Sacramento’s Office Market is Eager for Stability
By Cole Sweatt, Brokerage Manager, Sacramento Region, TRI Commercial
Now that we’ve had the chance to analyze the data from the first two quarters of 2021, it seems that consumers and businesses are experiencing positive trends throughout Northern California. However, the initial recovery has come with challenges, including semiconductor shortages, supply chain disruptions and increased commodity prices due to a confluence of demand from consumers. We have seen relief in some of these sectors, which has led to increased production and the stabilization of commodity pricing. Although inflation should curb a bit this year, this would seem to be a temporary activity as average inflation over the next couple years is projected to be higher than the average of the prior decade.
How is the office sector reacting, particularly in the capitol region near Sacramento? Office sales have been lukewarm in the first part of 2021. Investment strategies continue to change due to economic uncertainty and the long-term goals of companies occupying real estate. Employees have continued to trickle back into the office, but many employers have extended their stay-at-home and/or part-time policies through the fourth quarter of this year. As a result, the market is trending toward a flight to credit and quality.
The largest deal to date was the sale of the Zigguarat building in West Sacramento for $90 million ($241 per square foot). It is occupied by the State of California’s Department of General Services. The buyer, Nome Partners, purchased two more government-occupied buildings on Market Boulevard totaling 315,400 square feet for $57.5 million ($182 per square foot). Traditionally, owners have been mostly local, but we have seen an influx of investors on a national platform, which underscores the region’s strong composition and forward positioning.
Like most cities in Northern California and across the nation, Sacramento has experienced lukewarm activity on the leasing side. Net absorption trended in negative territory for the first time since 2011. That trend has continued through the second quarter of 2021. The current overall vacancy rate sits at 10.1 percent, resulting in negative 0.2 percent rent growth over the past 12 months. The government is the metro region’s largest employer and occupier, and two of the area’s largest leases to date are from the government sector.
Medical users are another strong category in the Sacramento region. UC Davis has leased 262,000 square feet since the first quarter of 2020. The university has plans to break ground in early 2022 on Aggie Square, a 1.2-million-square-foot, 25-acre development in South Sacramento geared toward attracting tech and life sciences tenants. The project will also feature classroom space and housing units.
On the construction side, the majority of the 2.3 million square feet under construction is projected to be occupied by various government agencies. The vacated office space will contribute to the increased vacancy in the region. On a positive note, minimal speculative development has occurred since 2010, leaving Sacramento in a strong position for a steady recovery.
Many people are also curious as to how much ghost office space is really on the market, as well as what may happen long-term if another COVID shutdown occurs. Companies with strong cash positions can weather the COVID storm. The greater concern is the sustainability of small- to mid-sized companies. Beyond that, new college graduates may have a degree, but they still need to have a mentor to be trained and people require a collaborative atmospher to spur innovation. Due to liability concerns, companies and developers need to find that delicate balance as they seek to provide safe, productive work environments.
A forward-thinking Rabin Company development in downtown Oakland is addressing these issues. This redevelopment project offers fresh tenant improvements with independent HVAC systems on each floor of the building and the ability to control airflow to a single office. I believe office demand will continue to lag for the next two to three years. The added emphasis on employee health will also lead developers and employers to seek expanded work areas and private office landscapes. There is a social side of business that does not get satisfied with email or Zoom calls. Northern California office demand will rebound, but only after the country stabilizes and recovers from this pandemic.