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California Secondary Markets See Potential For Gains From S.F.’s, LA’s Losses

As the economic slowdown batters gateway markets like San Francisco, some of California's secondary markets have shown resilience in spite of the coronavirus pandemic.

Since the summer, Sacramento, San Diego and the North Bay Area have had office markets that have seen fractions of the falloff found in Los Angeles and San Francisco. Markets across the state have taken a hit, but signs of life found in certain secondary and suburban markets may signal the potential for a quicker recovery outside of S.F. and LA, experts say.

"There's limited to no activity, especially in downtown urban centers," said Adam Segal, CEO of Cove, a tenant and owner advisory company. "Even renewals aren't necessarily guaranteed."

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Instead, many companies in the state's primary markets are opting to forgo expensive rents and operate remotely until there's a clearer pandemic timeline. In Q3, leasing activity in San Francisco fell almost 90% year-over-year, according to Colliers International. LA has seen a dip of 60% over that same time, according to Savills.

Vacancy rates, too, have risen in both markets, doubling year-to-date in San Francisco and rising by 11% in LA in Q3, according to brokerages. 

Though still down, office deals in Sacramento, which came into this year on a high note, haven't had as extreme of a falloff. Net absorption was negative 105K SF last quarter, but Sacramento's vacancy rate is down to 13.5% from its 13.8% figure coming into 2020, according to Colliers data. 

“We have seen an uptick in activity in the office market, specifically within the last 30 days, as more companies have returned to their offices due to imperative business operations," said CBRE Executive Vice President Jason Goff, who is based in Sacramento and specializes in office sales and leasing."It’s also encouraging to see some large renewals completed in the third quarter." 

Ron Thomas, a Cushman & Wakefield executive managing director in Sacramento, cited the city's status as a popular moving destination among Californians as a sign of growth. As one-bedroom rents in S.F. are down over 20% year-over-year, those in Sacramento are up 8.5%, according to Zumper

Home prices in Sacramento have also been rising and were up 11.4% year-over-year in August, according to Redfin. In July and August, the brokerage said Sacramento is the most popular destination in the country for homebuyers looking to leave their areas, led by San Franciscans looking to leave the pricey city

"This could bode very well for Sacramento long-term," Thomas said. "During the prior economic cycle, tech companies diligently followed the pool of talent across the nation to other cities such as Austin and Portland, which saw significant growth from incoming tech companies."

The North Bay, too, has started to see a boost from S.F., with its multifamily rents down only 2% to 3% year-over-year and its home prices rising to all-time highs in Napa and Sonoma counties

Cushman & Wakefield Executive Managing Director Whitney Strotz, who leads the brokerage's North Bay Area team, said their office has started seeing new business interest from the fallout in San Francisco.

"That is probably the largest bucket of demand we're seeing right now," Strotz said. "We're seeing that demand of businesses looking to provide a convenient, easier place for folks to work."

Southern California has so far yet to see a big difference between its primary and secondary markets emerge. Leasing slowdown aside, Los Angeles office owners have fared better than those in S.F. amid the pandemic, according to local experts. In Q3, the average annual asking rent for office space in LA County was $43.92 per SF, up almost 7% year-over-year, according to Savills. 

"Since the pandemic started, we've seen roughly 2M SF in LA County get added to the sublease market, which sounds like a lot," CBRE Vice Chairman Todd Doney, who is based in downtown LA, said in an interview. "But the reality is our whole market is around 220M SF.”

Like the North Bay and Sacramento in Northern California, San Diego has turned into a homebuying target in Southern California, and the city is likely viewed as a more feasible office destination than very mass transit-reliant markets like S.F., according to Hughes Marino Executive Vice President David Marino, who is based in the San Diego area.

For that same reason, Vickey Li, CEO of S.F.-based tenant advisory company OnePiece Work, said she expects a boost to eventually come to more suburban markets. 

“Short-term, within the next one to two years, the suburbs are definitely going to experience a huge increase in demand for more office space," she said. "However, long-term, within five years, I do think people will be starting to return to the city.”

Marino, who said he expects a lot of office vacancies to result from remote work around the country, said he isn't even quite sure about that.

“I think San Diego will not be as bad as some of the other major markets around the country like Houston, Dallas, LA or San Francisco," he said. "But it’s still going to be terrible."