The Knowledge Reportc o l l i e R s i n T e R n aT i o n a l | s a n F R a n c i s c o

Business confidence springs BackSeasonal lull —But Rents Still Set to Increase in 2010 New signs of business confidence emerged during the first quarter of 2010. Motivated by a belief that the market has hit, or is at the bottom, eager tenants took advantage of the city’s favorable leasing conditions. Overall leasing activity posted 1.34 million square feet during the first quarter which is a dramatic improvement from the 735,000 square feet of leasing activity that transpired this time last year. With rents hovering in lows not witnessed since 2003, San Francisco has become a viable location to companies once priced out. Currently there are 27 tenants from out of town representing more than one million square feet touring the San Francisco office market for opportunities.

Business confidence was evident from the city’s absorption, or net change in occupied space. More companies increased their occupancy rather than decreased. A total of 95,255 square feet of positive net absorption was recorded for the quarter, marking it the first time in the past seven quarters to post positive absorption.

However occupancy growth was unable to match the amount of new supply added to the city’s inventory during the quarter. The completion of One Kearny Street (110,000 SF) and the addition of 575 Florida Street (74,935 SF) and 50 O’Farrell Street (90,714 SF) to our inventory base added 222,714 square feet of vacant space, which increased the overall vacancy rate to 14.8 percent, from 14.7 percent in the fourth quarter of 2009.

San Francisco’s prospect for recovery is promising, as measured by a recent business confidence survey conducted the Bay Area Council; more local companies are planning to increase the size of their workforce than are planning layoffs. Out of the 498 senior executives who responded, 20 percent are planning on hiring new employees in the next six months, which is greater than the 17 percent who are expecting layoffs. This contrasts sharply with the grim survey conducted in the fourth quarter of 2009, which had 42 percent of respondents projecting layoffs, and just 10 percent looking at new hires.

Although the city’s unemployment experienced a slight uptick during the first two months of 2010, it should be noted that increased unemployment numbers are a typical occurrence this time of year. According to the California Department of Employment, the unemployment rate for San Francisco County was 9.9 percent for February 2010, an uptick from 9.4 percent posted in December 2009.

Most of the lease transactions completed in the first quarter involved “commodity” or “vanilla” space. Many landlords, confident in the improving economy, are taking the approach of leasing their buildings from the bottom – up, opting for low or in some cases even negative yielding deals on lower floor spaces (in order to lower their vacancy) and reserving their higher end view space for anticipated higher rents. As a result the average rent

MaRKeT indicaToRs

UPdaTe

Historical absorption and Vacancy Rates

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o F F i c e M a R K e T R e P o RT | F i R s T Q U a RT e R | 2 0 1 0

RenTal RaTes

Transactions mainly took place in commodity space during the first quarter, which caused average effective rents to drop from fourth quarter 2009, when the majority of deals (especially larger-sized deals) took place in premium view space.

eFFecTiVe RenTal RaTe coMPaRison

* Weighted average rents

4Q ‘09 Overall

1Q ‘10 Direct

1Q ‘10 Sublease

1Q ‘10 Overall

% ChangeOverall

Financial District – $38.81 $35.27 $15.86 $30.44 -21.6%

Class A $33.77 $34.14 $18.20 $31.38 -7.1%

All Markets – $40.60 $33.87 $20.87 $30.48 -24.9%

Class A $32.63 $32.74 $19.86 $30.50 -6.5%

All Markets – $27.51 $25.58 $21.97 $25.29 -8.1%

Class B $26.20 $24.86 $21.67 $24.44 -6.7%

All Markets – $24.25 $25.36 NA $25.36 4.6%

Class C $22.50 $22.33 NA $22.33 -0.8%

AVERAGE EFFECTIVE RENT: The total annual rent payments, net of rent-free periods, divided by the square footage. The average is an annual average per square foot per lease, divided by the number of leases.

WEIGHTED AVERAGE EFFECTIVE RENT: Same as for Average Effective Rent, but adjusted to reflect average per square foot per all leases (as opposed to average per square foot per lease).

Vacancy

neT aBsoRPTion

consTRUcTion

WeigHTed RenTal RaTe

non-WeigHTed RenTal RaTe

sale VolUMe

sale PRices

Q1 2010 2010Forecast

in th

ousa

nds

collieRs inTeRnaTional2

slumped over the quarter. The overall average net effective rent for Class A space dipped 6.5 percent to $30.50 per square foot, and the average net effective rent for Class A space in the Financial District decreased 7.1 percent to $31.38 per square foot.

Despite the signs of business growth exhibited during the first quarter of 2010, the velocity of San Francisco’s office market recovery will likely be impacted by a series of hurdles. The most disabling factor will be the more than 500,000 square feet of occupancy loss scheduled for the second quarter of 2010. Wells Fargo will vacate 350,000 square feet at 155 Fifth Street, Charles Schwab will leave behind 118,000 square feet at 101 Montgomery Street, and O’Melveny & Myers will return 56,000 square feet to 2 Embarcadero Center. Although we expect some growth in the next three months, it will unlikely outweigh the number of scheduled tenant move-outs. The second half of 2010 is looking more promising, and we foresee the year to end on a positive note.

aBsoRPTion

For the first time in seven quarters, the city posted positive absorption. The first quarter registered 95,255 square feet of positive net absorption. The occupancy growth was mainly attributed to expansions from small-to-midsized tenants and from new companies locating to San Francisco due to its favorable market conditions.

The largest contributor to the city’s absorption growth was Celegene’s occupancy of 61,000 square feet at 1500 Owens Street in Mission Bay. Other

significant contributors were; Twitter’s expansion into 31,000 square feet at 795 Folsom Street, and Yelp.com’s expansion by nearly 20,000 square feet at 706 Mission Street. Some new tenants to San Francisco include Charlotte Russe which occupied 52,000 square feet at 575 Florida Street, Greenberg Traurig, which moved into 29,000 square feet at 153 Townsend Street (the DLA Piper sublease), and Sears.com, which occupied the first half of its 24,500 square foot lease at 760 Market Street. The company will occupy the remaining space next quarter.

Vacancy

Despite the city having occupancy growth, it was unable to balance the addition of more than 222,714 square feet of vacant space that was added to the city’s inventory during the quarter. As a result, the overall vacancy rate increased marginally to 14.8 percent, from 14.7 percent posted last quarter.

The city’s new supply includes the completion of One Kearny Street, a 110,000-square-foot, unique, three-building project, which combines two existing historically-significant buildings, with one new building. Although the development has captured a lot of tenant interest, it was delivered vacant. Also, both 575 Florida Street and 50 O’Farrell Street were factored into the inventory during the quarter, which added 22,000 and 90,714 square feet of vacant space respectively.

The Knowledge Report | First Quarter | 2010 | San Francisco

The Financial District posted 41,000 square feet of negative net absorption. K&L Gates consolidated its offices at 4 Embarcadero Center, which left behind 44,000 square feet of vacant space at 55 Second Street and Design Within Reach left behind 60,000 square feet of vacant space at 225 Bush Street, in its move to 15,000 square feet in One Montgomery Tower.

SIGNIFICANT LEASES Q1 2010

class PRoPeRTy addRess daTe signed TenanT sQ. FT. TyPe

A 225 Bush Street Jan. 2010 Benefit Cosmetics 55,000 New

A 575 Florida Street Feb. 2010 Charlotte Russe 52,910 New

A 706 Mission Street Jan. 2010 Yelp.com 49,000 Renewal

A 560 Davis Street Jan. 2010 NORCAL Insurance 45,000 Renewal

UPdaTelease and investment Transactions

SIGNIFICANT INVESTMENT TRANSACTIONS Q1 2010 CLASS A

addRess sale daTe selleR BUyeR sQ. FT. sale PRice PRice/sF coMMenTs

49 Stevenson Street Jan. 2010 INVESCO Steven Pan 121,186 $24,200,000 $199.69 Actual Sale

550 Montgomery Street Feb. 2010 The Lurie Company Downtown Properties Holdings 94,488 $12,650,000 $133.88 Actual Sale

SIGNIFICANT INVESTMENT TRANSACTIONS Q1 2010 CLASS B

153 Kearny Street March 2010 Amalgamated Bank Sierra Maestra Properties 79,280 $4,300,000 $54.24 REO Sale

soUTH Financial disTRicT

noRTH Financial disTRicT

MaRKeT sTaTs

collieRs inTeRnaTional

The Knowledge Report | First Quarter | 2010 | San Francisco

leasing acTiViTy

Leasing activity has accelerated over the past twelve

months. A total of 1.34 million square feet of leasing

transactions took place during the first quarter of

the year, a significant jump compared to the first

quarter last year, where only 735,000 square feet of

office transactions took place. We expect the velocity

of leasing activity to increase as the year progresses.

The city’s lease transactions will likely reach their

historical annual volume of 6.7 million square feet.

Existing Properties Absorption New Supply U/C & Proposed

Class BldgsTotal

Inventory Sq. Ft.

Direct Vacant Sq. Ft.

Direct Vacancy

Rate

Sublease Vacant Sq. Ft.

Sublease Vacancy

Rate

Total Vacant Sq. Ft.

Occupied Space Sq. Ft.

Vacancy Rate

Current Period

Vacancy Rate Prior

Period

Net Absorption Current-Sq.

Ft.

Net Absorption

YTDSq. Ft.

Net New

Supply Current-Sq. Ft.

Net New Supply YTD

Sq. Ft.

Under Construction

Sq. Ft.

Proposed Sq. Ft.

294 oFFices in 61 coUnTRies on 6 conTinenTs

Usa 94canada 22latin america 17 asia Pacific 64 eMea 97

$48.1 billion in annual transaction volume 1.1 billion square feet under management

12,749 Professionals

conTacT inFoRMaTion

San FranciscoAlan CollenetteManaging Director 50 California Street 19th FloorSan Francisco, CA 94111 Tel: 415-788-3100Fax: 415-433-7844

ReseaRcH:Tove Nilsen Market Research Director 50 California Street 19th FloorSan Francisco, CA 94111Tel: 415-288-7827 Fax: 415-433-7844

This report has been prepared by colliers international for general information only. information contained herein has been obtained from sources deemed reli-able and no representation is made as to the accuracy thereof. colliers international does not guarantee, war-rant or represent that the information contained in this document is correct. any interested party should undertake their own inquiries as to the accuracy of the information. colliers international excludes unequivocally all inferred or implied terms, conditions and warranties arising out of this document and excludes all liability for loss and damages arising there from. This report and other research materials may be found on our website at www.colliersmn.com.

colliers Macaulay nicolls inc. and its country subsidiar-ies are member firms of colliers international Property consultants, an affiliation of independent companies with over 294 offices throughout more than 61 countries worldwide.

Sublease space was in high demand from tenants, particularly from the tech sector. Typically these tenants are a great fit for sublease opportunities, not only for economics but usually they prefer short term leases because it fits their flexible business model.

During the first quarter of 2010, more than 20 sublease transactions closed representing nearly 200,000 square feet. As a result, the amount of vacant sublease space declined to 1.3 percent (or 1.1 million square feet) from its peak of 1.7 percent in the third quarter of 2009.

RenTs

Rental rates were largely affected by the high number of transactions that took place in commodity space during the quarter. Many landlords are taking the approach of leasing their buildings from the bottom—up. Faced with an abundance of competing product, but confident in the improving economy, landlords are leasing their lower floor vacant space by agreeing to low yielding or in some cases negative yielding transactions in order to reduce their overall vacancy; reserving their best space for a better time in the cycle.

The effect is to incentivize value-conscious tenants to upgrade their location to a Class A building, albeit on lower, “commodity” floors. The wealth of transactions that transpired at the low end of the Class A rental range resulted in average effective Class A overall rents dipping 6.5 percent to $30.50 per square foot, and average net effective rent for Class A space in the Financial District decreasing 7.1 percent to $31.38 per square foot.

Currently, the sublease space inventory is dominated by opportunities with little time remaining on their terms, as well as less desirable space. Nearly half of the sublease inventory has only 12 months or less remaining on its term. Rental rates for sublease space are

declining concurrent with declining average length of their terms. During the first quarter, the average net effective rental rate for sublease Financial District Class A space was $18.20 per square foot, a 22.4 percent drop from the fourth quarter of 2009.

inVesTMenT

As for sale volume, the first quarter of 2010 showed increased investment activity and transactions, as the pressure from unspent capital continued to mount. There was a strong sense that the market had finally reached the bottom of a near three-year free fall in values. As unemployment figures shrink and the leasing market rebounds, investment sales activity is expected to gain momentum through the rest of 2010.

The first quarter of 2010 showed increased investment activity and a few transactions were recorded during the quarter.

Taiwanese real estate investor Steven Pan finalized the purchase of 49 Stevenson Street for $24.2 million, or $198 per square foot, and 550 Montgomery Street sold to Downtown Properties’ Goodwin Gaw, (a private investor with Hong Kong ties) for $134 per square foot. The property is 100 percent leased through a deal signed in 1960 to First Bank. First Bank’s lease expires in October of this year. Currently, 65 percent of its space is subleased to several subtenants.

Activity on recent offerings, including 303 Second Street and 333 Market Street, has been very strong. 303 Second Street received multiple offers, and is expected to sell for around $310 per square foot, with a current yield of 6.8 percent and projected stabilized yield of 6.95 percent. 333 Market Street, which is 100 percent leased to Wells Fargo through 2026, is rumored to be in escrow, at a price of approximately $330 million, or $505 per square foot, a yield of 6.5 percent.

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The Knowledge Report | First Quarter | 2010 | San Francisco