Commercial real estate market tightens in Sonoma County

San Francisco’s commercial real estate market all but glows red hot these days, and some of that energy seems to be radiating out to suburban communities in the North Bay.

Vacancy rates for Sonoma County office and industrial properties have declined markedly over the past three years. In particular, Petaluma businesses in recent years have leased hundreds of thousands of square feet of space that became vacant after a legion of telecom workers vacated the city. Also, the county’s industrial space is considered by some to be in tight supply.

What’s happening now has happened before, Sonoma State University economics professor Robert Eyler said. As real estate rates soar around San Francisco and Silicon Valley, more companies start to look for new space around the South Bay, East Bay and, to lesser extents, Marin and Sonoma counties.

“We are going through another classic wave” of expansion, Eyler said. “The demand sort of ripples out from the Bay Area.”

The county’s vacancy rate for ?office space declined this summer to ?16.2 percent, down from 18.3 percent a year earlier, according to Santa Rosa commercial brokerage Keegan & Coppin/Oncor International. In the last recession, the office vacancy rate peaked at 24.8 percent at the end of 2009 and was still at 22.2 percent in the third quarter of 2012.

The market for industrial space is even tighter. Only 6.4 percent of industrial space in Sonoma County was vacant this summer, down ?from 8.5 percent a year earlier, ?according to Keegan & Coppin. Three years ago, the rate stood at 13.3 percent.

Best market in years

Landlords and real estate brokers said the progress in leasing space has been noteworthy.

“It’s definitely the strongest market that we’ve seen in seven or eight years,” said Brad Baker, chairman and CEO of Codding Enterprises. “I think it’s going to grow stronger, and I think that bodes well for the economy.”

While there was broad agreement that vacancy rates are going down, there was less consensus on whether landlords have seen much improvement in rents, a piece of data that isn’t readily available.

Some experts suggested the leasing rates are at least approaching their pre-recession levels. But both SSU’s Eyler and Joan Woodard, president/CEO at Simons & Woodard, said landlords have yet to see significant increases in rents.

Woodard said her company has increased occupancy rates at its two Stony Point Road office buildings to between 88 and 92 percent. But rents there remain at about $1.70 to ?$1.75 a square foot per month, compared to more than $2 a square foot before the downturn.

“To be honest with you, I don’t believe we have improved in the office sector,” said Woodard, whose company owns or manages ?800,000 square feet of space. She ?still hasn’t seen good growth in office sector jobs for much of the county and “certainly not in Santa Rosa.”

Among the signs of change around the county:

Santa Rosa’s Museum on the Square development is slated in December to have its first tenants occupy office space overlooking Old Courthouse Square. The renovated telecommunication equipment building will have two of its five floors occupied by Luther Burbank Savings, one floor by TLCD Architecture, which designed the project, and on the ground floor, restaurants and food outlets.

Novato food producer Morton & Bassett Spices has become the largest tenant at Rohnert Park’s SOMO Village, formerly Sonoma Mountain Village. This summer the company signed a multi-year lease agreement with Codding Investments for 126,000 square feet of commercial space at the sprawling facility once used to make electronic testing equipment for Agilent Technologies.

Reno-based Basin Street Properties, the county’s largest office landlord, predicts its occupancy rates here will increase from ?75 percent at the start of the year to about 88 percent by Dec. 31.

Basin Street, with roughly ?2.5 million square feet of space in the county, has signed new leases this summer with Jacksonville, Fla.-based banking technology company FIS and San Francisco-based event ticketing company Vendini. Over the past year, it also has provided additional space to existing operations in Petaluma for Solairus Aviation, networking equipment maker Ciena and solar component maker Enphase Energy.

Petaluma’s office vacancy rate in the third quarter declined to 14 percent, according to Keegan & Coppin. In contrast, a whopping 40 percent of the city’s office space was unoccupied in the first quarter of 2010.

The declining supply of office space eventually will affect the cost of leasing, predicted Basin Street CEO Matt White.

“I think in 2016 you’re really going to see an upward pressure on rents,” he said.

At the Museum on the Square project, workers this week were boring holes through the floors, pushing through 8 inches of steel-reinforced concrete to provide passages for bathroom plumbing. Nearby light streamed in from tall windows overlooking the golden roof of the Empire Building and the five-story Rosenberg Apartments across the square.

Over the next year, the development is expected to become ?90 percent occupied as the concrete interior becomes transformed into office space, said developer Hugh Futrell.

While the county’s health care sector is “incredibly strong,” Futrell said he also has seen growth in accounting, law and financial services businesses.

“All three of those sectors are doing better,” Futrell said. “They have more clients. … That means more employment. That means more demand for office space.”

San Francisco’s tight market

For perspective, it helps to consider the San Francisco market. The office sector ended the third quarter with a 6 percent vacancy and ?a record high annual rent of ?$66.71 per square foot, according ?to Cushman & Wakefield. In contrast, Sonoma County’s monthly rates would translate into annual rates of roughly ?$20 to $30 per square foot for Class A space, the top tier in the market.

The brokerage reported that ?1.4 million square feet of new office space is expected to be completed in San Francisco in the current quarter, with 96 percent of the space already leased.

The tech boom is fueling the growth, with computer systems design jobs in San Francisco and the Peninsula expected to overtake the number of workers in the financial services sector by early next year, Cushman & Wakefield reported.

No building in Sonoma County

In Sonoma County, the commercial rents aren’t yet high enough justify new office construction, landlords said.

That’s also the case for industrial projects, said Larry Wasem, managing general partner of the Airport Business Center. He said he tells prospective clients that he would need to increase rents roughly ?35 percent or more from existing ?levels to cover the cost of constructing a new building.

“Then they get that big lump in their throat,” Wasem said.

Nonetheless, Keegan & Coppin President Al Coppin maintained the industrial market is running out of good spaces and needs more land for new development. Local governments, he said, should encourage the growth of industrial jobs, ?which are key to maintaining a strong economy.

“It’s not just going to naturally happen,” Coppin said.

Building owners said similar ?constraints affect the county’s ?housing market, an increasing ?concern of both business and elected leaders.

Existing homeowners and landlords benefit from the controls on real estate development, the building owners said. But the restrictions also affect who can afford to buy houses, rent apartments and lease commercial space here.

“If you don’t facilitate that growth,” said White of Basin Street, “it simply will become more expensive.”

For now, the good news with prospective tenants is “the word ‘recession’ isn’t in their minds,” said Barry Palma, a senior managing director for Newmark Cornish & Carey Commercial in Santa Rosa. Even so, many remain conservative these days and “aren’t taking more space than they need.”

When and how much office rents increase will depend on when the vacancy rate drops to or below ?10 percent, a point generally considered balanced between landlords and those leasing space, he said.

For now, said Palma, “it’s still a tenants’ market.”

You can reach Staff Writer ?Robert Digitale at 521-5285 or ?robert.digitale@pressdemocrat.com. On Twitter @rdigit