Local commercial real estate brokers leased out one of the highest square-foot totals in the nation last year. But Sacramento as a whole still hasn’t rebounded like its regional neighbors.
While businesses rented 830,000 square feet of office space in the greater Sacramento area — the fourth highest total in the nation — more than 85 million square feet of total commercial inventory still remains.
Industries driving commercial rebounds in the Bay Area and Silicon Valley, such as media, tech and energy companies, do not have a major presence in the capital, and indicators such as office vacancy, lease rates and unemployment suggest Sacramento is still off the mark in its recovery.
Meanwhile, the national vacancy rate has dropped for nine straight quarters. Across the country, office space that had long stood empty is being snapped up as the economy regenerates. Nationally, businesses are renting at the highest rate since the recession as they find themselves looking forward — a trend especially evident in Sacramento in 2012.
But in the capital, state government (which helped fuel the boom before the recession) has become the problem. A decade ago, the public sector claimed almost half of the region’s total office space, but today, federal, state or municipal governments only occupy an estimated 35 percent of the overall commercial real estate market.
“We’re not the Bay Area, New York, Boston or Texas, where there’s been a lot of great activity,” says Jon Walker, a Voit Real Estate senior vice president.
“We’re such a government town, and government hasn’t been doing too much and the private sector is limited. So even though we see some deals going on, we’re not seeing a flurry of deals like other sectors are seeing in those other bigger cities.”
The region’s real estate market also struggles due to its proximity to the highly desired Bay Area and a trend in companies taking less space to house their employees. Those market elements have kept vacancy rates high even as more space was being leased.
While the national vacancy rate dropped to 15.4 percent at the end of 2012, vacancy in the greater Sacramento area continues to hover above an unhealthy 16 percent, says Garrick Brown, Cassidy Turley’s director of research.
“For Sacramento, the recovery is lagging about 18 months behind the national trend, and that really has most to do with the fact that our economy is so based on the public sector,” Brown says.
The Roseville/Rocklin areas were once the Capital Region’s premiere suburban markets and had been an especially attractive destination for larger companies in need of space and parking not found downtown. Brown characterized the markets as “white hot” with new construction before the crash. But as businesses stopped expanding and construction ground to a halt, observers recognized an underlying problem with the development: Residents crave the perks of urban life.
“There is a reason for people to be in downtown Sacramento: You walk out your door, and you get to go to a restaurant or a coffee shop or an art gallery or a movie theater or any number of novelty stores that you don’t get in a suburban area,” says Ken Turton, Turton Commercial Real Estate’s principal, who brokers properties primarily in midtown and downtown.
The capital’s suburban vacancy rate is more than twice that of downtown, which is consistently below 10 percent — a healthy rate by most industry standards.
Away from the central buzz of downtown, the region’s suburban markets, where buildings are spread out and architecturally monotone, are less attractive to small- and moderate-sized businesses, Turton says.
He also notes many companies are growing because their competition is going belly-up, leaving plenty of vacant space. There has been barely any new construction since 2007.
As the region starts to see positive signs of growth, vacancy is expected to only incrementally decrease because businesses are still finding new ways to minimize office space.
Tech companies in the Bay Area, such as Google and Twitter, have long since dispensed with floor plates littered with corner offices and cubes in favor of communal work spaces — large open spaces often with no assigned desks or seating — where a wired workforce can interact around shared tables or common rooms.
This trend toward higher densities really took hold over the past decade, during which Brown estimates average office space has gone from four to five and in some cases six employees per 1,000 square feet.
“The trend lately has been value and how [to] stack as many people as you can in there. So, usually an open floor plan is what most people are going with as opposed to stacking a space with a bunch of offices,” Walker says.
In general, businesses are more streamlined and can operate with fewer in-house employees and services because of the technology available — wireless computing, cheap international phone services, payroll outsourcing — that allow even very small enterprises to compete in a big market.
“A small-business owner in today’s day and age can compete extremely effectively against a big business owner because they don’t enjoy that many more economies of scale,” Turton says. “It’s extremely efficient to run a business nowadays.”
If sustained, the continued decline of vacancy in the Capital Region over the next couple of years could open the door for new construction down the road, “but we’ve got to chip off a lot more space,” Walker says.
Other signs show Sacramento benefitting from the Bay Area tech boom, as has been the case in past years, as jobs come back and companies are priced out of greater San Francisco.
Since 2010, the equivalent space of 33 Transamerica towers has been leased in San Francisco, and the average asking rent in the city is more than twice that of Sacramento.
“We’re kind of an escape valve for the Bay Area,” Brown says. “The big thing that’s driven our growth in the past has been when Bay Area housing has gotten out of control with their pricing. Sooner or later we start seeing a trend of in-migration.”
Real estate experts recognize that Sacramento’s reliance on government occupancy and closeness to the Bay Area will always be a challenge. Still, as unemployment continues to fall and jobs start to trickle back into the region, brokers both large and small are looking to private companies to facilitate growth down the road, especially in the capital’s larger suburban areas.
Until recently, the business and financial services industries that drove private-sector growth in the region have been mostly missing in action.
“Until we build enough momentum, the in-migration is going to be limited, (but) when it does, we’re going to see a huge impact for office,” Brown says.
“For the rest of this year, we’re probably looking at more of the same — slow growth as far as occupancy, slow decline in vacancy — and rents aren’t going to improve much for landlords.”
Meanwhile, this period is still a buyer’s market, though it is not nearly as skewed as in years past. Lease rates are still just above historic lows, and the sheer amount of competition keeps them that way. Until absorption (the rate at which space sells in an area) takes off and vacant space diminishes, Sacramento’s commercial real estate market is still primed for the tenant.
“Landlords are still highly incentivized to get people into their space,” Brown says. “There’s a few exceptions — certainly downtown landlords are nowhere near as … well … desperate might be too strong of word in some cases and might be too weak a word in others. But for the most part, tenants are definitely in the driver’s seat, and they’re the ones who are writing their own ticket.”
This year could provide some of the first expansions in bank lending since 2008. So is the market back up to speed? No. But banks are slowly and smartly increasing their appetites for commercial lending, and the Capital Region will see its share of transactions.
Remember the wild days of the real estate boom when you could buy a house with nothing down? You still can. Well, maybe you can’t, but a very select group of wealthy buyers can.