The next wave of construction deliveries is poised to bring substantial positive absorption to the San Francisco market in 2018, as large technology tenants that signed leases in a record-breaking 2017 move into their new homes. While Dropbox, Facebook, Salesforce, and others prepare to occupy The Exchange, 181 Fremont, and the Salesforce Tower, respectively, other growing companies are increasingly facing stiff competition for the few large blocks of space available now and scheduled for delivery before the turn of the decade. With demand still outpacing supply, rental rates continue to trend upward, reaching the mid-$70s FS on average for Class A space, the high-$60s FS for well-located Class B product, and the high-$60s IG for creative offerings in SOMA. Rents are up 2.6% year over year, on average, for Financial District offices, with freshly renovated creative spaces achieving 5% growth. While vacancies rose to 7.0% in the first quarter, the increase is a mirage attributable to the gradual occupancy of the newly delivered buildings. The citywide vacancy rate is likely to decline over the course of 2018, as companies move into their new spaces and land subtenants to backfill their previous offices. Unemployment in San Francisco was at just 2.5% in February, and the strength and depth of the technology sector portends a strong year ahead.

1st Quarter 2018 | 1

Competition Heats Up at Park Tower

The only 2018 office delivery yet to secure a tenant, Park Tower at 250 Howard has captured the attention of some of the biggest names in tech. Late in the quarter, Amazon, Facebook, and Google were all rumored to be contemplating a 250K-750K s.f. deal in the 43-story tower, which could be ready for partial occupancy by the end of 2018. All three of those potential tenants signed a 100,000 s.f. or larger lease in the city during 2017, including Facebook’s commitment to the entire 181 Fremont tower, and Google signed on for 57,260 s.f. at 2 Harrison during the first quarter of this year. The competition at Park Tower indicates that demand for large blocks of tech space continues to exceed its available supply in San Francisco,

where the next wholly available new office project, the Oceanwide Center, won’t be ready until 2021. Depending on the city’s looming decisions on the rezoning of Central SOMA and the Prop. M office development cap, this imbalance between demand and supply could persist for years to come.

New Construction

Following the deliveries of 350 Bush and Salesforce Tower, 12 buildings totaling about 5.37 million s.f. were under construction at the end of the first quarter. Only 33.7% of that future inventory, or around 1.81 million s.f., was available for lease, more than half of it at the Oceanwide Center, a 1.25 million s.f. mixed-use project still three years down the road. The

Real Estate Market Review

San Francisco Office

1st Quarter

2018

Market Forecast Trends

ABSORPTION

CLASS A RENTAL RATE

VACANCY

UNDER CONSTRUCTION

Notable Lease Transactions

Google 2 Harrison Street, San Francisco 57,259 s.f. leased

Anaplan 50 Hawthorne Street, San Francisco 55,756 s.f. leased

Shack15 Ferry Building, San Francisco 46,095 s.f. leased

Notable Sale Transactions

Allianz Real Estate of America 333 Market Street, San Francisco 657,115 s.f. | $500M or $760.90/s.f.

DivcoWest 180 Townsend Street, San Francisco 41,125 s.f. | $28M or $681/s.f.

Kensington Investment Group 28 2nd Street, San Francisco 27,502 s.f. | $20M or $727/s.f.

2 | San Francisco Office Real Estate Market Review

deliveries of 181 Fremont (Facebook), 100 Hooper (Adobe), 510 Townsend (Stripe), 505 Brannan (Pinterest), and The Exchange (Dropbox) will generate substantial positive absorption when their first tenants move in later this year, potentially creating sublease opportunities for other tenants to backfill, but long-term vacancies and rents appear increasingly robust against the supply jolt. In response, developers and landlords are getting creative with existing properties to accommodate more office users. The Swig Company announced plans to break ground in June on a five-story addition to an existing 170,000 s.f. office building at 633 Folsom, originally developed by the firm in 1966. California Pacific Medical Center will move out of the building in April, and the roughly $72 million project will result in a 270,000 s.f. offering by 2020, allowing Swig to capitalize on the scarcity of availabilities in that size bracket.

Asking Rental Rates

Direct asking rental rates in downtown San Francisco were virtually unchanged quarter over quarter, but are up by 2.6%, on average, from a year ago. While traditional spaces with office-intensive build-outs have seen their price tags level off, some creative-space landlords have pushed rents upward by 5-7% over the past 12 months.

• Fully-serviced Class A rates ranged from the mid-$60s away from Market Street to over $100 for the upper floors of premier properties such as 4 Embarcadero Center. An office-heavy space on the lower floors of 345 California was asking $68 FS while a creative offering on the sixth floor of 153 Townsend was in the high-$70s FS.

• Class B availabilities spanned from the high-$50s for traditional build-outs in the northern reaches of the Financial District to the low-$80s for creative spaces in the South Financial District and SOMA. The top floor of 433 California, which has a tech-oriented build-out, was listed for $68 FS.

• Creative Class C product in SOMA averaged in the mid-to-high $60s IG, but well renovated spaces in premier locations, such as the area around South Park, eclipsed $80. A full floor with brick and timber features at 149-155 9th was priced at $65 IG.

As demand for creative space continued to boom, many landlords with less desirable build-outs provided turnkey renovations or made speculative investments to better position their assets. Direct office rents are likely to stay on a steady upward trajectory in the coming quarters.

Absorption/Vacancy

The San Francisco office market should enjoy considerable gains throughout 2018, building on a strong first quarter that saw 846,313 s.f. of positive net absorption.

The Salesforce Tower welcomed its first users, including Accenture and Bain & Company, to drive 404,849 s.f. of positive net absorption in the South Financial District. The 61-story tower is now about 10% occupied, with Salesforce and its other future tenants set to move in over the next several quarters.

• Across Market Street, the North Financial District saw 247,620 s.f. of positive net absorption in the first quarter, and will gain more when Twitch, Atlassian, and Publicis move into 350 Bush later this year.

• Showplace Square gained 97,129 s.f., as the Career Education Corporation moved into 44,406 s.f. at 350 Rhode Island. The other SOMA submarkets added 75,190 s.f., including Grubhub taking over 24,014 s.f. at 810 Mission in a sublease from Nerdwallet.

Despite the citywide gains, vacancies rose by 60 basis points, to 7.0%, on account of the new deliveries. The vacancy rate should fall back toward cycle lows in the coming quarters, as tenants fill up the new buildings.

Investment

A paucity of value-add opportunities in San Francisco’s downtown core tempered investment sale volume in the first quarter of 2018. Five buildings changed hands in the market over the past three months at an average price of $666/s.f., but the slowdown was not a reflection of waning investor confidence, as cap rates continued to hover around 5%. In the largest transaction of the quarter by dollars spent, New York-based Allianz Real Estate acquired a roughly 20% stake in 333 Market from Columbia Property Trust for $152.37 million; the deal was part of a new joint venture between the firms, which seek to own Class A properties in gateway cities. Allianz now holds about 45% of 333 Market, which Columbia bought for $395.25 million in December 2012. Partial interest transfers remain a hot commodity in San Francisco, because they are exempt from real-estate transfer taxes and avoid reassessments of property value. A stake in the Transamerica Pyramid, owned by the Dutch life insurance company Aegon (which purchased Transamerica Corporation in 1999), was rumored to be available at the end of the first quarter for around $900/s.f. The San Francisco landmark, built in 1972, has never sold.

Outside of the Financial District, DivcoWest bought 180 Townsend, a 41,125 S.f. Class B asset, for $28 million or $681/s.f. DivcoWest is expected to look for a new single headquarters tenant when the current user, Say Media, vacates the building. Finally, Oregon-based Kensington Investment Group obtained 28 2nd -Street for $20 million or $727/s.f. Kensington intends to spend about $4 million to renovate the 27,502 s.f. building into creative Class B office space.

Source: CoStar, San Francisco Business Times

Spotlight: Anaplan

Beyond the widely renowned tech giants, Anaplan is one of the city’s fastest-growing tenants. Founded in the United Kingdom in 2006, the cloud-based business management platform provider eventually brought its global headquarters to San Francisco, landing in 3,500 s.f. at 240 Stockton Street. Anaplan outgrew that space in 2013, first taking 14,230 s.f. at 625 2nd Street, and then expanding to 24,545 s.f. in the building in May 2015. After a year under the direction of new CEO Frank Calderoni, who took over in January 2017, Anaplan raised $60 million in a late-2017 funding round to push its valuation to $1.4 billion, setting the stage for the newly minted unicorn’s global expansion.

The first step for Anaplan was securing space to keep growing in San Francisco, a challenge in a market with limited availabilities companies bursting at the seams. In one of the largest deals of the first quarter, Anaplan subleased 55,756 s.f. at 50 Hawthorne from Athenahealth, which closed its San Francisco office late last year, an example of how the city’s tech sector depth ensures that one falling star meets a rising one to take its place. With a $92 effective rent, Anaplan’s 91-month sublease entails a $5.1 million annual commitment to San Francisco real estate. It’s a clear sign that prime space in the city remains a critical consideration for midsize tech firms looking to outfox giant competitors. Now at 800 employees and counting worldwide, Anaplan is ready to take on long-time industry leaders like Oracle and SAP.

Area Review

1st Quarter 2018 | 3kiddermathews.com

Net Absorption (SF)

2014

2015

2016

2013

2012

2011

2010

2009

2008

2007

2006

2005

1998

2004

2003

2002

2001

2000

1999

1997

2018

2017

-8M

-7M

-6M

-5M

-4M

-3M

-2M

-1M

0

1M

2M

3M

4M

FORECAST

3Q172Q171Q174Q163Q162Q161Q16

Availability

1Q18 4Q183Q182Q184Q17

Vacancy Sublease Availability

0%

2%

4%

6%

8%

10%

12%

14%

VACANCY VS AVAILABILITY

NET ABSORPTION - HISTORICAL

Average Sales Price (PSF) Cap Rate

2014

2015

2016

2013

2012

2011

2010

2009

2008

2007

2006

2005

1998

2004

2003

2002

2001

2000

1999

1997

2018

2017

$100

$200

$300

$400

$500

$600

$700

$800

$900

2%

3%

4%

5%

6%

7%

8%

9%

10%

AVERAGE SALES PRICE & CAPITALIZATION RATES

Net Absorption (SF)

3Q16 4Q162Q161Q16 1Q17 2Q17 3Q17 4Q17 1Q18-1M

-800K

-600K

-400K

-200K

0

200K

400K

600K

800K

1M

2Q17 3Q171Q174Q163Q162Q161Q16

Class B FiDi

FORECAST

Class A FiDi

4Q17 1Q18 3Q18 4Q182Q18

Class C SoMa

$60

$65

$70

$75

$80

ASKING LEASE RATE

Vacancy

2014

2015

2016

2013

2012

2011

2010

2009

2008

2007

2006

2005

1998

2004

2003

2002

2001

2000

1999

1997

2018

2017

Asking Lease Rate (PSF)

2%

4%

6%

8%

10%

12%

14%

16%

18%

$5

$15

$25

$35

$45

$55

$65

$75

$85

VACANCY VS FINANCIAL DISTRICT ASKING LEASE RATE

NET ABSORPTION - QUARTERLY

4 | San Francisco Office Real Estate Market Review

kiddermathews.com

This information supplied herein is from sources we deem reliable. It is provided without any representation, warranty or guarantee, expressed or implied as to its accuracy. Prospective Buyer or Tenant should conduct an independent investigation and verification of all matters deemed to be material, including, but not limited to, statements of income and expenses. CONSULT YOUR ATTORNEY, ACCOUNTANT, OR OTHER PROFESSIONAL ADVISOR.

Market Breakdown

Q1 2018 Q4 2017 Q1 2017 Annual % Change

Vacancy Rate 7.0% 6.4% 6.7% 4.5%

Availability Rate 10.1% 10.0% 11.6% -12.9%

Asking Lease Rate (Class A FiDi) $73.39 $73.16 $71.55 2.6%

Leased SF 1,906,107 3,768,280 3,205,598 -40.5%

Sold SF 518,404 817,919 2,398,728 -78.4%

Net Absorption 846,313 168,837 -818,080 N/A

Offices

Seattle206.296.9600

Bellevue425.454.7040

South Seattle206.248.7300

Tacoma253.722.1400

Olympia360.705.2800

Portland503.221.9900

San Francisco415.229.8888

Redwood Shores650.769.3600

Silicon Valley408.970.9400

Sacramento916.970.9700

Roseville916.751.3600

Los Angeles213.880.5250

Commerce323.727.1144

El Segundo310.807.0880

Long Beach562.472.0071

Orange County949.557.5000

Inland Empire909.764.6500

San Diego858.509.1200

Carlsbad760.430.1000

Reno775.301.1300

Phoenix602.513.5200

HISTORICAL NEW CONSTRUCTION & VACANCY RATE

SF

Vacancy RateNew Deliveries

2014

2015

2016

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

2018

2017

%

0

500K

1M

1.5M

2M

0%

5%

10%

15%

20%

New Deliveries

Vacancy Rate

ANTICIPATED CONSTRUCTION DELIVERIES, 2018-2022

SF Leased/UnivailableAnticipated Deliveries

2018 2019 2020 2021 20220

500K

1M

1.5M

2M

2.5M

3M

SF Leased/Unavailable

Anticipated Deliveries

HISTORICAL SALES ACTIVITY & MEDIAN SALES PRICE

SF

Median Price/Building SFBuilding SF

2014

2015

2016

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

2018

2017

$/SF

0

5M

10M

15M

20M

25M

$100

$240

$380

$520

$660

$800

Total Square Feet of Sales

Median Price/Building SF

ContactMark ReadExecutive VP, Brokerage415.229.8888mread@kiddermathews.com

Designated Broker

Mark Read | LIC #00572743