Hybrid working is set to remain a prevalent trend for Silicon Valley office workers. Most employees will likely be required to be in an office at least a few days a week. While hybrid working has broadened apartment residents’ search for housing, San Jose remains a desirable place to live, and overarching trends support strong rental housing demand. In the investment market, buyers have maintained interest, and transactions continue to close. Pricing in San Jose remains among the highest in the nation.
San Jose has continuously bolstered its status as one of the most saturated markets for tech employment in the country. Notwithstanding recent layoffs, major tech companies and startups alike are expected to continue to maintain a substantial presence in the metro area. Locally headquartered tech titans, including Apple and Google, continue to post substantial profit growth. Long-term employment forecasts indicate San Jose and the broader Bay Area will outperform national benchmarks. Market vacancy remains relatively low, at 5.4%.
As of the fourth quarter, about 8,000 units are under construction. This uptick in activity was triggered by strong demand coming out of the pandemic, but it is also consistent with 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 26.2%.
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In 2023, low utilization of office space has been joined by economic challenges. Tech companies, faced with decreasing valuations and tighter availability of capital, have looked to reduce costs by laying off staff and cutting back on office space. 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. Moreover, tenants are continuing to reduce their leased space in response to the changed nature and location of office work. While most occupiers have now settled on their space strategy, the process of delivering that strategy continues to play out as leases reach their expiration dates. As of the fourth quarter, vacancy is 15.2% and the availability rate is 19.0%.
The delivery of new office space has continued at a high clip in San Jose, as projects that started before the current downturn are now completing. However, it should be noted that a large proportion of new space has been self-build and preleased by major tech players such as Google, Adobe, and Apple and reflects long-term campus expansions. The active construction market has seen 3.7 million SF of new deliveries in the past 12 months and there are currently about 8,000 SF under construction.
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Property sales slowed this year in response to the lingering impacts of rising interest rates. Nevertheless, deals are still closing, with private investors and owners/users taking the opportunity to pick up assets at lower prices. Elsewhere, in the tightly held areas of central Silicon Valley, investors continue to pick up assets leased to highly creditworthy tenants, with no notable reduction from price levels seen in recent years.
For flex properties, new leases have been signed across a diverse range of industries including healthcare, robotics, cleantech, and information technology; however, lease sizes are in the smaller range, generally under 20,000 SF. The larger lease deals in the over 50,000-SF range that were being signed for much of the previous year have been notably absent in the past few months. The exception is a 68,600-SF lease signed by Cerebras Systems in Sunnyvale in June 2023. Cerebras is one of several AI-related businesses that are reported to have increased space requirements in Silicon Valley. Large lease signings in traditional logistics properties have been rare in recent quarters, but that is also a reflection of an extremely low level of available space.
New construction activity has increased to a total of 5.2 million SF of industrial space under construction across the entire market, a 20-year high. Almost all the product under construction is either distribution space at the southern part of the market around Gilroy and Morgan Hill, or data center space in Santa Clara. The growth in AI technology has strengthened the demand for data centers, and all the data centers under construction in Santa Clara are either fully preleased or owner-occupied. By contrast, almost all the distribution space under construction along Highway 101 south of San Jose is available, with the exception being Amazon’s distribution center in Hollister.
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Divergent forces are shaping the performance of the San Jose retail market in the fourth 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. However, a combination of population decline and the ongoing growth of non-store retailing have exerted negative pressure on consumer spending at traditional retailers. In addition, high interest rates, tech layoffs, and bank failures are also contributing to weaker consumer demand.
Although high inflation and rising interest rates have dampened retail spending and introduced more caution to retailers’ expansion plans, the impact on leasing activity in San Jose has not been severe. Sure, the number of new leases is below the average seen over the past decade, but retailers are continuing to take new spaces. Net absorption for the past 12 months was 260,000 SF, which matches the amount of newly delivered space over that period. Leasing deals that have closed in 2023 are primarily independent retailers, many of which are in categories such as beauty and personal care, fitness, fast food, and restaurants. The market vacancy rate currently stands at 4.3%.
In San Jose, as of the fourth quarter, there has been very little expansion in brick-and-mortar retail, with total retail inventory no higher than its 2019 level. Fortunately for owners, the low level of new construction has allowed vacancy to remain relatively low, and net absorption has been positive over the past 12 months, led by grocery stores, auto, and fitness-related uses. New construction activity is largely focused on creating mixed-use urban villages, with residential, hotel, and office uses above street-level retail. Several of these projects are underway or proposed. There are about 300,000 SF under construction in the market.
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