Activity in the urban core (Downtown, Midtown and East Sacramento) has been strong from both a sale and lease perspective.
Of course, leasing drives the bus in commercial real estate whether its office, retail or multi-family residential and leasing in all of these categories has been better than ever. We are seeing comparable lease rates for Office Space approaching record highs (exceeding in very specific instances) in all class categories (A, B and C). Vacancy rates in Midtown and the R Street business district are virtually non-existent. Exposed, authentic spaces are in high demand and spaces meeting that description downtown are pushing rents upwards of $3.00 per sf. Even Midtown is attracting rents of $2.75 per sf and higher for well designed, open space in fully improved condition.
Much of this demand is a result of the excitement generated by the new Golden 1 Center (the new Entertainment and Sports Center) located on K Street between 7th and 3rd Streets. This demand, however, is as much a derivative of the retail activation generated by the Golden 1 Center as it is the center itself. Historically leasing demand in the downtown grid has been driven by Government, Legal, Finance and Real Estate related professions. Demand for Midtown space has historically been driven by local professionals, real estate development related firms and some high-tech. Today we are seeing demand from virtually every business sector seeking to compete for top young professional talent. Businesses are realizing that quality of life in the work environment may be the key variable in selecting which firm to work for young millennials in high demand. The amenity rich and ergonomically sensitive Midtown and Downtown submarkets provide the most desirable environments in the region. We are seeing that employers are demonstrating a willingness to pay a premium for well-designed space in great locations within these districts.
As a result of the increased retail amenities as well as continued relocation and expansion of top professional firms to the urban core we are seeing dramatic increases in residential migration to these same submarkets. Virtually every multi-family property owner from duplexes to 170 unit apartment complexes have waiting lists. Vacancies are immediately responded to with multiple offers.
Leasing demand has led to equally (if not more) active investment demand for available properties within these markets. Any cash flowing leased investment is attracting multiple offers at record low Capitalization Rates and even dilapidated restoration projects are getting more attention and higher pricing than ever. Virtually all meaningful land in Midtown and Downtown is in contract or recently sold. Interestingly, almost all of this land is being purchased to develop multi-family projects. Almost all proposed projects are stick frame over concrete podium construction. Even though activity has increased dramatically and rents are approaching record highs, the cost of construction inclusive of Title 24 standards and current California Code Compliance has risen even more dramatically and the only new projects that “pencil” are stick frame multi-family housing. Even then, the economic underwriting is heavily predicated on current rents, interest rates in the low to mid 3% range and disposition Capitalization Rates in the 4 – 4 ½% range. These disposition rates allow developers the latitude to stabilize projects at sub 7% returns and still exit with a handsome profit. Even record low Cap Rates for office product in the midtown and R Street corridor markets are not enough to offset construction and stabilization costs at current lease rents and land pricing.
Once rents (either retail or office) can consistently exceed $2.25 per sf NNN additional new construction should become economically viable.
Principal – Lic. #01219637
Turton Commercial Real Estate
2409 L Street
Sacramento, CA 95816