Forecasting the Capitalization Rate of Office, Industrial, and Retail Properties in the North Bay Area: A 5-Year Outlook

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The real estate market is constantly evolving. It’s influenced by various factors such as economic conditions, market trends, and investor sentiment. As such, forecasting the capitalization rate of  property types such as office, industrial, and retail properties, requires careful analysis and consideration of multiple variables. We at Keegan & Coppin will delve into the North Bay Area real estate market and provide an estimated 5-year forecast on the capitalization rate of these property types.

The North Bay Area, known for its picturesque landscapes and proximity to major metropolitan areas such as San Francisco, has long been a desirable location for real estate investors. However, like any other market, it is not immune to fluctuations and changes. Let’s take a closer look at each property type and their respective capitalization rate forecast.

Office Properties: The office market in the North Bay Area has historically been strong, driven by demand from various industries such as technology, healthcare, and professional services. However, in recent years, the office market has experienced some challenges due to changing work dynamics, including the rise of remote work and flexible office space options.

Over the next 5 years, it is expected that the capitalization rate for office properties in the North Bay Area will experience some upward pressure. This can be attributed to potential oversupply in certain submarkets, as well as the continued uncertainty around the future of office space demand. As remote work becomes more prevalent and companies reassess their office space needs, some investors may demand higher returns to compensate for increased risk. However, prime office properties in prime locations with strong tenant profiles are likely to remain resilient, and the impact on capitalization rates may be moderate.

Industrial Properties: The industrial market has been a standout performer in recent years, driven by the growth of e-commerce and logistics. The North Bay Area, with its proximity to major transportation hubs and favorable business environment, has seen strong demand for industrial properties from companies looking to expand their supply chain operations.

Looking ahead, the industrial market is expected to continue its upward trajectory, with the capitalization rate for industrial properties in the North Bay Area projected to remain relatively stable or even decline slightly over the next 5 years. The ongoing growth of e-commerce, the need for last-mile distribution facilities, and limited supply of industrial properties are expected to support continued investor interest in this property type, potentially leading to compressed cap rates in prime locations.

Retail Properties: The retail market has faced challenges in recent years, with the rise of online shopping and changing consumer preferences impacting brick-and-mortar retail. The North Bay Area, with its unique mix of urban and suburban environments, has experienced varying trends in the retail sector.

Forecasting the capitalization rate for retail properties in the North Bay Area is challenging due to the changing dynamics of the retail market. While some well-located retail properties with strong anchor tenants may continue to perform well, others may face higher vacancies and increased risks. As such, the capitalization rate for retail properties in the North Bay Area is expected to be mixed, with potential variations depending on the location, tenant mix, and property condition. Overall, the retail market is likely to face some headwinds in the coming years, which may result in slightly higher capitalization rates for certain properties.

In conclusion, the North Bay Area real estate market is expected to face some challenges and opportunities in the next 5 years. While the industrial market is projected to remain strong, with stable or even declining capitalization rates for industrial properties, the office and retail markets may experience some upward pressure on cap rates due to changing demand dynamics and increased risks.

As with any investment, it is crucial for investors to conduct thorough research, analysis, and due diligence before making any business decisions.

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Petaluma Forecast for 2016

Petaluma experienced positive industrial absorption throughout 2015. The market vacancies over 4 quarters were:

• Q4, 2014 Industrial: 6.6%
• Q4, 2015 Industrial: 4.1%

Result: The tight Industrial Market got much tighter. There were some large deals, such as the sale of 1450 Technology Lane (roughly 80,000 sf of Industrial with a total building size of 125,000 +/- sf) and 80,000 +/- additional sf at 3800 Lakeville leased to Morris Distributing. Those two deals took a healthy bite out of the standing vacancy, but the absorption was primarily driven by deals in the sub-10,000 SF range. Because of lack of Southerly inventory, the asking rate for Industrial space has increased by about 10% to the $.90 – $1.00/psf range on a Standard Industrial Gross basis.

Forecast: We will continue to see upward pressure on Industrial rates throughout 2016. While there will be some moves generated within town for existing tenants addressing their needs, we also expect migration from both directions on 101. Those moving north will be primarily cost driven, while those moving south hope to increase market draw and more favorable distribution routes. There are two projects in the market which should alleviate some of the pressure; however neither has broken ground yet.

Petaluma’s Office did not fare well. The most previous four quarters were virtually flat:

• Q4, 2014 Office: 15.8%
• Q4, 2015 Office: 15.9%

Result: Petaluma, despite its quality of life draw, continues to be a tough sell for office space. Most office deals are still in the incubator-sized range and businesses that ‘right-size’ basically create a wash. Some grow, some shrink, others watch the pot simmer and wait to see how the economy performs. Office tenants are always more cautious than Industrial tenants. This is partially due to a higher level of oversight, but is also due to fear of previous market corrections being projected against current national and global developments. It doesn’t matter if Google moves in to the market. It doesn’t matter if a biomed obtains FDA approval. While these developments impact the local economy, the office market is driven by tenants and buyers with an eye on global enterprise. It doesn’t make any sense, but it is a consumer confidence-driven package.

Forecast: Despite the gloomy numbers above, we should start to see some positive market absorption. I don’t believe we will see any upward pressure on rent, but I do believe we will see a reduction in vacancy due to dwindling supply and steep rent increases in Marin County office rents. There comes a point where decision makers start looking at their bottom line despite that which is happening hundreds (or thousands) of miles away.

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Economic Indicators – 2016

The financial indicators for the nine Bay Area County Economies will continue their buoyant stride.

We all know that nothing lasts forever, but we are fortunate enough to be experiencing the effects of both local and global economic forces propelling our continuing expansion.

We have a confluence of economic drivers that are creating and continuing a sort of “perfect storm” financial environment. Just starting with the platform created by the success of a few of the Silicon Valley heavy hitters; Apple, Facebook, Google, and Twitter alone create a phenomenal foundation. Such an environment is and has become a magnet for international wealth, international talent and creating thousands of robust jobs and new tiers for business innovation.

In addition, we have a relatively new phenomenon in the explosion of the craft beer industry, and that is adding momentum to the already established Bay Area wine and food culture that continues its worldwide popularity. Tourism is at an all time high, and understandable considering the Bay Area’s location to the wine country, spectacular coast and intrinsic beauty.

As the Bay Area’s economy responds to these energetic market forces, you are witnessing the entire nine county expansion as it responds to these beneficial influences.

Both Sonoma & Marin County are seeing unprecedented appreciation in rents in both the commercial and residential sectors. Contra Costa County and Solano County are expanding their already vibrant transportation corridors and distribution hubs and pushing development to the east as far as Livermore. The BART expansion service to Antioch is opening in 2017.

The pressure for new housing in all counties continues and as such is creating multi-level job expansion on many fronts to accommodate that growth and demand.

Watch for the wine and beer industries to benefit from the Smart Train track system for transporting goods to Bay Area ports for international distribution.

Expect interest rates to stay low with some market up-tick because an election year status quo will want the appearance of a stable economic environment. The Federal Reserve will go to great lengths to avoid waves that could impact the current smooth sailing of today’s economic climate.

Contributed by:
Annette Cooper, Senior Real Estate Advisor
Rhonda Deringer, Senior Real Estate Advisor
Catherine Chapnick, Broker Associate

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Economic Overview

Santa Rosa is the largest city between Portland and San Francisco with an estimated population of 175,000. It serves as the county seat for Sonoma County which is known worldwide as a leading wine region and has become a major player in the up and coming craft beer industry. Along with the agriculture the region is famous for; Santa Rosa is also home to other industries including high-tech, biomedical, manufacturing, education, tourism, and various other professional and personal services. The labor market has bounced back with companies hiring new employees. This is evidenced by an unemployment rate of just 4.7% down from the double digit rates we were experiencing at the height of the recession. There is a quality of life in Sonoma County that drives residents and companies alike to the region. This creates an environment for prospering business with Santa Rosa serving as the economic hub.

The major business parks and shopping centers put together the bulk of the base occupancy in the region.  In South Santa Rosa there is the Industry West Industrial Center and the Oak Manor Industrial Area which have many large manufacturing warehouses, as well as the Northpoint Corporate Center with a mix of Office and Industrial.  In Central Santa Rosa there is a vibrant downtown area with a mix of office and retail as well as the nearby Santa Rosa Business Park and the Stony Point Office Park which both have large multi tenant office buildings.  Further north is the airport area with parks such as the Airport Business Center and Westwind Business Park which have a mix of office and industrial uses.  Santa Rosa is also home to three shopping malls which together house over 200 merchants.

The economic recovery has accelerated over the past few years; particularly the industrial and retail market and high occupancy rates have allured investors to these product types. Santa Rosa has over 16,000,000 square feet of industrial buildings with a current vacancy rate of approximately 8% and almost 8,000,000 square feet of retail buildings with a vacancy rate of approximately 3.4%. These low vacancies have attracted investors and we are seeing more competition for available investments and lower cap rates which make it a great time for owner’s to consider selling.  The office market has been slower to recover with a vacancy rate of 16% in over 9,500,000 square feet of office buildings.  This also provides great opportunity for owner-users to be able to buy a vacant building for their business and take advantage of the still low mortgage interest rates.

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