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April 25, 2014

Kidder Mathews: Silicon Valley Office 1st Quarter 2014

The Registry San Francisco

Slow office leasing activity in the first quarter of 2014 led to negative net absorption across Silicon Valley. This negative net absorption of -177,990 square feet caused vacancy to increase slightly, to 11.69%. Investment sale activity remained strong, with the hope that this lull in leasing will end in coming quarters. With many deals currently in the negotiation stages, as well as flowing VC money, activity should increase throughout 2014.

Downtown Mountain View has been a hotspot for tech tenants, which has driven vacancy near 0% and rental rates to some of the highest in the Bay Area. Tenants are willing to pay a premium for downtown Mountain View's prestigious address, Caltrain proximity, and the ability to attract talent from San Francisco. However, there is rarely office space available in this submarket. This changed in the first quarter, as a handful of 30,000+ square foot buildings are either available or will be available soon. For example, the build-to-suit project on West Evelyn was never occupied by Nuance, who leased it for 12 years and is now seeking a sublessor. The new developments at 250 Bryant, 150 West Evelyn, and 605 Castro are all available and should be deliverable within a year. All these buildings have strong activity, and it would not be surprising to see them leased in the coming quarters at full-service rental rates north of $7 per square foot, as Pure Storage is paying slightly over this $7 per square foot threshold on the 22,598 square feet they subleased on Castro Street this quarter.

The suburban submarket of Cupertino experienced a large amount of negative net absorption, which is uncharacteristic of this desirable submarket with 4% vacancy. However, as part of the real estate lifecycle, large blocks of space came to market, which gives new tenants opportunity to expand in the West Valley, if they can justify Cupertino's average office rental rates of $3.78 per square foot. Cupertino's biggest tenant, Apple, completed demolition of roughly 1.8 million square feet of office and R&D buildings to make way for their new "spaceship" Campus2, which, when completed, will add 2.8 million square feet of office space to Cupertino. This is the largest private construction project in the history of Silicon Valley.

The first quarter's slow leasing activity is reflected in the relatively small size of the largest new transactions. This quarter, the largest transaction was Ensighten's 28,930 square foot lease in San Jose. Groupon expanded in Palo Alto, taking 27,443 square feet at 210 Portage Avenue. Electric Cloud is the latest mid-sized tenant to move into downtown San Jose, leasing 18,622 square feet at 35 South Market Street. Despite smaller lease transactions in the first quarter, a handful of larger office deals are currently in negotiation. This should lead to an uptick in activity for the second and third quarters.

Venture Capital funding has always been a driving force in the Silicon Valley real estate market. VC activity increased dramatically in the first quarter of 2014, reversing a trend of decreasing funding experienced throughout 2013. According to PitchBook, the Bay Area received $5.7 billion in funding this quarter, which is 37% of all global VC capital invested.

Much of this ended up in Silicon Valley. As these tech, software, and life science companies grow and get funding, their real estate needs grow as well. VC money drives the real estate market, and this increase in funding should make for an active year.

For more information contact: Reed Payne, Executive Vice President, Brokerage 408.970.9400

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