its peak for the cycle at $1,618 per month. Francisco’s history (Salesforce’s lease of 714,000 square Vacancy would climb to a peak of 5.8% in Q1 2009 and feet in Q2 2014) and one of its biggest sale transactions rents would bottom out at $1,475 per month in Q4 2009 (Salesforce exercised its option to buy this property in October 2014 for $640 million, or approximately $450 before they began to slowly rebound. By Q2 2011, the per square foot). average asking rent was already exceeding peak values from the last economic cycle at $1,637 per month. By R&D space hasn’t been far behind. The current vacancy Q3 2011, vacancy had fallen below past cycle peak at just rate for R&D product in the Bay Area is 11.6%. It had 3.6%. Three years later (Q3 2014), the average asking rent reached as high as 18.3% in Q1 2010. But the current metric in the Bay Area is at an all-time record high of $2,234 per has fallen significantly below what was recorded at the month. This is up 51% over recession-era lows and 38% peak of the last cycle. R&D vacancy reached its low-water over where they peaked during the last growth period. mark during the 2003 – 2008 expansion in Q2 2008 at Thanks to a booming tech sector, office came next. During 15.0%. The current level of vacancy is the lowest that the last economic cycle, office vacancy throughout the Bay the market has seen since Q3 2001. The average asking Area reached a low-water mark of 10.8% in Q3 2007. The rent back then was $2.36 per square foot (on a monthly

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 21 COMMERCIAL REAL ESTATE OVERVIEW

triple net basis). This metric has never fully returned to its height of the last cycle of just 3.6% (Q3 2007). But here dot-com peaks mainly because its functionality and users we see a flood of demand and a construction pipeline have radically shifted. Now, outside of the biotech sector, struggling to keep pace. We expect vacancy to be in the it’s largely utilized as a lower cost option for office users mid 3% range by the end of Q1 2015. But asking rents have or for other quasi-industrial uses as opposed to true R&D. already surpassed past peaks. The current average asking That being said, the average asking rent that was in place rent for warehouse space in the Bay Area is $0.63 per at the peak of the last cycle (Q3 2008) was $1.42 per square foot (on a monthly triple net basis). This number square foot. After dropping as low as $1.11 (Q3 2010), this is up 26% from the Recession-Era low of $0.50 (Q3 2011) metric has since rebounded to $1.53 per square foot, or and 5% over the market’s previous record of $0.60 per 8% above the past peak. square foot Q4 2007).

Shopping center vacancy trends are following a similar The issue of commercial real estate pattern. The lowest level of vacancy that we have on record for the Bay Area came in Q1 2007 when this metric fell returning to where it stood prior to as low as 4.4%. The average asking rent at that time was the 2008 downturn is already behind $30.88 per square foot (on an annual triple net basis). us... The current growth cycle is now Vacancy levels climbed to a peak of 7.7% in Q2 2010. The average asking rent didn’t bottom out until reaching starting to challenge records set by the $22.19 in Q1 2011. Vacancy now stands at 5.3%, still dot.com boom. above the peak of the last cycle though we have never tracked a tighter market for Class A space. Class A, or premium space, vacancy is virtually non-existent at just Industrial space initially lagged in the recovery, but has 1.1%. By comparison, this metric stood at 2.9% in Q1 since rebounded sharply. Manufacturing space in the Bay 2007. Meanwhile, though the average asking rent for all Area saw vacancy levels fall as low as 4.5% in Q3 2007. shopping center subtypes and product classes has only The average asking rent peaked in Q3 2008 at $0.65 per improved slightly during the Post-Recession Era to $23.43 square foot (on a monthly triple net basis). Following the per square foot, the average asking rate for Class A shop high profile closures of manufacturers like Solyndra and space (typically availabilities of 3,000 square foot or less) others, vacancy peaked at 7.5% in Q2 2012. The average has routinely averaged between $60 and $72 per square asking rent hit bottom earlier, dropping as low as $0.47 per foot in the past few months. Like spaces in 2007 leased square foot in Q2 2011. As of Q3 2014, vacancy was below in the $38 to $44 per square foot range with these rates past cycle lows at just 4.4%. The average asking rent of reaching as low as $32 to $38 per square foot as recently $0.61 per square foot was still below the $0.65 peak of as three years ago. Regardless, a wave of new development the last cycle and has lagged in growth thanks to the fact with significantly higher asking rates will start to impact that most of the rebound in occupancy for this product the market in 2015 and will result in this metric climbing type has been driven by owner purchases as opposed to significantly along with occupancy growth. leasing activity. However, with space requirements on the The same trends are taking place on the investment front rise and quality space in short supply, we anticipate asking as well. Deal flow peaked in 2007 when more than $34.9 rents to surpass previous peaks in either Q1 or Q2 of 2015. billion in Bay Area commercial real estate changed hands. Meanwhile, warehouse vacancy stood at just 4.8% as this That year we tracked 810 major deals with an average cap report went to press. This compares to a Recession-Era rate on closed transactions of 5.5%. These totals would peak of 9.5% (Q2 2010) and a low-water mark at the plummet in the initial aftermath of the recession to just 171

22 www.dtz.com DTZ 2015 FORECAST deals in 2009 equating to $3.5 billion of total deal activity. sales. That being said, many local owners of modern The cap rate on closed sales that year surged to 8.5%. distribution facilities (the product type most in demand) Through the first nine months of 2014, the average cap have been reluctant to part with them as rental rate growth rate on deals that we have tracked has fallen to a record throughout the Bay Area has accelerated. However, the low of just 5.1%. Investor demand is at its highest levels few modern projects that we have seen sell in the past year since 1999 with pricing skyrocketing. In fact, demand is have typically been at pricing of $150 per square foot or far outpacing supply for virtually every product type in more with cap rates in the low 5% range or below. the Bay Area. This lack of available product is why total deal volume through Q3 2014 stood at just $18.0 billion (547 deals) and is likely to close the year at somewhere near $28.0 billion.

Pricing for individual product types, however, has clearly rebounded. At the peak of the last cycle (2007), the average price on apartment product that sold in the Bay Area was $227,000 per unit. The average cap rate on closed deals was 6.1%. These numbers dropped to $162,000 per unit and 6.7% in 2009. They now stand at $246,000 per unit and just 5.3%.

Pricing for office investment properties in the Bay Area peaked at $383 per square foot in 2007. The average cap rate on those sales was 5.2%. By 2010 those values were just $218 per square foot with an average cap rate of 5.8%. We enter 2015 with new development at decade high Through the first nine months of 2014 these metrics had levels for retail and quarter-century high levels for office, industrial and multifamily. The largest project currently rebounded to $375 per square foot and an average cap underway is Apple’s new 2.8 million square foot campus rate of just 4.8%. The amazing thing about this is that in Cupertino (scheduled delivery date of Spring 2016). deal activity in 2014 has been overwhelmingly dominated by Class B and C and value-add projects, with core office The trend has been clear. Fundamentals for every property in short supply. The balance of deals that informed 2007 type have now either surpassed past cycle peaks or are numbers had a much larger share of premium core near surpassing them. Increasingly the measuring stick for properties, yet 2014 averages have still outpaced them. this growth cycle is not the last one, but the granddaddy Industrial pricing peaked during the last cycle (2007) at of them all in the Bay Area; the dot-com boom. This holds $135 per square foot and with an average cap rate of 5.9%. particularly true for the office sector and this is the key The low-water mark for pricing came in 2010 when the sector to watch to understand the Bay Area economy, average on closed deals fell to just $82 per square foot with because tech is ultimately the engine that is driving things. an average cap rate of 8.0%. As of the close of Q3 2014, Here is something to consider; from 1996 to 2000, the year-to-date totals for industrial sales indicated an average Bay Area’s office market saw local occupancy grow by price of $103 per square foot and a cap rate of 6.0%. The 27.5 million square feet. The devastating dot-com crash price per square foot metric has actually decreased from of 2000 led to all of that space being returned back to the 2013’s $142 per square foot reading thanks to a 2014 deal marketplace (occupancy declined by -27.8 million square pipeline that has included only a couple of modern facilities feet in 2001/2002). Bay Area office properties regained and has otherwise been dominated by older product

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 23 COMMERCIAL REAL ESTATE OVERVIEW

20.7 million square feet of occupancy between 2003 and 2007, only to hemorrhage back -10.8 million square feet Here is something to consider; from 1996 of that space in 2008/2009. However, throughout the to 2000, the Bay Area’s office market current growth period, office occupancy in the region has increased by 27.6 million square feet—more than all of the saw local occupancy grow by 27.5 million growth created by the first tech boom and this time with a square feet... Throughout the current much more stable footing. growth period... it has increased by 27.6 million square feet.

sellers probably should be asking themselves isn’t whether the economy will turn in a strong performance in 2015 or even whether the Bay Area’s commercial real estate market will continue to post strong occupancy growth ahead. The more pertinent questions will have more to do with individual circumstance;

• With multifamily development levels skyrocketing, what will happen to vacancy and rents? The current development boom is radically changing the San Francisco skyline; the largest new multifamily project • Office occupancy growth has been at near record in the works is the 42-story Lumina Condominium Tower levels for the past few years; can it continue at this at 201 Folsom Street. Upon its completion in November 2015, this project will add 655 new housing units to the pace? Will current levels of development be too South Beach district. little, too much or just right?

• Industrial vacancy has sharply tightened over the The difference this time around is that the dot-com boom past 18 months. New development is returning, was led by a mix of start-ups and upstarts that were armed but is it too little too late? And can industrial with little more than speculative funding and untested developments even pencil at current rents? business plans. This cycle is being driven by proven • Retail demand remains white hot and there is finally players; among them some of the world’s most profitable new product in the pipeline poised to facilitate companies. Salesforce, Apple, Google, Facebook, growth, but will sharp rent increases possibly kill Samsung, LinkedIn, Box and countless others have grown the golden goose? their local real estate presence by millions of square feet over the past couple of years. And the Bay Area’s pipeline Tech Fuels Office Building Boom of active tenant requirements remains thick as we head but Still Not Enough into 2015. With the close of Q3 2014 the Bay Area’s office market The indicators are clear and all point towards increasing recorded its 18th consecutive quarter of vacancy declines growth in the year ahead and the strong likelihood that as overall vacancy dropped from 11.0% to 10.5%. The the coming year should emerge as the strongest yet of third quarter of the year saw the highest level of occupancy the Post-Recession era. But the market isn’t without growth the market has recorded over the past two years; some challenges lurking just beneath the surface. The just under 1.9 million square feet of space was absorbed real question that landlords, tenant, investors, buyers and between July and September. That brought year-to-date

24 www.dtz.com DTZ 2015 FORECAST net absorption totals to roughly five million square feet and It is a similar situation in Silicon Valley, where there was 7.6 based upon the activity we have seen through the first two million square feet of new office space under construction months of the fourth quarter (this report went to press in as Q3 2014 came to a close. But less than one million early December 2014), all indications are that the market square feet of that space is available for lease. The rest of will close the year with over 6.5 million square feet of total it has commitments in place whether we are talking about occupancy growth. This will make 2014 the third strongest speculative multitenant projects (a trend on the rise) or performance in terms of growth that the market has seen corporate campuses that are being built. Apple, Samsung, over the last 25 years, outpaced only by 1999 and 2000. LinkedIn and Google are among the major users with new corporate campuses in various stages of development. Office development has also kicked into high gear in the Here too we expect construction levels to increase heading region, something that we really haven’t seen since the late into 2015 and for existing projects in the pipeline to have 1990s. We are currently tracking 12.6 million square feet a minimal impact on underlying market fundamentals. of new space under development with San Francisco and Though the 12.6 million square feet of office construction Silicon Valley having emerged as the twin peaks of growth. currently underway throughout the Bay Area is the largest In San Francisco this trend is all about new highrise office amount that we have tracked since the late 1990s, this buildings situated primarily south of Market Street from level of new supply is not enough to keep up with demand. the SoMa district to mid-Market. In Silicon Valley it is all about large new corporate campuses, but in both places it is all still about tech.

There was 4.2 million square feet of office space under construction in San Francisco as of the end of Q3 2014. This includes the 1.4 million square foot Salesforce Tower which was the site of the largest lease ever signed in the history of San Francisco earlier in the year when Salesforce agreed to take roughly 700,000 square feet of this project. They later exercised an option to buy the project and will emerge as one of the city’s larger landlords when the project is completed in 2017. Only 1.1 million square Following Salesforce Tower, 222 Second Street is the next feet of the 4.2 million square feet of office space under largest office project under construction in San Francisco. construction remained available as this report went to Slated for July 2015 delivery, this 26-story, 452,000 square foot tower is already fully leased to LinkedIn. press. Deliveries will add 2.8 million square feet of new space to the San Francisco skyline in 2015, but over 2.5 That demand continues to be driven by tech companies, million square feet of that space has already been leased. large and small. Tech users have accounted for 70% to Because of this, we anticipate more projects currently in 80% of all of the region’s annual occupancy growth since the planning stages will begin construction in the year 2010. The trend of clustering for these space users has ahead with even more cranes popping up. We also don’t meant that the lion’s share of the region’s growth has expect this first wave of new deliveries to have much of an remained focused on San Francisco and Silicon Valley. impact on the marketplace in terms of vacancy or rents. However, there are some notable and active smaller tech It still won’t be enough to sate demand or do anything but pockets throughout the Bay Area in places like Alameda, act as a minor speed bump (at most) in terms of rental Emeryville, the North Bay and Contra Costa County. rate growth. Recent speculation that Google or another major tech firm may be considering taking a large chunk of space of the

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historic former Sears Building in Downtown Oakland (if not The San Francisco office market should see another strong its entirety) had helped to bolster hopes that a new wave year of growth in 2015. We expect occupancy to increase of tech users may help revitalize that city as the market by as much as three million square feet in the year ahead for available space in San Francisco continues to tighten. and for vacancy to fall to the low 5% mark by the second half of the year. New office construction will also continue Still, office occupancy growth has largely been all about to ramp up in the coming year as the 2.8 million square the Highway 101 Corridor (from Mountain View to Market feet of space slated for 2015 delivery will have little impact Street) in 2014. San Mateo County has seen a notable on fundamentals. This will set the stage for continued increase in activity, but its numbers still pale in comparison aggressive rental rate growth. Ultimately, skyrocketing to those being racked up in San Francisco and Silicon Valley. rents and tight leasing conditions will increasingly drive space users to explore options in San Mateo County and The challenge of finding quality space both the East and North Bay. is increasingly becoming an issue in San Francisco. With most of the new construction slated for 2015 deliveries already accounted for, we expect rental rate growth to continue to be aggressive.

Despite Increased New Construction, San Francisco Market to Tighten Further Through Q3 2014, the San Francisco office market had One of the larger office deals of the year in San Francisco didn’t come from the tech sector, but from the healthcare absorbed 2.5 million square feet of space as its vacancy field. Kaiser leased 264,000 square feet at a new Class rate fell to just 7.0%. Meanwhile, the current average A project being built at 1600 Owens Street. Later in the asking rent of $4.95 per square foot (on a monthly full year, Kaiser exercised their option to purchase the building. service basis) reflects a year-over-year increase of 14.8%. We anticipate the San Francisco market to close 2014 with Suburban Resurgence to Bolster over three million square feet of positive net absorption San Mateo County and a vacancy rate near 6.5%. We have already seen a trend of legal and non-profits The challenge of finding quality space is increasingly moving increasingly to the East Bay and the North Bay has becoming an issue in San Francisco. With most of the benefited from some smaller professional users relocating new construction slated for 2015 deliveries already from San Francisco to Marin County. San Mateo County accounted for, we expect rental rate growth to continue has also seen a bounce. After a couple of sluggish years, to be aggressive. Assuming 2015 rents continue to grow occupancy growth has picked up considerably in the at a 15% annual pace (and nearly every indicator seems Peninsula’s suburban marketplace. As of the close of Q3 to support that argument), we could be looking at an 2014, office vacancy in San Mateo County stood at 12.1%, average asking rent approaching $5.70 per square foot down from 14.4% one year earlier and at its lowest point in San Francisco by the end of next year. But with rents since Q3 2007. Office occupancy in this trade area had skyrocketing and the availability of quality space remaining increased by just over 1.1 million square feet through the tight, we also think that there is a strong chance that many first nine months of 2014 and was on track to close the tenants start to look to neighboring markets. year at roughly 1.4 million square feet as this report went

26 www.dtz.com DTZ 2015 FORECAST to press. Tech users are the driver here as well, with users like Box leading the way. Box leased 334,000 square feet of space at the Crossing/900 in Redwood City in Q3 and is expected to act as a magnet for other tech companies to locate in the South County and Redwood City, in particular.

As their younger workforces continue to age (the oldest millennials are now 34), look for more tech companies to explore open suburban offices. This trend... will likely most benefit San Mateo County Genentech’s renewal on 428,000 square feet of space at Gateway Commons in South San Francisco was the projects in the years ahead. largest office deal of the year in San Mateo County.

As their younger workforces continue to age (the oldest Tightening Vacancy in Silicon Valley to millennials are now 34), look for more tech companies to Boost Rental Growth explore open suburban offices. This trend, along with the Silicon Valley remains one of the dual epicenters that rising rents and tightening conditions in San Francisco will have driven Bay Area growth and that certainly won’t likely most benefit San Mateo County projects in the years change in 2015, though an improving overall economy ahead. The most successful suburban office projects will and tightening leasing conditions both here and in San be those along mass transit lines that offer an “urban feel” Francisco will increasingly start to carry over to other Bay in a suburban setting. Area markets. In Silicon Valley’s case, we are talking about a market where vacancy had fallen to 10.1% as of the close We expect another strong year of growth in this market of Q3 2014 and that was finally poised to descend into with net absorption totals likely to outpace those of 2014. single digits for the first time since Q1 2007. We anticipate approximately 1.5 million square feet of occupancy growth in the coming year. New construction Silicon Valley recorded over 1.4 million square feet of here will not be a significant factor. By the end of 2014 occupancy growth through the first nine months of 2014 there will be about 1.5 million square feet of office space and was on track to close the year with close to 2.0 million in the development pipeline but only 350,000 square feet square feet of total net absorption and a vacancy rate in of that space is not already accounted for. Most of what the mid 9.0% range. Of the 7.6 million square feet of is currently under construction are large new campus space under construction as this report went to press, 4.1 buildings for local users like Facebook (435,000 square million square feet was slated for 2015 delivery. Of that feet in Menlo Park) or Genentech (480,000 square feet in office space, only about 825,000 square feet was actually South San Francisco). As a result, we see vacancy tumbling available. The remainder of these projects consist of new below the 10% mark over the course of the year and likely corporate campus additions like Samsung’s 650,000 ending 2015 somewhere in the high 8% range. Meanwhile, square foot new headquarters buildings in San Jose or the current average asking rent for office space in San speculative multitenant projects where developers have Mateo County is $3.76 per square foot. We see it closing successfully pre-leased the majority of the space. As such, in on the $4.00 per square foot mark in 2015. new construction will have only a minimal impact on the marketplace in 2015.

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is a growing professional and business services presence and a small, but active, tech sector in the East Bay. Deals in the pipeline for Q4 2014 will likely bring this trade area above the 100,000 square foot mark in terms of growth for the year and vacancy will be in the high 14% range as we start 2015.

The most important thing to watch in determining the performance of the office market here over the next few years is the multifamily market. Vacancy levels are at One of the largest office deals inked in Silicon Valley all-time lows and tenant demand is at an all-time high. this year was Netflix’s expansion into roughly 243,000 square feet at the new Grove at Los Gatos project. This Renters have increasingly been priced out of the San new two-building campus development from Sand Hill Francisco, San Mateo County and Silicon Valley markets will be fully occupied by the streaming media giant upon and are landing in greater numbers in the East Bay. This its completion in Summer 2015. has particularly impacted Alameda County and trade areas along BART lines. The conditions are ripe for Look for Silicon Valley to close 2015 with occupancy Oakland to undergo the kinds of changes that Brooklyn growth totals at, or near, the two million square foot underwent starting in the late 1990s when out-of-control mark and for vacancy levels in the high 7.0% range. The rents in Manhattan led to the revitalization of this borough. current average asking rent in Silicon Valley of $3.99 has Rumors that one of the region’s major tech players might increased by only 2% over the past year. The pace of take the historic Sears building in downtown Oakland are growth will escalate in 2015 now that vacancy levels are critical because this could lead to a proliferation of tech falling into the single digits and that the lion’s share of new space users coming to the East Bay for cheaper rents and development continues to be delivered to the marketplace to follow a workforce that already has a strong presence with occupants in place. Look for asking rents closer to the on the sunny-side of the Bay. $4.20 mark by the close of 2015. Regardless if the “Brooklynification” of Oakland takes place starting in 2015 (though if it happens, it could be East Bay on the Brink? argued that the trend began in 2014), or if any major tech As of the close of Q3 2014, office vacancy in the Oakland players land in downtown or anywhere else (remember marketplace was 14.6%. This number has moved only that the East Bay does already have some vital, though minimally over the course of the past year. It stood at small, tech pockets), we see growth levels kicking up in 15% at the end of 2013 and occupancy growth through 2015. Other space user types outside of the tech industry the first nine months of 2014 stood at just 72,000 square are being priced out of San Francisco and improving feet. That is not very much considering a local inventory economic conditions will also mean expansion from space approaching 29.5 million square feet. Growth hasn’t users already established in the marketplace. Look for the always been this slow in the Post-Recession Era; Oakland Oakland marketplace to close the coming year with close has actually averaged 127,000 square feet per year of to 300,000 square feet of positive net absorption and for occupancy growth since 2010. But this is nowhere near vacancy to fall to the low 13% range by the end of 2015. the 322,000 square feet of annual growth averaged during Substantial moves by tech players will accelerate this. In the expansion years of the last cycle. The problem has the meantime, also look for today’s average asking rent of been that government and education are among the major $2.58 per square foot to move closer to the $2.75 mark. tenant types here and neither is in growth mode. Still, there

28 www.dtz.com DTZ 2015 FORECAST

Steady As She Goes for Contra Costa County rate in the low 10% range. The average asking rate for office space here is currently $2.27 per square foot. This These trends that should result in increasing occupancy metric has climbed by 4% over the past year. growth totals in the Oakland marketplace will also impact office space in the Contra Costa County market, but to a Neither Walnut Creek nor Pleasanton currently have any lesser degree. Activity has been mixed in the Walnut Creek major new office projects under construction so new marketplace for much of 2014. This trade area had posted development is not a factor impacting fundamentals in occupancy gains of two of the first three quarters of 2014, Contra Costa County yet. We think it likely that we will but was still in the red to the tune of -138,000 square feet see a project or two enter the pipeline sometime in 2015, by the close of Q3 2014. Vacancy stood at 16%, up from a but chances are that any new office buildings that start reading of 14.8% one year earlier. Fourth quarter activity construction over the next 18 months will be build-to-suits is expected to bring occupancy growth totals for the year and not speculative development. back into the black, but barely. We anticipate that office vacancy in the Walnut Creek market will close the year in the high 14% range not far from where it started in January. The conditions are ripe for Oakland Despite spotty activity, this has not deterred rental rate to undergo the kinds of changes that growth. The current average asking rent of $2.26 per square foot is up 17% year-over-year. Brooklyn underwent starting in the late 1990s when out of control rents in Manhattan led to the revitalization of this borough.

Both of these market areas tend to be active with smaller users in the professional and business services fields and both are home to a couple of large corporate headquarters facilities. Over the past few years, consolidation among the latter has at various times challenged growth in both markets. As these have traditionally been slower activity and slower growth locations, it only takes one or two of these moves to potentially move a market into the red. One of the largest new office deals signed in the East Bay And some concerns remain that there may be a major in 2014 was URS’ lease of 73,000 square feet at 1333 corporate user or two that may potentially bring large Broadway in Oakland. blocks of space back to the market in 2015. We are aware of no actual solid plans for this however and all other The Pleasanton marketplace experienced modest levels of indications point towards much stronger growth from space givebacks in the first quarter of 2014, but since that both the professional and business services sectors thanks time has recorded fairly steady growth. As of the end of Q3 to the improving overall economy and pricing pressures 2014, vacancy here stood at 11.1%, its lowest level since Q1 driving more tenants to the East Bay. 2008. The Tri-Valley marketplace had posted occupancy gains in excess of 258,000 square feet through the first We expect the Walnut Creek marketplace to see growth nine months of 2014 and was on track to close the year resume to levels in line with historical norms during with over 400,000 square feet of growth and a vacancy economic expansions. Throughout the last economic

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cycle, this market averaged about 250,000 square feet biotech hub in the City, has instead found a rabid leasing of positive net absorption annually. We think that 2015 base with the tech industry. With rents rising in the will see between 250,000 and 300,000 square feet of City, we see biotech increasingly focusing either on the local occupancy growth with local vacancy falling to the traditional Bay Area focal point of San Mateo County or mid 12% range. We also expect the average asking rent increasingly heading to Marin. to increase to the $2.40 per square foot range over the course of the year. With rents rising in the City, we see biotech increasingly focusing either on the traditional Bay Area focal point of San Mateo County or increasingly heading to Marin.

Office vacancy in the North Bay stood at 15.0% as of the close of Q3 2014, down from 15.7% a year earlier. Through

The largest Contra Costa County office lease that we the first none months of the year, occupancy growth has tracked in 2014 was Archer Norris’ renewal and expansion been modest at just over 40,000 square feet. Deals in into 50,000 square feet of space at 2033 N. Main Street the pipeline should translate into final 2014 totals coming in Walnut Creek. in near 100,000 square feet with overall vacancy in the high 14% range. We expect growth levels to pick back We also expect somewhere between 250,000 and up in 2015 and come in at levels closer to historic norms 300,000 square feet of growth in the Pleasanton during expansionary periods. The market averaged about marketplace, which would translate into a local vacancy 180,000 square feet of annual occupancy growth over rate in the high 8% range by the close of 2015. We see the course of the last cycle. We think that occupancy sub-10% vacancy rates helping to accelerate rental growth in 2015 will approach 200,000 square feet as rate growth and would not be surprised to see the local the market experiences growing demand from both local average asking rent approaching $2.40 per square foot users, tenants displaced from BioMarin’s acquisition of by late in the year. San Rafael Corporate Center, and tenants priced out of San Francisco. Look for North Bay vacancy to drop into Increased Biotech, Professional and Business the 13% range and for the average asking rent to climb Service Demand to Boost North Bay from its current level of $1.97 per square foot to above the $2.15 mark. The North Bay continues to be a tale of two basic user types. Historically the bread-and-butter tenant here has (and still is) the professional and business service user, R&D Vacancy Back to Dot-com Levels, however, we are increasingly seeing this marketplace but Not Growth emerge as a biotech hot spot. We think the latter trend So far we have said plenty about the impact of the Bay will continue heading into 2015 and will help to drive Area’s tech sector on the region’s office market, but it is local growth. Mission Bay in San Francisco, which was critical to note that this isn’t the only type of space that originally developed with the purpose of becoming a these users are impacting. The region’s R&D marketplace

30 www.dtz.com DTZ 2015 FORECAST closed Q3 2014 with a vacancy rate of 11.6%, substantially rate has fallen, so too has the availability of higher quality lower from the 13.9% rate recorded one year earlier. biotech space. This market boasts the region’s highest This is also the lowest level of R&D vacancy recorded in asking rates primarily because the lion’s share of the the Bay Area since Q3 2001 when this metric stood at local inventory is higher quality space geared towards life 10.9%. Vacancy was climbing then as the dot-com crash science users. The current average of $2.26 per square continued to unwind through the region’s economy and it foot (on a monthly triple net basis) will likely climb closer ended up settling in the high teens. It never left the teens to the $2.50 per square foot range by the end of 2015. throughout the entire growth cycle that followed or the However, with quality space in short supply we also expect Great Recession, for that matter. The reason is because occupancy growth here to slow. We should see 2014 close for most of the first tech boom, R&D space was about out with over 900,000 square feet of positive absorption light manufacturing and true research and development for this market but expect growth totals to fall below the for tech players. There always has been an active biotech 500,000 square foot mark in 2015. R&D vacancy in San segment of this market as well, but that hasn’t really Mateo County will likely be in the 5.0% range by the end changed much. What has changed is that the new R&D of the year. users are primarily tech companies looking for economical alternatives to office space. So while we are back to first tech boom vacancy levels, the demand for this type of space is nowhere near what we saw in the late 1990s. From 1998 through 2000, the market averaged growth in excess of 9.1 million square feet per year. Over the last three years it has averaged just over 2 million square feet annually.

The region’s R&D marketplace closed Q3 2014 with a vacancy rate of 11.6%... the One of the biggest R&D deals of the year took place in Q1 when Life Technologies relocated to 205,000 lowest level of R&D vacancy recorded square feet at The Science Center at Oyster Point in South San Francisco. since... Q3 2001.

R&D product in Santa Clara County is all about tech users Regardless, R&D activity is up significantly. We anticipate seeking a lower cost alternative to office space and the that the market will close 2014 with somewhere in the local inventory consists of flexible product geared towards neighborhood of 4.5 million square feet of total occupancy these tenants. It also is the region’s most active trade area. growth and a vacancy rate in the high 10% range. We Vacancy here stood at 10.6% as of the close of Q3 2014 expect occupancy growth to fall slightly in 2015, simply and occupancy growth through the first nine months of because the amount of quality available space in the the year totaled in excess of 1.7 million square feet. This market may end up thwarting growth in the coming year. market should close 2014 with more than 2.3 million square feet of total growth and a vacancy rate in the 9% San Mateo County R&D vacancy was the Bay Area’s range. Look for continued growth at this pace throughout lowest as of the close of Q3 2014 at just 7.6%. This metric 2015 with vacancy approaching the 7% range by year-end. stood at 11.8% a year earlier. Fourth quarter activity should The current average asking rent of $1.71 per square foot see that number falling to the low 7% range but as that will be closing in on $1.80 per square foot by March 2015.

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total growth for the year. We anticipate just under one million square feet of net absorption in 2015 which, in the continued absence of new development, will drive overall vacancy downward to the 14% range. The current average asking rent of $0.91 per square foot is unlikely to grow by much in the coming year. We don’t see an environment that supports rental rate growth for all but the highest quality projects here until vacancy levels move closer to the 10% mark. R&D projects here are likely not looking at that scenario until sometime in 2016.

Can Bay Area Industrial Build on a Record Year? Google’s expansion into 500,000 square feet of space at San Antonio Station in Mountain View was the region’s As the third quarter of 2014 came to a close, the Bay Area’s largest R&D lease in 2014. The global tech giant will fully industrial real estate market was closing in on a record occupy this project when renovations are completed in year for growth. Vacancy levels for both warehouse and early 2015. manufacturing space had dropped precipitously. Nearly 4.1 million square feet of industrial occupancy growth had The East Bay R&D market is driven by quasi-industrial occurred in just nine months. To give you an historical users, with product geared towards these uses. But while perspective, the last time the region has seen that much industrial demand in the region is skyrocketing, it is being growth was in 1997 when the market recorded nearly 4.6 driven by transportation/distribution and logistics users million square feet of positive net absorption. But that seeking warehouse space. As a result, with the exception of was over the course of the entire year. These tallies were a small biotech R&D pocket in Alameda County’s Berkeley, through three quarters and all indications were that as Emeryville and Alameda submarkets, the growth here has much as another million square feet of growth would be been much slower than what we have seen for R&D space added to those totals in Q4. This would make 2014 the elsewhere in the Bay Area. As this report went to press, strongest year for industrial growth in the Bay Area that we vacancy stood at 18.2% and occupancy growth through have tracked in over thirty years of keeping local statistics. the first nine months of 2014 stood at just over 608,000 square feet. The market will close 2014 with vacancy in But a quick look beneath the numbers shows that this the mid 17% range and roughly 800,000 square feet of growth has been far from even both in terms of industrial product type and geography. It also uncovers some challenges that could slow growth in 2015. While both R&D product in Santa Clara County is all the warehouse and manufacturing sectors now have extremely low vacancy levels, only one of these two about tech users seeking a lower cost industrial product types has been accounting for growth. alternative to office space and the local As of the end of Q3 2014, Bay Area manufacturing vacancy inventory consists of flexible product stood at just 4.3%. This metric had peaked at 7.5% as geared towards these tenants. It also is recently as Q2 2012. It also had reached as low as 4.6% at the peak of the last cycle (Q2 2007), a level that has the region’s most active trade area. now been surpassed. In fact, vacancy is now at its lowest

32 www.dtz.com DTZ 2015 FORECAST level since it stood at 4.2% in Q3 2001. But manufacturing growth. It creates huge challenges for local businesses vacancy has moved little over the course of 2014. It stood that need to grow and it dissuades new growth from space at 4.4% at the close of the first quarter and then, after users looking to expand to the area. But the challenge here dropping a mere ten basis points, remained where it is is that while demand levels are up, there are a couple now for the next six months. With no new product having of significant hurdles that, so far, have prevented any come online, this just means one thing; flat growth. Just speculative new manufacturing development. 79,000 square feet of space had been absorbed through the first nine months of 2014. And this number is not likely to increase by very much during the final quarter of the As Q3 2014 came to a close, the Bay year. As this report went to press in early December, all Area’s industrial was closing in on a indications were that the manufacturing sector would close the year with total occupancy growth close to the record year for growth. Nearly 4.1 million 140,000 square foot mark and a vacancy rate unchanged square feet of industrial occupancy from current levels. growth had occurred in just nine months... The last time the region has seen that much growth was in 1997 when the market recorded 4.6 million square feet of positive net absorption.

The first challenge is that, with the exception of the inland East Bay, little remains in the way of available and developable industrially-zoned land in every local One of the largest lease of the year was on the Peninsula. In Q1 FedEx leased to 418,000 square feet of space at market. In San Francisco, the city’s already extremely the SFO Logistics Center in South San Francisco. small industrial sector (primarily in the Bayview/Hunter’s Point, Potrero Hill and Dog Patch areas) is increasingly Considering that the local inventory base consists of more being razed to make way for other property types. As land than 147 million square feet of product, an annual net prices have escalated throughout the Bay Area, the highest absorption total of just 140,000 square feet is exceedingly and best use of properties has shifted. As a result, we low. Yet our brokers report that demand is up. The problem have seen a major trend in recent years of aging industrial is simple; vacancy is now at its lowest level in 13 years and buildings in San Francisco, Silicon Valley and (to a lesser there simply is not much remaining available in terms of degree) San Mateo County being razed to make way for quality space. new multifamily, retail or office projects. In fact, since 2002 the region has demolished over 13.9 million square Throughout the Bay Area, there was 6.3 million square feet of industrial space. In contrast, only 7.5 million square feet of manufacturing space available as of the close of feet of new product was built during that same period. Q3 2014. The average age of that space was 45 years old. Much of that space borders on functional obsolescence. Of course, with industrial land in short supply, prices have The fact is that the lack of available modern manufacturing skyrocketed. But rents have only begun to grow over the space in the marketplace is already potentially thwarting past 18 months so the challenge of making new projects

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pencil is a real one. The current average asking rent for This year’s record growth numbers have been almost manufacturing space in the Bay Area is $0.61 per square entirely generated by the Bay Area’s warehouse sector. foot (on a monthly triple net basis). This number has A lack of available quality product remains an issue here, increased 15% over the past year. It has climbed 28% but at least when it comes to warehouse/distribution since hitting a Post-Recession low of $0.47 per square space we are seeing some signs of life on the development foot in Q2 2011. But it has yet to return to the $0.65 per front. Over 1.8 million square feet of new product had square foot rate reached at the peak of the last cycle (Q3 been delivered to the marketplace through the first nine 2008). We believe that this will occur over the first half of months of 2014 and there was another 816,000 square 2015. However, rental rate growth would need to be more feet of space under construction as this report went to aggressive than that to offset rising land and construction press in early December. We expect the construction costs even in Contra Costa, Napa, Solano or Sonoma pipeline to grow significantly heading into 2015 and are Counties (the only Bay Area localities where larger parcels aware of as much as five million square feet of additional of industrially-zoned land are generally still available). projects that are in various stages of planning that might be shovel-ready soon. We think it likely that total deliveries for the region will exceed the 3.5 million square foot mark in 2015 and may be more higher in 2016. Keep in mind that in roughly 30 years of keeping local statistics, there are only two years we know of where the warehouse sector added more than two million square feet of new space. The record is 3.2 million square feet in 1997; this was preceded by 2.45 million square feet of new development in 1996. One of the top East Bay industrial leases of 2014 was But as large as these figures may sound, the real question Sunlight Supply’s Q2 relocation to a 148,000 square is whether this may be too little, too late? foot building in the Livermore Valley Business Park in Livermore.

This year’s record growth numbers have Looking forward to 2015, we anticipate that the lack of available quality product will only intensify as an issue. We been almost entirely generated by the do see the development pipeline on the rise, but most of Bay Area’s warehouse sector. A lack of this will be built out as warehouse/distribution space. We may see a rise in build-to-suit manufacturing projects in the available quality product remains an coming year as well as significant rehabs or redevelopment issue here, but at least when it comes of aging properties in order to sate demand, but none of it is to warehouse/distribution space we likely to be speculative. Speculative industrial development is back, but only for the warehouse sector and we don’t are seeing some signs of life on the expect that to change in the coming year. Look for 2015 development front. manufacturing growth levels to be stymied by a lack of available space and likely total no more than 250,000 square feet of second-generation space at most. Vacancy Warehouse vacancy stood at 4.8% as of the close of Q3 will remain tight and in the low 4% range helping to drive 2014, down significantly from the 7.4% rate that had been rents up further with the average asking rate likely surpassing in place exactly one year before. Year-to-date occupancy the $0.70 per square foot mark by the end of 2015. growth totals were in excess of four million square feet. We expect Q4 activity to add another million square feet

34 www.dtz.com DTZ 2015 FORECAST to that total making this the strongest year for warehouse the development pipeline will continue to expand in May occupancy growth that we have ever tracked. It would also 2015. We are tracking 14 projects that will actively be mean that warehouse vacancy would stand at just 4.2% under construction come January 1, 2015. Those projects as 2014 drew to a close. will add 2.4 million square feet of inventory to the local market next year, with most slated for completion in May or beyond. Yet with six months left before most of these We expect Q4 activity to add another projects will even be delivered, only one million square feet million square feet... making this the of this space remains available. strongest year for warehouse occupancy Occupancy growth for the warehouse sector in 2015 will be growth that we have ever tracked. It driven primarily by new construction. Low levels of vacancy in existing, second-generation space will leave few suitable would also mean that warehouse vacancy options for most space users. Meanwhile, growth will be would stand at just 4.2% as 2014 drew limited by how quickly developers came bring projects to market. As a result, we are unlikely to match 2014’s to a close. record growth levels in the coming year. However, if our development forecast holds true, the market will realize as much as 3.5 million square feet of positive net absorption in What is unclear is whether or not we will be able to 2015. As more than 80% of this is likely to be in new projects maintain this pace heading into 2015. The issue is not don’t look for vacancy levels to fall all that much further. We one of demand, which we continue to see strengthening, expect the market to see vacancy rates in the high 3.0% or but supply. Heading into 2015 there will be somewhere low 4.0% range come 2016. between seven and eight million square feet of available space on the market. The average age of what remains available out there is 46 years old. Much of what remains has varying degrees of functional obsolescence at a time in which demand is largely being driven by transportation, logistics and e-commerce users in need of modern space. For e-commerce players, bulk warehouse buildings that are just 10 to 15 years old are generally outdated. Of course, we still also see strong demand from food users in the Bay Area; wine, beer and spirits players remain extremely active in the North Bay and grocery distributors continue to see growth as local markets expand. But with few exceptions, nearly all of these categories are finding The largest industrial deal of 2014 in Silicon Valley was a renewal. In Q1, Applied Materials re-upped on significant challenges in finding quality available space the 150,000 square feet that they lease at 901 Walsh with local vacancy levels so tight. Avenue in Santa Clara.

It is a telling statistic that of the 1.8 million square feet of All of these factors will put immense pressure on rents. speculative space that had been delivered to the market The average asking rent in the region as this report went through Q3 2014, that 80% of it had leasing commitments to press was $0.63 per square foot (on a monthly triple in place before completion. All of this space was expected net basis). This total has jumped by 16% in the past year. to be leased by the end of this year. We mentioned that It now has surpassed peak levels of the last cycle ($0.60

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per square foot in Q4 2007) and stands at its highest level tenant demand, tightening leasing conditions, diminished ever. It’s about to go higher. We anticipate the average availability of quality space, rapidly escalating rents and asking rent to close in on the $0.70 range by the end a development pipeline that is struggling to keep pace. In of next year. Asking rates for new projects are already the case of both the industrial and retail market we are also at, near, or above, that rate now. The lack of available seeing new development drive a reset in rents. second-generation space will mean that landlords for all but the most challenged properties will likely be able to aggressively raise rents as well. The biggest challenge may be the

The biggest challenge against this dynamic might be the neighbors. Plentiful second-generation neighbors. Plentiful second-generation space (albeit space (albeit plagued by the same issues plagued by the same issues of functionality) remains available in the Sacramento, Stockton and Central Valley of functionality) remains available in markets with asking rates for large blocks of space the Sacramento, Stockton and Central (100,000 square feet or more) as low as $0.30 per Valley markets with asking rates for square foot. More modern space in those trade areas can run anywhere from $0.10 to $0.20 per square foot large blocks of space as low as $0.30 per square foot.

Construction costs have skyrocketed for all property types across the Bay Area. Part of the problem is labor. According to Bureau of Labor statistics for the Bay Area (including the BLS survey areas of San Francisco-San Mateo-Redwood City, San Jose-Sunnyvale-Santa Clara and Oakland-Fremont-Hayward) construction In Q3, Lockheed renewed its 100,000 square foot lease employment peaked here at 171,000 in September 2006. at 2940 Kifer Road in Santa Clara. The construction sector was decimated everywhere during the recession including the Bay Area. Construction more depending on the buildout and other factors, but employment reached a low of just 104,300 in March the fact is that costs are substantially lower in the Central 2011. That’s roughly 67,000 jobs locally. This sector has Valley. This, and currently cheap gas, could entice many emerged as one of the strongest growth categories locally distribution users inland though the need for speedy over the past year or so, but contractors have struggled delivery, traffic concerns and the long-term volatility of to fill job openings—particularly for skilled laborers. As of gas prices are certainly factors to consider. Regardless, October 2014, construction employment in the Bay Area look for 2015 to be a year in which supply will struggle to had rebounded to 144,000. That’s still about 27,000 keep pace with demand and for demand to remain at, or fewer workers than peak employment levels in 2006. near, record levels. But commercial development levels now are more than five times greater than what they were in 2006. To say that this is a problem would be an understatement. There Retail Demand Up, Rents Up Even More are more jobs to go around than contractors; hence labor Every single property type in the Bay Area is experiencing costs are rapidly escalating. Meanwhile, land prices are some variation of the same following issues; strong up and the cost of raw materials is up. In addition, many

36 www.dtz.com DTZ 2015 FORECAST municipalities are sharply increasing their development In 2013 the Bay Area recorded occupancy growth in fees as they, too, look to cash-in on current demand levels excess of 1.8 million square feet. It posted more than 1.5 and offset other soaring public sector costs. All of this million square feet of growth in 2012. These were years means that depending on the product type and location, when actual demand levels were lower than what we are construction costs are anywhere from 15% to 30% above seeing today. However, quality space was still available where they stood just a couple of years ago. in the marketplace.

Retailer demand for space in the region remains extremely robust, but newer high quality product is what they want. Most of the Bay Area’s 6.9 million square feet of currently available shopping center space resides in the region’s Class B and C centers. Though those projects are benefiting from spillover demand and retailers looking for cheaper rents, most of the action is being driven by national credit retailers who want Class A space. New construction has been largely driving occupancy growth trends in the region. We are currently tracking 774,000 square feet of shopping center projects in the construction pipeline but are aware of over one million square feet more in the planned stages that are likely to begin construction sometime in Q4. Yet, amazingly, over 70% of the space already under construction has leasing commitments in One of the largest retail leases of the year was Bass place and nearly half of the million square feet of projects Pro Shops’ deal for 145,000 square feet at the planned we anticipate to go forward shortly has also been leased 350,000 Almaden Ranch project at Highway 85 and Almaden Expressway in San Jose. up. Supply is not keeping up with demand in the Bay Area.

San Mateo County now has a vacancy rate of just 2.6%. This has significant implications for all commercial Net absorption through the first nine months of the year property types but will perhaps have the greatest impact there has actually been negative to the tune of -27,000 on the Bay Area’s retail marketplace. square feet simply because there are virtually no existing

Shopping center vacancy throughout the Bay Area stood at 5.3% as of the close of Q3 2014. While vacancy had Every single property type in the Bay declined in 16 of the previous 17 quarters, the overall rate of decline has been slowing significantly. One year Area is experiencing some variation of prior to this reading, vacancy stood at 5.9%. Occupancy the same following issues; strong tenant growth through the first nine months of the year stood at just over one million square feet. Based on deals we demand, tightening leasing conditions, expect to close in Q4, we anticipate that the market will diminished availability of quality close the year with close to 1.2 million square feet of total space, rapidly escalating rents and a occupancy growth and that shopping center vacancy will stand somewhere near 5.1%. development pipeline that is struggling to keep pace.

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options for shopping center tenants to grow. Conditions 404,000 square feet by the end of Q4. Remarkably, only are nearly as tight in both the San Francisco and North Bay 80,000 square feet of it remains without commitments. markets which both have current vacancy rates of 4.7%. Likewise, development levels are creeping up in Santa The North Bay has seen 102,000 square feet of occupancy Clara County. As Q3 came to a close we were tracking growth so far this year, but most of that landed in new 479,000 square feet of space under construction here, but projects that came online earlier in the year. Meanwhile, were aware of over 500,000 square feet of projects shovel the constricted San Francisco shopping center market ready and expected to begin construction soon. But with has seen no new shopping center deliveries and has only much of it already accounted for, it will bring little relief to seen occupancy through the first three quarters of 2014 a supply-constrained marketplace. increase by 2,000 square feet.

All told, we are tracking over four million square feet of retail projects in the planning stage... We would not be surprised if the pipeline delivered as much as 2.5 million square feet of new space in the coming year.

The good news is that development levels are about to rise significantly. The East and South Bay markets will be the greatest beneficiaries of this trend. All told, we are tracking over four million square feet of projects in the planning Sporting goods is one of the few big box categories still in expansion mode as demonstrated by the two largest stage. Heading into 2015 at least one million square feet leases we tracked in 2014; the aforementioned Bass Pro will be under construction and we would not be surprised Shop deal and Dick’s Sporting Goods lease of 84,000 if the pipeline delivered as much as 2.5 million square feet square feet at Serramonte Center in Daly City. of new space in the coming year. However, there is the issue of rents. Vacancy in the Santa Clara County marketplace now We are now tracking asking rents for shop space in new stands at 4.9%. Occupancy here has increased by projects that range between $60 and $72 per square foot 577,000 square feet so far this year, but it also helps that (on an annual triple net basis). This is in suburban markets over 148,000 square feet of new space came online during where the asking rates for premium space as recently as that time as well and that space is now 96% occupied. three years ago was typically in the high $30 range. High The East Bay has absorbed over 318,000 square feet of demand, low supply and rapidly escalating construction (mostly) previously vacant space this year as its vacancy and development costs are all driving this trend. But will rate has fallen to just 5.7%. These two markets will be the retail tenants be able to weather this huge an increase in focal point of Bay Area occupancy growth heading into rents? Keep in mind that the typical expense ratio for a 2015, simply because they have the highest levels of new restaurant tenant typically has them spending between development in the works. There is 265,000 square feet 10% and 15% of their gross sales on real estate costs like of space in the East Bay pipeline as of the end of Q3, but rent. So what happens to a restaurant operator if their shovel-ready projects should take that figure to at least

38 www.dtz.com DTZ 2015 FORECAST rent climbs 40% in three years, but their sales have only long time even as the overall economic picture brightens. climbed by 15% in that same period? Let’s just say that The long and short of it is that the retail marketplace still the region’s rapidly escalating rents for premium space faces some considerable big picture challenges. are wreaking havoc with a lot of retailer’s expense ratios. Despite all of the relative strengths of the Bay Area retail The good news is all the economic indicators are up. The marketplace, asking rents cannot continue to increase bad news is that this might not be enough to prevent a at the current pace. They are simply unsustainable and higher level of volatility in the marketplace in terms of could ultimately lead to a higher level of retail failures and tenants. In the meantime, aggressive rental rates for a significantly increased level of volatility when it comes premium projects could be a boon for weaker Class B and to occupancy. Meanwhile, keep in mind that about 85% C shopping centers which may see an increase in demand of all of the occupancy growth that we have tracked in the from bargain hunters. local marketplace since 2010 has come from national retail tenants as opposed to mom-and-pop retailers. Many of High demand, low supply and rapidly these chains will increasingly opt to expand elsewhere if pricing for quality space becomes too prohibitive. We are escalating construction and development not at that point yet, but if rent growth doesn’t slow in costs are all driving this trend of 2015 (and give retailers a chance to catch up), we will be. skyrocketing rents. But will retail tenants be able to weather this huge an increase in rents?

As strong as the Bay Area’s retail marketplace is (and it is arguably the nation’s strongest in terms of landlord fundamentals), none of these local dynamics change the bigger picture challenges that the retail world continues to face. The rise of e-commerce has impacted virtually every retail category to some degree or another. For some (like The November purchase of the 3,221 unit Parkmerced record stores, book stores, office supplies or consumer project in San Francisco by the 601W Companies marked a local milestone. This is the first billion dollar apartment electronics) it has posed severe challenges. Others transaction (not counting multiple property or portfolio (like grocery, drug stores, restaurants and service based sales) we are aware of. FIG sold the project for $442,000 retail) have only felt a minimal impact. The most obvious per unit. impact has been felt by hard-goods retailers but direct competition from e-commerce players like Amazon and Will Multifamily Drive the “Brooklynization” Alibaba has not been the only challenge that technology of Oakland? has thrown in the face of retailers. It has also made the retail pricing environment much more competitive as Multifamily was the first commercial real estate product consumers increasingly use the internet to search for the type to rebound following the recession so it is only natural best prices whether they end up purchasing those goods that this asset class may be a little further ahead in the online or at bricks and mortar outlets. Thanks to this last cycle. Bay Area apartment vacancy hit its recession era trend, middle class shoppers who retreated to frugality peak early (5.8% in Q1 2009) but had fallen below the mode during the recession may be staying there for a very pre-recession low-water mark (3.8% in Q2 2007) by Q2

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2011. At that time the region’s office sector was still not quite one year into its recovery cycle and industrial product, Apartment vacancy hit a record low though stabilized, had yet to show any significant signs of in the East Bay at just 2.9%, with both recovery. Vacancy for multifamily would eventually fall as low as 3.6%. This is a rate that has been reached a number the Alameda (2.7%) and Contra Costa of times over the past three years (most recently in Q2 County markets (3.2%) breaking 2013), but as the cycle has increasingly shifted towards new development, those low-water marks are increasingly records... A number of North Bay trade behind us. areas did posted all-time lows; Sonoma

As of the close of Q3 2014, vacancy in the nine-county (2.5%), Marin (2.6%) and Napa (3.1%) (Alameda, Contra Costa, Marin, Napa, San Francisco, San Counties all broke records in Q3 2014. Mateo, Santa Clara, Solano and Sonoma Counties) Bay Area stood at just 3.9%. This reflects a slight uptick from the 3.8% rate that was in place three months prior to that. But while nearly every East and North Bay marketplace While this was certainly not a record in terms of the region saw vacancy decline to record levels in Q3, all of the Bay as a whole, a number of local records were set with the Area’s peninsula trade areas saw this metric climbing. San most recent batch of statistics. Apartment vacancy hit Francisco vacancy climbed from 4.6% to 4.9%, San Mateo a record low in the East Bay at just 2.9%, with both the County vacancy increased from 4.9% to 5.7% and Santa Clara County saw this metric tick up from 4.0% to 4.2%. This trend of increasing vacancy all comes down to one thing; new development.

Throughout the Bay Area over 10,500 new multifamily units were delivered to the marketplace in 2013. By the time final statistics are available for 2014 that record will be broken. We anticipate that total deliveries will exceed the 11,000 unit threshold. Through the first nine months The sale of the 366-unit Apex project by Essex Property of the year, just over 8,700 new units had been delivered Trust to Lyon Communities in August was the largest Santa Clara County apartment sale of 2014. This Milpitas and there nearly 16,500 more units in the development project traded for $150 million, or $410,000 per unit, pipeline with scheduled deliveries through 2017. Santa and a reported cap rate of just 4.9%. Clara County (6,500+ units) and San Francisco (4,800+ units) lead the region in terms of the amount of new multifamily construction underway, but proposed projects Alameda (2.7%) and Contra Costa County markets (3.2%) are multiplying in the East Bay as well. breaking records. Vacancy continued to be extremely tight in the North Bay at just 3.7%. While this didn’t set any The current average asking rent in the Bay Area of records (the North Bay had accomplished that feat just $2,234 per month has increased 11.4% in the past year three months earlier when vacancy fell to 3.2%), a number but this statistic hides a number of disparate trends in the of North Bay trade areas did post some all-time lows. region’s different markets. San Francisco rents now rival Sonoma (2.5%), Marin (2.6%) and Napa (3.1%) Counties Manhattan’s for being the most expensive in the country all posted record lows in Q3 2014. In fact, Solano County at $3,400 (up annually by 9.8%) but the pace of growth (5.4%) was the only trade area in the North Bay that failed here has slowed to single-digits thanks to the impact of to set any new occupancy records. new construction. The same is true of Santa Clara County

40 www.dtz.com DTZ 2015 FORECAST where the average asking rent is now $2,369 (up 10.7% Brooklyn’s average apartment rents between 1995 and annually). Both will see vacancy climb and rents flatten as 1999 was roughly 40%; in other words, a unit that would deliveries mount. rent at $2,000 per month in Manhattan was comparable to product that would lease at $1,200 per month in Brooklyn. The current average asking rent in San Francisco of $3,400 per month is 41% more than the existing Alameda County average of $1,994 per month.

In the late 1990s large numbers of renters were priced out of Manhattan, leading to a surge of in-migration to the borough of Brooklyn. This trend continued heading into the 2000s; rental rate growth in Manhattan slowed from the double-digits but remained in the 5% to 10% range The July purchase of the 542-unit Kirker Creek throughout the early part of that decade. Meanwhile, savvy Apartments in Pittsburg was the largest East Bay developers increasingly pursued redevelopment projects in multifamily transaction we tracked in 2014. Sares-Regis sold this project to Kennedy Wilson for a reported $96.5 Brooklyn as this borough increasingly was reborn. million, or $178,000 per unit. The idea that this would eventually happen in the East Bay is not a new one. Many believed that this would occur Meanwhile, rents are escalating in the East Bay. The during the first tech boom. However, that boom came to an current average asking rate of $1,866 has jumped by 10.7% end abruptly and long before this trend ever had a chance in the past year and will likely accelerate going forward. to materialize. But multifamily wasn’t ahead of the curve in We are tracking more than 2,600 units under construction and though this pipeline will only be getting bigger, most of what is being built will not be delivered before late 2015. The revitalization of Brooklyn that So what does this mean for 2015? We anticipate that overall vacancy levels for the region will increase slightly. started in the late 1990s and that Peninsula market vacancy (San Francisco, San Mateo and continues today holds a number of Santa Clara Counties) will continue to climb as the pace of parallels to current dynamics at play in new apartment deliveries intensifies in the coming year. The East and North Bay may set new record lows for the Bay Area... We are already seeing a vacancy; but these levels simply cannot fall much further. surge of in-migration to the East Bay from While the development pipeline will continue to ramp up in the East Bay, there will be nowhere near the amount of renters priced out of the San Francisco, new supply needed in 2015 to sate rising levels of demand. Silicon Valley and Peninsula markets...

The revitalization of Brooklyn that started in the late 1990s and that continues today holds a number of parallels to that cycle and this time it is. We are already seeing a surge current dynamics at play in the Bay Area. From 1995 of in-migration to the East Bay from renters priced out of through 1999 the Manhattan apartment market posted the San Francisco, Silicon Valley and Peninsula markets. double-digit rental rate growth, typically ranging between Vacancy in Alameda County had reached as high as 7.1% 10% and 15% annually. This has roughly been the same during the recession and averaged 5.5% throughout the level of growth posted by the San Francisco marketplace last economic cycle. But it hasn’t exceeded the 3% range over the last few years. The gap between Manhattan and

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now since 2010. Meanwhile, the overall economy seems to be moving into higher gear as we head into 2015 with risks Expect 2015 to be a year where aggressive of a downturn declining. We may not be at the beginning of this economic cycle, but all evidence indicates that we levels of new development slow rental have a way to go before reaching the peak. rate growth in the San Francisco, San Mateo and Santa Clara County markets; growth may flatten by the end of the year as deliveries of new product surges in these trade areas. However, rental rate growth will return as these markets absorb this space...

become aggressive enough to crash rents in the City. But The purchase of the Paragon Apartments to Essex Property Trust in the third quarter for $111 million was one of the this just isn’t going to happen. San Francisco added 3,000 largest sales of the year. Prudential sold the 301-unit new units in 2013; the largest amount we have tracked in project for a reported price of $369,000 per unit. 30 years. What happened to asking rents? The current average rate of $3,400 per month is up 9.8% from where it There are a couple of factors that could potentially prevent stood at the same time last year. Yes, vacancy is up slightly the “Brooklynization” of Oakland. The first comes down (Q3’s reading of 4.9% compares to 4.8% a year earlier) to political will. A focused strategy by Oakland city and the rate of rental rate growth slowed slightly from government on renewal in key neighborhoods could go a the double-digits. But rents didn’t flatten, much less fall. long way towards accelerating a process that basic market Heading into 2015 there were roughly 5,000 new units dynamics are already fueling, it would also be the smart under construction in San Francisco with deliveries slated strategy for focusing these trends in ways that give the through 2017. We expect deliveries in the coming year municipality the greatest benefits that come with urban to approach the 4,000 unit mark. While we anticipate renewal while minimizing most of the negative impact increasing vacancy levels in the City and think that asking that can come with gentrification. The most obvious rents will finally flatten, we don’t see any major declines strategy would be to focus on revitalizing Downtown coming. If anything, we anticipate that the market may and the greater CBD by promoting development and take the equivalent of a “breather” in terms of rental rate redevelopment in those areas. Of course, a lack of political growth by late in the year. But that this will be short-lived will could just as easily prevent this trend from occurring. and that rents will start to tick up further as new product It won’t stop the influx of renters priced out of other Bay is absorbed. Area markets, nor will it keep local rents from climbing. But Expect 2015 to be a year where aggressive levels of new political ineptness could prevent the city from maximizing development slow rental rate growth in the San Francisco, the potential positives of those trends. San Mateo and Santa Clara County markets; growth may The other potential factor that could prevent the flatten by the end of the year as deliveries of new product “Brooklynization” of Oakland is new construction levels surges in these trade areas. However, rental rate growth in San Francisco and the Peninsula markets. This scenario will return as these markets absorb this space and this is based on the idea that new development levels might process likely won’t take very long.

42 www.dtz.com DTZ 2015 FORECAST

Look for rents to surge in the East Bay as tenant demand How has this surge in demand impacted the local continues to increase. A lagging development pipeline commercial real estate investment market? Through the won’t add enough new multifamily housing units to meet first nine months of 2014 we tracked over $18 billion of this demand this year, though this pipeline will expand sales throughout the Bay Area (our data includes property significantly in the coming year. We won’t see significant sales valued at $5 million or above) and 547 total closed levels of new development coming online in the East Bay deals. This compares to $15.4 billion in closed deals before 2016; until then expect vacancy levels in the 3% throughout all of 2013. And all indications are that final range or less and for rental rate growth to remain in strong tallies for Q4 2014 will surpass anything else we have double-digit territory. seen in the past year thanks to some mega-transactions

There is not a single commercial real estate investment type in the Bay Area where the word robust would not be appropriate in terms of describing investor demand.

Increasing Interest Rates Not Likely to be Major Factor in 2015 There is not a single commercial real estate investment type in the Bay Area where the word robust would not be appropriate in terms of describing investor demand. We would normally see healthy investor appetite on the basis of vacancy and rent fundamentals for any of the major asset classes. But the region’s performance has far outpaced that of most other U.S. markets and remains a focal point of global investment interest. With Asian economic growth One of the largest office sales to close in San Francisco slowing and European performance remaining spotty, a in 2014 was the Rockefeller Group’s $395 million sale flood of foreign capital is landing on American shores. San of the 662,000 square foot Blue Shield of California Francisco and Silicon Valley’s status as a global gateway Building at 50 Beale Street in September. This 23-story office tower traded at a reported 4.5% cap rate and a market means that we now have investors of every type price of $597 per square foot. (from private individuals to REITs and major institutions) and from every locale (from regional to national to global) like Blackstone’s sale of the former Equity Office portfolio looking to acquire properties in the Bay Area. This is not to Hudson Pacific. This one deal alone accounts for 26 a new trend. It’s been in place throughout the upswing in Northern California office properties changing hands at a this cycle, but it continues to escalate and all indications price tag of $3.5 billion. We anticipate total deal activity are that improving U.S. economic performance in 2015 and for 2014 to exceed $25 billion in the Bay Area. This would continued weaker performances in Asia, Europe and Latin make 2014 the strongest year for commercial real estate America will continue to drive large amounts of foreign trades since the local record was set in 2007 at $35 billion. capital here in the coming year.

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The average cap rate (for all property types) that we were will be minimal and not likely to significantly impact the tracking as this report went to press was a record low number of would-be buyers in the market. In fact, we don’t 4.5%. Average cap rates for all individual property types see a major impact to the commercial markets in 2015 are extremely low; from 4.4% (office) up to 5.6% (retail) at all. The properties that may feel some pain would be with industrial and apartment properties trades averaging value-add projects in secondary and tertiary markets. In 5.3% and 5.4%, respectively. other words, the product already at the bottom of the wish list will feel it most. In the Bay Area, however, where the real challenge has been too many investors chasing too few properties, increased interest rates in the coming year will have little impact on pricing and cap rates other than establishing the ceiling for now.

We anticipate total deal activity for 2014 Google continues to expand its Bay Area presence both via to exceed $25 billion in the Bay Area. leasing and purchases; in May the tech titan purchased the four building Middlefield R&D Park in Mountain View This would make 2014 the strongest for a reported $250 million. Deutsche Asset & Wealth Management sold the 399,000 square foot project for year for commercial real estate trades $627 per square foot. since the local record was set in 2007 at

Demand in the region is on the upswing not just from $35 billion. investors, but from cash-rich tech users who want to exploit the benefits of ownership while avoiding the challenges posed by an ever tightening leasing market. Through the We anticipate that office and multifamily product will first nine months of 2014, the most active capital sector continue to see the greatest level of activity in 2015. This in terms of net acquisitions was equity fund buyers. This is because both property types are further along in the group accounted for $1.2 billion of net sales (difference cycle with waves of new development on the way. between acquisitions and dispositions). Owner/users reported the second highest amount ($691M) followed by Multifamily Investment Outlook foreign investors ($410M). Conversely, the private equity sector disposed of more assets than it acquired with a net Significant deliveries of multifamily product will result in negative $1.3B. However, this group was responsible for increased vacancy levels and flattening rental rate growth the most acquisitions year-to-date at $6.5 billion. But final for multifamily product in the San Francisco, San Mateo tallies for the year should see significant increases posted and Santa Clara County markets come 2015. Meanwhile, by the owner/user and equity fund buyer categories. East and North Bay fundamentals will only tighten, with rental rate growth accelerating. As interest rates begin the Before sharing our forecast for 2015 investment activity, process of returning to “normalcy,” some current owners let’s address the issue of interest rates. As we stated will see the first few months of 2015 as a time to sell at, earlier in the economic forecast of this report, we expect or near, peak values. Despite near record sales volume the Fed to begin raising rates by Q2 or Q3 2015. But numbers, the lack of available quality projects has been a we don’t see a major impact on commercial real estate major factor impeding activity in 2014. Through the first investment locally. The increased price of borrowing nine months of 2014 we tracked $3.9 billion of apartment

44 www.dtz.com DTZ 2015 FORECAST sales across 143 major transactions. Final tallies for the year should exceed $5 billion, making 2014 the second In just the month of October 2014, strongest year for trading activity we have ever recorded. Google expanded its commercial real The record was set in 2007 at $5.3 billion, but we think the market could surpass that in the coming year. estate footprint in the Bay Area through leases and acquisitions by 2.8 million Demand for multifamily investment square feet—roughly the amount of the will remain robust in 2015 and longer- Empire State Building. term investors won’t flinch in the face of modest vacancy increases or temporarily Office Investment Outlook flattening rental rate growth. As long as Office sales represented half of the activity that we tracked there is quality product available, this in 2014. Investors have been aggressively pursuing office properties as the volume of deals through the first three asset class will remain white hot. quarters of 2014 reached $11.1 billion. This exceeds the entire amount of deal activity recorded in 2013 by $3.2 billion (the Bay Area recorded just over $7.9 billion in office Demand for multifamily investment will remain robust in trades in 2013). We expect final 2014 tallies for the office 2015 and longer-term investors won’t flinch in the face of sector to approach the $18 billion mark. It won’t surpass the modest vacancy increases or temporarily flattening rental $22.8 billion record set in 2007, but this will be the second rate growth. As long as there is quality product available, highest total that the marketplace has ever recorded. this asset class will remain white hot. The average price Bay Area office sales have historically been a two-market achieved on trades throughout the region through Q3 race between the “vertical” San Francisco and the “campus 2014 was $246,000 per unit (with an average cap rate environment” Silicon Valley. Both have been white hot of 5.3%). San Mateo County led all other markets with in 2014, thanks partially to corporate users. Google an average transaction price of $342,000 per unit (5.1% continues to expand its Bay Area presence both via leasing cap rate). Silicon Valley followed with $293,000 per unit and purchases; in Q3 the tech giant acquired properties (5.1% cap rate). In San Francisco, a dearth of institutional in Mountain View and one building in San Francisco and grade trades have skewed the average sale price metrics followed this up in early Q4 with the purchase of 934,000 downward to just $250,000 per unit (it was $302,000 square feet at the Pacific Shores project in Redwood per unit in 2013), but these mostly Class B and C projects City. In fact, during the month of October 2014 Google averaged a cap rate of just 4.6%. Meanwhile, the average expanded its commercial real estate footprint in the Bay price in the East Bay was $193,000 per unit (5.4% cap Area through leases and acquisitions by 2.8 million square rate) and in the North Bay it was $131,000 per unit (6.3% feet—roughly the amount of the Empire State Building. cap rate). Average pricing will remain at, or near, the But Google certainly hasn’t been the only active player; same for the San Francisco, San Mateo and Silicon Valley Facebook also expanded its campus plans in Menlo Park marketplaces. Cap rates will also stay roughly the same; through the acquisition of Tyco Electronics’ Bohannon they have little room to contract further but we also don’t Industrial Park, totaling 1.4 million square feet. Last, but see pricing declines on the horizon that would drive them certainly not least, Salesforce exercised their option to upward. Pricing will continue to increase aggressively in purchase the 1.4 million Salesforce Tower in San Francisco the East and North Bay with cap rates falling further. a full two years before it’s slated completion date.

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 45 COMMERCIAL REAL ESTATE OVERVIEW

Through the first nine months of 2014, pricing on closed Industrial Investment Outlook office deals throughout the region averaged $375 per A shortage of available product has been the issue plaguing square foot (the average cap rate on these transactions industrial sale activity in the Bay Area. Through Q3 2014 was 4.8%). In San Francisco pricing averaged $588 per we had tracked $1.4 billion of trades and we expected this square foot (4.0% cap rate). San Mateo County followed number to approach $2 billion for the full year. This would at $365 per square foot (5.6%) while Silicon Valley trades place it above 2013’s $1.5 billion total, but well below 2011 averaged at $319 per square foot (5.8% cap rate). East and 2012 tallies. The record total for industrial trades in Bay office deals averaged $196 per square foot (6.4% cap the Bay Area was set in 2007 when $4.2 billion of product rate) while the North Bay came in at $280 per square foot changed hands. We don’t anticipate that this record will (5.9% cap rate). be broken in 2015. Look for core office product to continue to generate top Through the first nine months of 2014, pricing on closed pricing in 2015, but also increased investor interest in Class industrial deals throughout the region averaged $103 per B and C product as well as projects situated in the Bay square foot (the average cap rate on these transactions Area’s secondary marketplaces as they continue to search was 6.0%). Activity, as always, was largely focused on for greater yield. Still, with the current wave of new office the region’s two largest industrial markets; the East and development in San Francisco unlikely to impact underlying South Bay (Silicon Valley). Pricing for East Bay industrial fundamentals there significantly, we see demand likely deals averaged $55 per square foot (7.3% cap rate) while ticking up further. Look for pricing to continue to edge up trades averaged $116 per square foot (4.9% cap rate) slightly, but cap rates in most trade areas simply can’t fall in Silicon Valley. Pricing in San Mateo County averaged much further. We also expect higher levels of trading in $88 per square foot (5.2%), while the North Bay came 2015. Both the availability of office product and deal flow in at $82 per square foot (6.9% cap rate). Deals in San was on the increase over the final months of 2014 and Francisco were few and far between, with many of them this trend will continue in the year ahead. More current redevelopment plays. owners will be looking to achieve near peak pricing while demand remains white hot. But demand won’t abate for Heading into the final months of 2014, industrial this product type in the coming year. availability remained an issue. With rental rate growth having just returned to the marketplace over the past 18 months, and now in the process of accelerating, many owners are reluctant to part ways with their investments at this point in the cycle. We don’t see that changing in 2015 as underlying fundamentals continue to improve for landlords. But while activity will likely slow, look for the deals that do close to close at top dollar. Expect pricing to increase substantially with stronger demand building for industrial product. Cap rates will compress further in response to these dynamics. One of the most significant industrial sales of the year was MetLife’s September acquisition of the 575,000 square foot Cherry Logistics Center in Newark. McShane Retail Investment Outlook Development sold this project for a reported $87.3 million ($152 per square foot) and a 4.5% cap rate. Quality retail and shopping center investment This fully leased project sold quickly after its completion demonstrating that trends currently favor merchant opportunities have also been difficult to find in 2014, builders. though deal volume is up from 2013 levels. We tracked

46 www.dtz.com DTZ 2015 FORECAST

$1.7 billion in closed deals in 2013 and were aware of $1.6 near record lows for premium retail product and there is billion in trades through the first three quarters of 2014. We not much room for them to fall further. Most of the gains anticipate that final tallies for 2014 will exceed $2.1 billion. in pricing are likely to be for non-core assets or shopping The record for trading activity remains 2007’s $2.7 billion. centers in the region’s secondary marketplaces. There cap rates have some wiggle room and we are likely to see considerable interest coming from investors willing to forego “the sure thing” in order search of better yields.

While 2014 will likely close as the second strongest year for overall commercial real estate deal activity in the region’s history, all indications are that 2015 could potentially surpass these totals. Thanks to its robust, tech-driven economy, and the continued drive of investors looking for safe, core investments in gateway markets, the Bay Area continues to be one of the hottest real estate markets in the US. Demand for product here driven by local, regional, national and global investors and lingering weaknesses in Madison Marquette’s August sale of the Bay Street Emeryville lifestyle center to UBS was the region’s largest the Asian and European economies, as well as increasing shopping center sale of the year. This 392,000 square volatility on Wall Street, are likely to drive more capital foot center traded for $289.2 million ($738 per square foot) and a reported cap rate of 4.8%. into the real estate arena over the next year. This is despite the fact that interest rates are likely to be increased by the Fed by midyear 2015. The end result will be that increasing Through the first nine months of 2014, pricing on closed demand will likely offset any potential impact on pricing retail deals throughout the region averaged $383 per that may come with a slightly higher cost of borrowing. square foot (the average cap rate on these transactions was 5.7%). In San Francisco pricing averaged $786 per square foot (5.1% cap rate). San Mateo County followed at $434 per square foot (5.5%) while Silicon Valley trades averaged at $310 per square foot (5.7% cap rate). East Bay office deals averaged $319 per square foot (6.7% cap rate) while the North Bay came in at $280 per square foot (5.1% cap rate).

We see most of 2014’s trends continuing to play out in 2015. Deal activity will continue to tick up incrementally, but the availability of quality product will remain an issue. Premier properties will continue to command top dollar with pricing remaining high and cap rates extremely low. Most of the deal activity, however, will be focused on Class B and C projects and value-add deals. Expect more redevelopment plays as well in the coming year. Pricing on the whole will likely continue to tick up a notch, but we don’t expect aggressive growth. Cap rates are already

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 47 BAY AREA Oce / R&D 2014 Leases

O ce/R&D Leases Q1-Q3 2014 Notable Trends Based on Total Square Footage Technoloy Silicon Valley inked 64% of the total technology deals in the Bay Area. 5% Technology firmsrepresented over 40% of leasing in three of the seven Bay Area markets. Professional / Business Services 0% Salesforce signed the largest deal with 714,000 SF in San Francisco. Life Sciences

Google leased over 2.1 million square feet during 2014. + 12%

Government / Education / Non Profit 5%

BAY AREA & NATIONWIDE Job Growth 2014 YTD

Bay Area Top 5 Industries Jobs Added From October 2013-2014 Educational/Health Services 16%

Leisure & Hospitality 15% Construction 12%

Professional Services Information / General Business 1% 7%

Top 5 Metropolitan Statistical Areas % change in job growth from 2013

.2% 2.5%

1.8% 1.5% 1.0% 0.%

Dallas SA Los Aneles SA New York SA Chicao SA ashinton DC SA Bay Area SA Reunion Tower Bank of America Plaza Empire State Buildin illis Tower ashinton onument Transamerica Pyramid

48 www.dtz.com BAY AREA Venture Capital Funding

Bay Area Top 5 Industries Funding Distribution in $ Millions YTD 2014 in $ Millions Q3-2014

New England Software $652M $8.7B

Media & $1.6B Bay Area Entertainment LA $4.4B $581M

Biotechnology $1.2B Southwest $527M IT Services $1.1B Midwest $395M $ Millions for YTD 2014 Industrial/Energy $30M 1 Icon = $400M

BAY AREA Oce / R&D Requirements

By Total Square Feet 2014 YTD Large Users represent 42% of total square footage ≤10,000 SF 1.9M 10,000 – 39,999 SF 4.6M 40,000 – 59,999 SF 2.3M 60,000 – 99,990 SF 3.8M Size Segment ≥100,000 SF 12.9M

Million Square 1 2 3 4 5 6 7 8 9 10 11 12 13 Feet

Government Government & Non-Proﬁt & Non-Proﬁt Notable Trends Google expands Bay Area footprint in 2014: Technology • 2.1 million SF leased Oce/R&D • 1.8 million SF purchased Requirements Alibaba claims the largest global IPO ever at $25 billion in 2014 by Industry Professional & Near Dot-com peak levels of venture capital funding is fueling recent Corp. Services requirements in the market

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 49 BAY AREA MARKETS TOP LEASE TRANSACTIONS Q1-Q3 2014

San Francisco Office Market Notable Leases of 2014 (Through Q3 2014)

Tenant Quarter Total SF Address City/Submarket Transaction Type

Salesforce Q2 714,000 415 Mission St South Financial Relocation

LinkedIn Q3 450,209 222 2nd St South Financial Relocation

Twitter Q1 313,206 1 10th St Mid-Market Relocation

Bank of America Q1 261,150 555 California St North Financial Renewal

Google Q3 242,640 1 Market St - Spear Tower South Financial Relocation

San Francisco Industrial Market Notable Leases of 2014 (Through Q3 2014)

Tenant Quarter Total SF Address City/Submarket Transaction Type

Confidential Tenant Q3 131,000 1600 Donner Ave Bayview Relocation

Archstone Q1 125,000 801 Brannan St Showplace Square Relocation

Royal Motors Q2 76,000 2000 McKinnon Ave Bayview Relocation/Expansion

East Star Building Supply Q3 36,000 301 Toland St Bayview Relocation

Royal Motors Q2 29,640 2050 Mckinnon Bayview Relocation/Expansion

San Mateo County Office Market Notable Leases of 2014 (Through Q3 2014)

Tenant Quarter Total SF Address City/Submarket Transaction Type

Box, Inc. Q3 334,212 Crossing/900 Redwood City Relocation/Expansion

Intuit Q3 210,000 180 Jefferson Dr Menlo Park Renewal

Genesys Telecommunications Q1 156,477 2001 Junipero Serra Blvd Daly City Renewal/Expansion

Gilead Sciences Q1 108,088 101 Lincoln Centre Dr Foster City Expansion

Walmart.Com Q2 106,099 950 Elm Ave San Bruno Expansion

San Mateo County R&D Market Notable Leases of 2014 (Through Q3 2014)

Tenant Quarter Total SF Address City/Submarket Transaction Type

Onyx Pharmaceuticals Q3 107,000 269 Grand Ave, E. S San Francisco Relocation

Rinat Neuroscience Corporation Q3 106,368 230 Grand Ave, E. S San Francisco Renewal

Solazyme Q3 106,076 201 & 225 Gateway Blvd S San Francisco Expansion/Renewal

Bristol Myers Squibb Q3 60,984 740 Bay Rd - Bldg C Redwood City Relocation

Crescendo Q3 53,980 347 Oyster Point Blvd S San Francisco Renewal

San Mateo County Warehouse Market Notable Leases of 2014 (Through Q3 2014)

Tenant Quarter Total SF Address City/Submarket Transaction Type

Blue Print Studios Trends, Inc. Q1 121,000 344 Shaw Rd S San Francisco Relocation

Classic Party Rentals Q3 96,795 1625 Rollins Rd Burlingame Expansion

Greenleaf Produce Q2 89,062 455 Valley Dr Brisbane Relocation

Service West Q1 70,328 100 Grand Ave, E. S San Francisco Renewal

Flying Food Group Q2 69,500 240 Littlefield Ave S San Francisco Relocation

50 www.dtz.com DTZ 2015 FORECAST

Santa Clara County Office Market Notable Leases of 2014 (Through Q3 2014) Tenant Quarter Total SF Address City/Submarket Transaction Type Ericsson Q2 412,492 Santa Clara Square Santa Clara Relocation Citrix Q1 170,000 4800 Great America Pkwy Santa Clara Expansion Apple Inc. Q2 103,638 20525 Mariani Ave Cupertino Renewal WhatsApp Q2 78,000 250 Bryant Ave Mountain View Expansion Apple Inc. Q3 72,632 Cupertino City Center Cupertino Expansion

Santa Clara County R&D Market Notable Leases of 2014 (Through Q3 2014) Tenant Quarter Total SF Address City/Submarket Transaction Type Google Inc. Q3 424,825 1184-1220 Mathilda Ave Sunnyvale Expansion Google Inc. Q2 397,510 700 Middlefield & 1101 Maude Mountain View Expansion EMC Q3 300,000 2831 & 2841 Mission College Santa Clara Renewal Google Inc. Q2 288,050 950-1000 W. Maude Ave Sunnyvale Expansion Machine Zone Q3 265,294 1050 Page Mill Rd Palo Alto Expansion

Santa Clara County Warehouse Market Notable Leases of 2014 (Through Q3 2014) Tenant Quarter Total SF Address City/Submarket Transaction Type Legacy Transportation Q3 194,000 935 McLaughlin Ave San Jose Renewal GE Hitachi Nuclear Q2 158,200 1989 Little Orchard St San Jose Renewal DGA Services Q2 142,783 1065 Montague Expy Milpitas Relocation Eagle Recycling Q2 120,000 205 Alma Ave San Jose Relocation Interline Brands Q2 103,140 650 Brennan St San Jose Renewal

Santa Clara County Manufacturing Market Notable Leases of 2014 (Through Q3 2014) Tenant Quarter Total SF Address City/Submarket Transaction Type Flextronics Q3 499,206 637-1177 Gibraltar Dr Milpitas Renewal Airtonics Metal Products Q3 88,351 140 San Pedro Morgan Hill Relocation OnCore, LLC Q1 73,000 2243 Lundy Ave North San Jose Renewal Cloud 9 Lisousine, Inc. Q1 31,166 1039 Sinclair Frontage Rd Milpitas Relocation Sears Logistics Services Q1 30,455 1021-1101 Cadillac Ct Milpitas Renewal

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 51 BAY AREA MARKETS TOP LEASE TRANSACTIONS Q1-Q3 2014

East Bay Office Market Notable Leases of 2014 (Through Q3 2014)

Tenant Quarter Total SF Address City/Submarket Transaction Type

Ellie Mae Q3 105,451 4420 Rosewood Dr Pleasanton Relocation

24 Hour Fitness Q3 84,000 12647 Alcosta Blvd San Ramon Renewal

Penumbra Q3 81,904 1321 & 1411 Harbor Bay Pkwy Alameda Relocation

County of Alameda Q1 71,652 1000 Broadway Oakland Renewal

T-Mobile Q3 56,772 1855 Gateway Blvd Concord Renewal

East Bay R&D Market Notable Leases of 2014 (Through Q3 2014)

Tenant Quarter Total SF Address City/Submarket Transaction Type

L-3 Communications Q3 135,579 2700-2800 Merced St San Leandro Renewal

Hewlett Packard Q1 129,883 4209-4213 Technology Dr Fremont Renewal

Smart Modular Technologies Q2 79,480 39870 Eureka Dr Newark Renewal

Kateeva Q3 75,342 7007 Gateway Blvd Newark Relocation

All Quality and Services Q2 72,536 401 Kato Terr Fremont Renewal

East Bay Warehouse Market Notable Leases of 2014 (Through Q3 2014)

Tenant Quarter Total SF Address City/Submarket Transaction Type

Confidential Tenant Q2 574,640 38811 Cherry St Newark New

Living Spaces Q3 311,348 The Crossings @ 880, Bldg 3 Fremont New

Macy’s Department Stores Q3 257,500 1200 Whipple Rd Union City Renewal

One Source Distributors Q1 223,984 2001 Marina Blvd San Leandro Relocation

Uni-Tile & Marble Q1 198,000 21111 Cabot Blvd Hayward Relocation

East Bay Manufacturing Market Notable Leases of 2014 (Through Q3 2014)

Tenant Quarter Total SF Address City/Submarket Transaction Type

Synnex Corp Q2 177,041 5555 Auto Mall Pkwy Fremont Relocation

Chef’s Warehouse Q3 117,420 1250 Whipple Rd Union City Relocation

Nefab Q2 87,074 8477 Central Ave Newark Relocation

Celestica Q2 81,485 40737 Encyclopedia Cir Fremont Renewal

Bay Advanced Technologies Q3 76,526 8100 Central Ave Newark Renewal

52 www.dtz.com DTZ 2015 FORECAST

Marin County Office Market Notable Leases of 2014 (Through Q3 2014)

Tenant Quarter Total SF Address City/Submarket Transaction Type

Marin Healthcare District Q1 45,277 1350 S Eliseo Dr Greenbrae New

Sitecore USA Inc. Q2 36,402 2320 Marinship Way Sausalito New

Ultragenyx Pharmaceutical Q3 24,846 60 Leveroni Ct Novato Expansion

Raptor Pharmaceutical Q3 19,106 500 Hanger Ave Novato New

Pacific Pulmonary Q2 17,361 773 San Marin Dr Novato Sublease

Marin County Industrial Market Notable Leases of 2014 (Through Q3 2014)

Tenant Quarter Total SF Address City/Submarket Transaction Type

Mikes Bikes Q1 28,800 55 Leveroni Ct Novato Expansion

BioMarin Q3 11,840 240 W Francisco Blvd San Rafael Expansion

Weldon Exhibits Q4 10,191 33 Commercial Blvd Novato Expansion

Tesla Motors Inc. Q3 6,509 21 Duffy Pl San Rafael Expansion

Platt Electric Supply, Inc. Q2 6,058 654 Irwin St San Rafael New

Sonoma County Office Market Notable Leases of 2014 (Through Q3 2014)

Tenant Quarter Total SF Address City/Submarket Transaction Type

Sutter Pacific Q1 18,754 131 Stony Cir Santa Rosa New

KLH Consulting Q3 14,066 2235 Mercury Way Santa Rosa New

RGN Q3 12,880 3550 Round Barn Blvd Santa Rosa New

Kaiser Permanente Q1 11,766 3559 Round Barn Blvd Santa Rosa New

L2 Communications Q3 11,153 420 Aviation Blvd Santa Rosa New

Sonoma County Industrial Market Notable Leases of 2014 (Through Q3 2014)

Tenant Quarter Total SF Address City/Submarket Transaction Type

Lagunitas Brewing Co. Q3 132,100 1250 N. McDowell Blvd Petaluma Expansion

M.A. Silva Corks Q3 66,925 3455 Westwind Blvd Santa Rosa New

Pace Supply Q3 47,600 150 Todd Rd Santa Rosa Renewal

Synergy Health Q3 31,000 3200 Lakeville Petaluma New

Medtronic Inc. Q2 26,129 5343 Skylane Blvd Santa Rosa Renewal

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 53 BAY AREA MARKETS TOP LEASE TRANSACTIONS Q1-Q3 2014

Bay Area Retail Notable Leases of 2014 (Through Q3 2014)

Tenant Total SF Shopping Center/Address City

Hobby Lobby 93,311 7050 Amador Plaza Rd Dublin

Dick's Sporting Goods 49,500 1975 Cleveland Ave Santa Rosa

The Hall 34,280 1028-1056 Market St San Francisco

John & Michael Dollar Outlet 34,000 2213-2225 El Camino Real Santa Clara

Plank 33,500 98 Broadway Oakland

Stein Mart 32,000 20580-20680 Homestead Rd Cupertino

24 Hour Fitness 28355 1650 Industrial Rd San Carlos

National Gourmet Market 27,500 3846-3848 Castro Valley Blvd Castro Valley

Sprouts 26,700 4026 Maher St Napa

Jo Ann's Fabrics 25127 4301 First St Livermore

Maserati of Walnut Creek 24,944 2330 N Main St Walnut Creek

The Complete Backyard 24,460 1331-1351 Coleman Ave Santa Clara

Good Earth Market 23,267 203-207 Flamingo Rd Mill Valley

Zanotto's 23,200 1322-1356 S Mary Sunnyvale

PetroMart Retail Group 22356 404 19th Ave (E) San Mateo

99 Cent Store 21,800 3684 Sonoma Blvd Vallejo

Sprouts Market 20,901 20558 Stevens Creek Blvd Cupertino

Royal Palace Banquet Hall 20,900 6044-6096 Stevenson Blvd Fremont

Impact Hub 20,425 2315-2323 Broadway Oakland

Ross Dress for Less 20,132 1030 N Rengstorff Ave Mountain View

Party City 18600 2720 Santa Rosa Ave Santa Rosa

Espetus 16473 1686 Market St (R) San Francisco

Chavez Supermarket 16293 400 Norfolk Ave (E) San Mateo

Papa John's Pizza 14565 Mission Blvd & Mattox Rd Hayward

Steve & Jean Elliot 14000 575 Rohnert Park Expressway Rohnert Park

America's Tire Company 6,147 3850 Beacon Ave Fremont

Chevron 6,000 San Pablo Ave Hercules

Biotech Equipment Sales, Inc. 5,000 226 Miller Ave South San Francisco

Citibank 4,642 130 Throckmorton Ave Mill Valley

Carl's Jr. 4,027 98 Peabody Rd Vacaville

54 www.dtz.com DTZ 2015 FORECAST

Credits Sources Author Market Research DTZ Research Garrick Brown, Vice President of Research, West Region Stephen Epps PriceWaterhouseCoopers’ Money Tree Abigail Friedman Renaissance Capital Design & Production Molly Herrick SalesGenie Liz Dreessen, Senior Graphic Designer Jason Karbelk IPO Monitor Herman Chan, Graphic Designer Andrew Koutsoukos Silicon Valley Business Journal Julie Leiker Gasbuddy.com Managing Editors Lynn Nguyen BEA Mark Bollozos, Regional VP, Marketing Erica Ryan Federal Reserve Konrad Knutsen, Vice President , Research Kevin Smith Moody’s Analytics Krissy Daily, Creative Director Cole Speers Shiller PE 10 Ratio Katelyn Spiro Bureau of Labor Statistics CoStar Group

Terms Commercial Real Estate (CRE) Vacancy Commercial property includes office buildings, industrial property, Available square footage divided by total square footage of inventory. medical centers, hotels, malls, retail stores, shopping centers, farm land, multi-family housing buildings, warehouses, and garages. Net Absorption Change in occupied square footage from period to period. Office Includes Class A, Class B, Class C, and suburban garden office buildings Gross Absorption over 10,000 square feet. Class A product is steel and concrete Total lease square footage signed from period to period. construction, built after 1980, quality tenants, excellent amenities, and premium rents. Class B product is built after 1960, fair to good finishes, Average Rent Rate and wide range of tenants. The weighted average (per square footage) of quoted rents at the end of 2011. Rates are quoted full service for office, NNN for all other property R&D types. Rates are monthly for all properties with the exception of retail Modern flex buildings with some space dedicated to research and/ shopping centers, quoted per annum. Apartment rental rates are quoted or product development. Buildings usually have parking greater than monthly per unit. 3.5/1000, clear height less than 18’, 1-2 stories, and three sides of glass. N/A Industrial (IND) Indicates information was not applicable or not available at press time. Buildings used for warehouse, light manufacturing and R&D purposes that meet those building’s specifications. Total Dollar Volume Dollar amount of total transactions in a given period. Manufacturing (MFG) Manufacturing buildings generally have a parking ratio less than Total Properties Traded 3/1000, clear height less than 18’, dock or grade-level doors, 6-15% Total number of properties sold in a given period. office buildout, and one side of glass. Total Volume SF Warehouse (WHSE) Square footage amount of total transactions in a given period Warehouse buildings generally have a parking ratio less than 2/1000, clear height greater than 18’, multiple dock and/or grade-level doors, Average Price per Square Foot limited office buildout, and a limited amount of glass. Average sale price per square foot, excluding apartments, in a given period. Retail Shopping Center A planned group of connected retail stores, usually with an attached Average Price per Unit parking area, specially developed on a parcel of private property and Average sale price per unit (apartment) in a given period. managed by a single organization. Market Capitalization (Cap) Rate Building Base The estimated return on a property based on the total net income Total market inventory of buildings generally over 10,000 square feet. divided by the purchase price.

Gross Leaseable Area (GLA) Forecast Methodology Total market inventory of retail shopping centers generally over 50,000 Forecast analytics calculated by DTZ Research. The basis of the model square feet. applies growth projections of various indices with a strong correlation to ession analysis of past market activity and projections from reliable Total Availables sources within DTZ. All space being marketed for lease, direct or sublease, available within 90 days. This may include availabilities with pending leases.

SAN FRANCISCO BAY AREA COMMERCIAL REAL ESTATE 2015 FORECAST 55 DTZ is a global leader in commercial real estate services providing occupiers, tenants and investors around the world with a full spectrum of property solutions. Our core capabilities include agency leasing, tenant representation, corporate and global occupier services, property management, facilities management, facilities services, capital markets, investment and asset management, valuation, building consultancy, research, consulting, and project and development management. DTZ manages 3.3 billion square feet and $63 billion in transaction volume globally on behalf of institutional, corporate, government and private clients. Our more than 28,000 employees operate across more than 260 offices in more than 50 countries and proudly represent DTZ’s culture of excellence, client advocacy, integrity and collaboration.

For further information, Visit us at www.dtz.com. Follow us on Twitter @DTZ