As of the third quarter of 2023, the San Jose multifamily market remains somewhat subdued, as the continuing impact of high-interest rates and economic uncertainty in the face of tech layoffs and bank failures keeps leasing activity in check. Despite recent price declines, the single-family housing market remains expensive. As a result, a significant portion of new households will continue to become renters rather than owners, creating a backstop for apartment demand.
Leasing remains muted in the third quarter of 2023. Tenant demand dampened in the latter half of 2022 amid rising inflation, higher interest rates, and economic uncertainty. Apartment demand slowed abruptly, and net absorption was negative in the second half of the year. For the past 12 months, net absorption currently stands at 1,400 units. Together with an uptick in new deliveries in recent months, vacancy has increased to 5.0%. Demand for affordable housing is robust, but supply has not kept up with demand due to rising construction costs and a lack of public funding.
As of 2023Q3 about 7,900 units are under construction. This is close to the all-time high level of construction activity and compares to the 10-year average of 7,100 units actively under construction across the metro. This uptick in activity is a continuation of the longer trend. Robust levels of new apartment construction have been easily absorbed over the past decade, with a net of roughly 33,000 market-rate apartments opening during this period, increasing inventory by 27.1%. The Downtown San Jose Submarket has also been among the most targeted submarkets by developers. Other markets include Santa Clara, Sunnyvale, and Mountain View.
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Investment sales activity has slowed in the past year to about half its long-term average. Up until fairly recently, high-quality new properties with strong tenants were trading in excess of $1,000/SF, keeping average market prices at their highest ever levels. However, no such deals have closed to date in 2023. Looking ahead, continued uncertainty around weak tenant demand, elevated levels of speculative development, and the general economic slowdown present headwinds to both market performance and asset values.
The San Jose leasing market has slowed over the past year, impacted by the sharp rise in interest rates that has hit tech company valuations and led them to prioritize cost-cutting over expansion. As of the third quarter of 2023, most major tech companies have enacted staff layoffs and announced reductions in leased office space. While these layoffs cut across national and global locations, Silicon Valley has seen thousands of job losses. And in terms of office absorption, the first months of 2023 have seen lease exits and downsizing outweighing new leasing activity. As of 2023Q3 vacancy is 13.7%.
As of the third quarter of 2023, 7.9 million SF of office space is under construction, representing 5.5% of the market’s existing inventory, well above the national average of 1.5%. While speculative office projects have been quick to lease in the past, weakening demand from tech tenants in 2023 is expected to present leasing challenges, particularly in Downtown San Jose, where much of the new product is set to deliver. The active construction market has seen 980,000 SF of new deliveries in the year prior to 2023Q3. Most of this activity has been owner-build or preleased projects for single tenants.
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In the third quarter of 2023, leasing activity in San Jose continues to be negatively impacted by subdued tenant demand, on the back of high interest rates and recessionary concerns. With a relatively small tally of 3.5 million SF of industrial product under construction across the entire market, competition from new supply will not be of major concern for landlords in the coming quarters, or likely for the next several years. Looking forward, vacancy is projected to increase over the next year, with demand continuing to remain depressed as the economy moves towards a mild recession later in 2023.
Large lease signings in traditional logistics properties have been rare in recent quarters, but that is mainly a reflection of an extremely low level of available space. In fact, there are only three existing logistics properties in the entire market currently listing more than 100,000 SF of available space, one of which is a property built in Gilroy in 1957. Net absorption has been negative in 2023 to date; however, vacancy, at 6.3%, remains low in comparison to historical levels.
Over the past 10 years, the net amount of industrial space in San Jose has declined as older industrial buildings have been replaced by other uses, such as residential and office. Most of the space currently under construction is preleased data center space, clustered in the Santa Clara Submarket. Logistics space under construction amounts to just 880,000 SF, which suggests that the very low vacancy rate for distribution properties will continue. In the R&D segment, the 847,000-SF manufacturing/research facility being built for Intuitive Surgical at 932 Kifer Road in Sunnyvale is the largest project currently underway.
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Divergent forces are shaping the performance of the San Jose retail market in the third quarter of 2023. Silicon Valley has seen strong economic growth in the years since the pandemic, with increased demand for tech company products and services generating higher wages and incomes for market residents. Median household income rose from $140,000 in 21Q1 to $175,000 in 22Q4. However, a combination of population decline and the ongoing growth of non-store retailing has exerted negative pressure on consumer spending at traditional retailers.
Leasing activity in San Jose slowed over the past six months, as high inflation and rising interest rates dampened retail spending and led retailers to adopt a more cautious approach. While retail net absorption was relatively robust, at 320,000 SF over the past 12 months, the slow rate of leasing so far in 2023 is projected to lead to a reduction in net absorption in the quarters ahead.
Retail space under construction has remained at 180,000 SF in the third quarter of 2023. San Jose’s Santana Row has had a large influence on construction projects with existing plans to revitalize existing malls and neighborhood centers by transforming them into mixed-use urban villages, providing much-needed housing and refreshing retail offerings. Other larger construction projects include car dealerships or street-level retail as part of larger residential developments.
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