As of the second 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. The structure and characteristics of the San Jose multifamily market derive from the success and growth of the technology-based economy of Silicon Valley. The impressive growth of this sector over the past 30 years has driven large increases in employment and income and generated strong growth in housing demand. One consequence of the region’s success is that housing in San Jose is among the costliest in the nation. Another consequence is instability. The tech market tends to grow in waves and is occasionally subject to sudden reversals, such as the dot-com bust of 2001-02.
Leasing remains muted in the second 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 1,100 units. Vacancy has increased to 5.4%. The best performing assets are those in the mid and lower tiers, which have vacancy rates of around 4.3%, whereas 4 & 5 Star vacancy is 7.3%. 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 2023Q2 about 8,100 units are under construction, representing 5.2% of the market’s inventory. 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 32,000 market-rate apartments opening during this period, increasing inventory by 26.1%. Submarkets experiencing the most development activity include Downtown San Jose, Santa Clara, Sunnyvale, and Mountain View.
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San Jose largely avoided the unprecedented collapse in tenant demand that emptied office buildings in neighboring San Francisco in the wake of the pandemic. However, the market is now facing a different challenge, as tech companies, faced with decreasing valuations and tighter availability of capital, are forced to cut costs by laying off staff and cutting back on office space. The relatively robust performance of San Jose’s office market during the pandemic can be credited partly to the dispersed geography of the market, with office space located in multiple employment centers throughout Silicon Valley, rather than being concentrated in a downtown central business district that relies on mass transit.
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 second 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 2023Q2 vacancy is 12.7% and the availability rate is 17.5%.
As of the second quarter of 2023, 7.4 million SF of office space is under construction, representing 5.2% of the market’s existing inventory, well above the national average of 1.6%. While speculative office projects have been quick to lease in the past, weakening demand from tech tenants in 2023 may present leasing challenges, particularly in Downtown San Jose, where much of the speculative development is set to deliver. The active construction market has seen 2.2 million SF of new deliveries in the year prior to 2023Q2. Most of this activity has been owner-build or preleased projects for single tenants.
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Flex properties constitute over half of industrial real estate in San Jose compared to only 10% of industrial space nationally. Many local flex R&D properties even compete directly with San Jose’s 140 million-SF stock of office properties for the same tenants. Thus, leasing momentum tends to follow the same boom and bust trends that drive growth in the tech sector.
Current vacancy is at 6.1%. For flex properties, there has been 10,000 SF of net absorption in the past 12 months, with leasing activity across a diverse range of industries including healthcare, robotics, cleantech, and information technology. 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.
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. However, the demand for logistics and flex properties has led to an increase in construction with 3.7 million SF underway. Most of the space currently under construction is preleased data center space, clustered in the Santa Clara Submarket.
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Divergent forces are shaping the performance of the San Jose retail market in the second quarter of 2023. A combination of population decline and the ongoing growth of non-store retailing have exerted negative pressure on consumer spending at traditional retailers. Consequently, as of 22Q3 there has been very little expansion in brick-and-mortar retail, with total retail inventory no higher than its 2019 level and vacancy 30 basis points higher. Moreover, leasing activity has slowed. As a result, the market was only able to achieve a moderate increase in net absorption over the past 12 months, led by grocery stores, auto, and fitness-related uses.
Leasing activity in San Jose slowed over the past six months, as high inflation and rising interest rates caused retailers to adopt a more cautious approach. The uptick in leasing that occurred a year ago, which included several new grocery store leases, has since abated. And while retail net absorption was relatively robust, at 340,000 SF over the past 12 months, the slow rate of leasing so far in 2023 will likely see a reduction in net absorption in the quarters ahead. San Jose’s mall properties have been the most successful at keeping their occupancy high, with the mall vacancy rate declining from 6% to 3.5% over the past 12 months.
The current amount of retail space under construction in the market is 210,000 SF. Santana Row, a mixed-use center located in Santa Clara, south of Westfield Valley Fair, has been a significant influencer in the retail market for the past two decades. As one of the first outdoor lifestyle centers, it remains a popular dining and shopping destination and has served as a model for new developments around the country. Santana Row’s influence is evident in plans to revitalize existing malls and neighborhood centers in San Jose by transforming them into mixed-use urban villages, providing much-needed housing and refreshing retail offerings.
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