Investors of All Stripes Are Still Interested in Silicon Valley Office Buildings

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Investors of All Stripes Are Still Interested in Silicon Valley Office Buildings

Unlike neighboring San Francisco and many large office markets nationally, the Silicon Valley office market has continued to shine throughout the current recession, with positive net absorption, stable rents and ongoing investor activity.

The strength of the Valley’s office market is a reflection of its tenants, which have continued to grow and expand during the COVID-19 pandemic as other industries have contracted. “NVIDIA, Paypal, Crowdstrike, and AMD are just some of the companies that have more than doubled their value during this period,” says Alexander Quinn, director of research for Northern California with real estate services firm JLL. Eleven Silicon Valley-based companies also went public in 2020, with an estimated market cap of $41 billion, Quinn adds. That, in turn, has fueled more venture funding in local technology start-ups, including those specializing in fintech, AI and autonomous vehicles.

In fact, Oxford Economics forecasts that the San Jose Metropolitan Statistical Areas will realize the highest GDP growth among major U.S. metros in 2021, ahead of Austin and Seattle.

“The valley really hasn’t experienced a full correction to date,” says Quinn. As a result, 54 of the market’s office buildings with a total area of 3.3 million sq. ft. were traded over the last three quarters of 2020. The buildings sold at an average price of $630 per sq. ft.

During the preceding three quarters, from the third quarter of 2019 through the first quarter of 2020, 246 of Silicon Valley’s office properties traded hands, at an average price of $610 per sq. ft. But according to Quinn, the more recent transactions have involved higher quality assets, which led to increased pricing and steady cap rates, especially for buildings with high credit tenants and limited rent rolls. Deals on core-plus buildings, however, proved more difficult to consummate as some sellers chose to pull their properties off the market until more favorable market conditions.

The transactions that did close involved both newly built class-A product and older assets occupied by credit tenants with long-term leases, according to Joe Moriarty, senior vice president in the Silicon Valley office of real estate services firm CBRE.

For example, local developer Hunter Storm sold three new class-A office buildings occupied by Roku in the Coleman Highline mixed-use complex in North San Jose to BCORE Coleman, an affiliate of investment giant Blackstone, for $275 million.

In addition, three Cupertino office portfolios consisting of office buildings developed in the 1980s and occupied by Apple were picked up by a three different investors, including San Francisco-based Swift Real Estate and two foreign-based entities.

Overall, San Jose, one of the Valley’s major hubs, saw 84 office properties trade hands in 2020, with a transaction volume of $3.59 billion, according to the year-end report from data firm Real Capital Analytics (RCA). When all commercial property transactions that took place in the city are taken into account, San Jose moved up one spot among the most active investment sales markets in the U.S. last year, to number 14.

The most active buyers in Western states in 2020 included private equity players and REITs with large reserves of capital, including Blackstone, Brookfield Asset Management and Alexandria, RCA reports.

Moriarty predicts that when the pandemic ends, the majority of Silicon Valley giants will require employees to return to the office because it’s difficult to collaborate, work in groups and onboard and mentor new employees while working remotely. In fact, many tech companies are expanding their footprints to allow for social distancing, as health and safety are the biggest concerns tech employees have about returning to the office, he notes.

Moriarty adds that similar to life science companies, some tech companies’ operations require employees to work on-site even during the pandemic. This includes work in research and development and/or production, like engineering labs and chip development and manufacturing.

An eventual office comeback is inevitable and investors willing to wait it out will reap the rewards, according to Quinn. “Put simply, while current deal activity is down and will likely mute values in the short-term, longer term investors are likely to be rewarded with robust demand from businesses building the new post-COVID economy,” he says.

However, in the meantime, leasing activity has been sluggish as tenants continue to consider their post-pandemic space needs. For the year 2020, leasing activity in Silicon Valley totaled 1.6 million sq. ft., the lowest level in 12 years, with North San Jose and Santa Clara reporting the highest vacancy rates, at 19.5 percent and 14.4 percent respectively, according to data from JLL.  Vacancy may rise even further when 7.7 million sq. ft. of new office space is delivered to the market later this year.

Moriarty notes that just 3.1 million sq. ft. of sublet space was added to the market in 2020, which represents about 1.5 percent of the total inventory of 240 million sq. ft. of Silicon Valley office space. Much of the sublet space coming on the market so far is not pandemic-related, according to him. For example, ASML, a major supplier of semiconductors to the chip industry, placed its former headquarters on the sublet market because it is expanding and has moved into two new buildings.

But the decrease in leasing velocity and increase in sublet space is putting downward pressure on rents, resulting in direct rental rates remaining mostly flat, with landlords increasing concessions in lieu of reducing rates.

The slowdown doesn’t seem to be scaring off investors. There is a mix of investors, many new to this market, looking for office assets in the Valley, according to Moriarty, but few owners are selling.

Some investors are anticipating continued expansion of the life sciences sector and robust need for lab space and are seeking flex office and R&D spaces to convert to lab space, according to Quinn.

“Not many buyers looking for a quick flip, as there aren’t many bargains/distressed assets in the market,” he adds.

“There’s a lot of dry powder available for investment in commercial real estate,” says Will Connors, senior managing director for capital markets, in JLL’s Silicon Valley office. “It is, therefore, not a liquidity issue, but more about understanding where prices will land.”

He adds that high-net-worth investors and investors pursuing life sciences space are more active in the market right now compared to other buyer pools.

 


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Investors of All Stripes Are Still Interested in Silicon Valley Office Buildings

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