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RESEARCH & FORECAST REPORTsAn FRAncIsco

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On the Up and Up Investment Sales | Premium Space Leases | Demand Fueled by Tech Sector

oveRvIew

Despite posting negative absorption for the quarter, the city’s office market fundamentals are showing signs that vacancy will stabilize and rental rates will rise through year end. The compounding effect of Wells Fargo, Charles Schwab, and BlackRock (Barclays) returning large blocks of office space caused the city to post 317,655 square feet of negative net absorption, which pushed the year-to-date total to 272,110 square feet of negative net absorption. The drop in absorption over the quarter pushed the overall vacancy to 15.2 percent from 14.8 percent.

Aside from overall occupancy loss for the quarter, the San Francisco market is beginning to experience modest job growth. Preliminary May labor force data from California Employment Development Department for San Francisco puts the unemployment rate at 9.2 percent. The number of unemployed in San Francisco fell by 1,900 in May, while overall California employment increased by 40,000, and unemployment shed 0.3 percentage points to post 11.9 percent.

The city’s employment growth is largely driven by its technology sector, as indicated by active tenants in the market. Of the 1.88 million square feet of total leasing transactions that took place during the second quarter, 30 percent were from tech-related companies.

Rental rates appear to have stabilized, as owners are reaching their bottom-line for profitable transactions. The average effective rent for direct Class A transactions during the second quarter was $33.33 per square foot, a 1.8 percent increase from first quarter’s average of $32.74 per square foot. The average effective rent for direct Class B transactions increased 6.2 percent to $26.41 per square foot from $24.81 per square foot.

The desire to secure core assets at cyclical low prices ignited the quarter’s investment activity. Sale transaction volume increased during the quarter, 333 Market Street sold to a group of Korean investors for $333 million, 351 California Street sold to a Turkish investor for $35 million, and Kilroy Realty Corp. picked up 303 Second Street for $237 million. Also, one of the city’s core assets, 255 California Street, is under contract to sell for $43 million, or $247 per square foot.

Rent IncReAses

The quarter over quarter surge in weighted average rents was from a series of large renewals locking in premium space at historically low rates, although higher than current average levels.

mARket IndIcAtoRs

updAteAbsorption and vacancy Rates

Q2

2010

Ye

2010

vAcAncY —

net AbsoRptIon —

constRuctIon — —

weIghted RentAl RAte

non weIghted RentAl RAte

sAles volume

sAle pRIces

Q2 2010 | office

1Q ‘10 overall

2Q ‘10 Direct

2Q’10Sublease

2Q ‘10overall

% Change

Financial District: Class A $30.44 $31.38

$39.90 $33.82

$26.69 $27.47

$39.34 $33.43

29.2% 6.5%

All Markets: Class A $30.48 $30.50

$39.18 $33.33

$22.74 $20.33

$38.70 $33.01

27.0% 8.2%

All Markets: Class B $25.29 $24.44

$25.45 $26.41

$18.00 $18.00

$25.42 $26.26

0.5% 7.4%

All Markets: Class C $25.36 $22.33

$24.17 $22.02

NANA

$24.16 $21.94

-4.7% -1.7%

0%

5%

10%

15%

20%

- 8

- 6

- 4

- 2

0

2

4

6

8

2Q '04

3Q '04

4Q '04

1Q '05

2Q '05

3Q '05

4Q '05

1Q '06

2Q '06

3Q '06

4Q '06

1Q '07

2Q '07

3Q '07

4Q '07

1Q '08

2Q '08

3Q '08

4Q '08

1Q '09

2Q '09

3Q '09

4Q '09

1Q '10

2Q '10

Net Absorption Vacancy

*weighted average rents

in h

undr

ed-t

hous

ands

NORTHWESTNORTHEAST

AIR-PORT

SOUTHEAST

SOUTHWEST

union square

yerba buena

leAsIng ActIvItY

The reemergence of the tech sector is fueling overall leasing activity. There is a growing list of technology companies moving to San Francisco, including TechCrunch, MetaCafe, Ustream, Encover Inc., Yammer Inc., and Zinch. During the second quarter alone, nearly 30 percent of office leasing activity was from tech-related tenants, and currently 1.3 million square feet, or 29 percent, of active tenant requirements are from tech firms.

AbsoRptIon

The 317,655 square feet of occupancy loss during the second quarter concludes the majority of space returns that were forecasted for this year. Year-to-date the market posted 272,110 square feet of negative net absorption. The most significant contributions to the absorption loss were from Wells Fargo returning 350,000 square feet at 155 5th Street, Charles Schwab vacating 118,000 square feet of holding space at 101 Montgomery Street, and Barclays placing 115,000 square feet of vacant space at 45 Fremont Street on the sublease market.

A significant amount of city’s negative absorption was offset by new tenants to the city and by tenant expansions. Tenants such as DocuSign taking 42,000 square feet in San Francisco, and Benefit Cosmetics expanding by more than

35,000 square feet in its move from 685 Market Street to 225 Bush Street, have helped to soften the total effects of the city’s occupancy loss.

vAcAncY

Absorption loss pressed the overall vacancy rate to 15.2 percent, a slight increase from the 14.8 percent posted in the first quarter. The vacancy rate was able to stay low since no new construction projects were delivered over the quarter.

Sublease space had little effect on overall market conditions. The city’s sublease vacancy currently accounts for just 1.4 percent of its total inventory. The total sublease inventory only increased by 39,000 square feet over the quarter from “right-sizing” tenants. The largest impact on the sublease vacancy rate during the second quarter came from Blackrock, which is currently subleasing 115,000 square feet at 45 Fremont Street.

Moreover, more than 23 percent of the vacant office space for sublease has less than 12 months left on its term. As we begin to see sublease space terms expire, the impact of vacant sublease space (lower rental rates, flexible terms, etc.) will have even less of an effect on overall market conditions.

There has been an uptick in activity in Union Square over the quarter. Close to 20 office lease transactions were recorded for the submarket representing almost 80,000 square feet.

updAte lease and Investment transactions

sIgnIFIcAnt leAses Q2 2010

pRopeRtY AddRess tenAnt sIze tYpe dAte sIgned clAss

One Market - Landmark Salesforce.com 260,000 Renewal April 2010 Class A

505 Montgomery Street Latham & Watkins 117,154 Renewal May 2010 Class A

555 California Street Goldman Sachs 72,000 Renewal April 2010 Class A

44 Montgomery Street Securities & Exchanges Comission 60,000 Renewal April 2010 Class A

The Ferry Building Conifer Group LLC 51,424 Renewal June 2010 Class A

sIgnIFIcAnt sAles Q2 2010

pRopeRtY AddRess selleR buYeR sQ. Ft. sAle dAte clAss sAle pRIce pRIce peR sF

333 Market Street Principal Real Estate InvestorsKorean Federation of Community Credit Cooperatives JV Korean Teachers Credit Union

655,398 June 2010 class A $332,166,667 $506.82

303 Second Street Kennedy Associates OBO Multi-Employer Property Trust

Kilroy Realty 700,945 May 2010 class A $233,328,500 $332.88

255 California Street* Lexington Realty TrustHighridge Partners JV Baupost Capital

173,747 June 2010 class A $43,000,000 $247.48

351 California Street Jorei Enterprises LLC Polidev International 136,791 June 2010 class b $35,000,000 $255.86

*Terms agreed. Sale not yet closed escrow.

p. 2 | collIeRs InteRnAtIonAl

research & forecast report | Q2 2010 | oFFice | San FranciSco

leAsIng ActIvItY

Leasing activity continued to pick up from the first quarter, and 1.88 million square feet of office lease transactions were registered for the second quarter of the year. The past three quarters combined represent 5.3 million square feet of leases. Historical annual averages for leasing activity are approximately 6.7 million square feet.

existing properties Absorption new supply

u/c & proposed

Class Bldgs Total Inventory

SF

Direct

Vacant SF

Direct Vacancy

Rate

Sublease

Vacant

SF

Sublease

Vacancy

Rate

Total

Vacant

SF

Occupied

Space SF

Vacancy

Rate

Current

Period

Vacancy

Rate

Prior

Period

Net

Absorption

Current SF

YTD Net

Absorption

net

new

supply

current

sF

net new

supply YtdsF

under

construction

sF

proposedsF

Colliers InternationalOffice Market Report - Q2 2010

Class Bldgs Total Direct Direct Sublease Sublea

Total Occupied Vacanc Vacanc Net Net Net

Net New

Under Proposed

DOWNTOWN MARKET:

A 172 52,123,101 6,996,056 13.4% 932,097 1.8% 7,928,153 44,194,948 15.2% 14.5% (378,561) (285,542) - - 210,000 6,383,520

B 239 23,882,495 3,968,544 16.6% 194,505 0.8% 4,163,049 19,719,446 17.4% 17.5% 26,200 (26,931) - 182,073 -

C 120 7,218,574 539,232 7.5% - 0.0% 539,232 6,679,342 7.5% 8.0% 34,706 40,363 - - - -

Total 531 83,224,170 11,503,832 13.8% 1,126,602 1.4% 12,630,434 70,593,736 15.2% 14.8% (317,655) (272,110) - 182,073 210,000 6,383,520

FINANCIAL DISTRICT:

A 106 40,236,611 4,504,403 11.2% 766,654 1.9% 5,271,057 34,965,554 13.1% 12.9% (82,244) (40,099) - - - 4,710,000

B 66 7,730,141 1,090,717 14.1% 23,004 0.3% 1,113,721 6,616,420 14.4% 14.1% (30,263) (86,901) - - - -

C 34 1,659,983 143,445 8.6% - 0.0% 143,445 1,516,538 8.6% 8.8% 10,992 (15,524) - - - -

Total 206 49,626,735 5,738,565 11.6% 789,658 1.6% 6,528,223 43,098,512 13.2% 13.0% (101,515) (142,524) - - - 4,710,000

- - -

SUBMARKETS:

North Financial 109 26,573,274 3,437,553 12.9% 510,323 1.9% 3,947,876 22,625,398 14.9% 15.0% 44,654 83,444 - - - 469,000

South Financial 97 23,053,461 2,301,012 10.0% 279,335 1.2% 2,580,347 20,473,114 11.2% 10.6% (146,169) (225,968) - - - 4,241,000

Total 206 49,626,735 5,738,565 11.6% 789,658 1.6% 6,528,223 43,098,512 13.2% 13.0% (101,515) (142,524) - - - 4,710,000

Union Square 50 3,692,571 454,309 12.3% 6,879 0.2% 461,188 3,231,383 12.5% 13.6% 42,476 72,085 - 182,073 -

Yerba Buena 31 4,044,270 934,651 23.1% 142,090 3.5% 1,076,741 2,967,529 26.6% 18.3% (336,698) (326,224) - - - 140,000

SOMA West 23 2,338,507 561,214 24.0% - 0.0% 561,214 1,777,293 24.0% 25.1% 25,825 10,285 - - - -

SOMA East 40 4,803,937 652,191 13.6% 73,961 1.5% 726,152 4,077,785 15.1% 14.0% (53,034) (37,697) - - - 212,000

Civic Center/Mid-Market 46 6,347,635 1,643,693 25.9% - 0.0% 1,643,693 4,703,942 25.9% 25.9% 549 (22,199) - - 221,000

Jackson Square 34 2,265,711 259,646 11.5% 4,139 0.2% 263,785 2,001,926 11.6% 11.5% (3,182) 8,251 - - - -

North Waterfront 44 3,790,147 298,767 7.9% 31,759 0.8% 330,526 3,459,621 8.7% 10.8% 77,391 72,522 - - - -

Van Ness Corridor 22 1,508,380 190,628 12.6% 78,116 5.2% 268,744 1,239,636 17.8% 18.2% 6,075 7,093 - - - -

Potrero West 11 1,232,809 104,850 8.5% - 0.0% 104,850 1,127,959 8.5% 7.9% 9,030 9,192 - - - -

Potrero East 10 1,008,376 122,843 12.2% - 0.0% 122,843 885,533 12.2% 9.9% (23,501) (22,823) - - - -

Mission Bay 14 2,565,092 542,475 21.1% - 0.0% 542,475 2,022,617 21.1% 22.7% 38,929 99,929 - - 210,000 1,100,520

Total 531 83,224,170 11,503,832 13.8% 1,126,602 1.4% 12,630,434 70,593,736 15.2% 14.8% (317,655) (272,110) - 182,073 210,000 6,383,520

-

QUARTERLY COMPARISON AND TOTALSQ1 - 10 531 83,149,235 11,202,883 13.5% 1,087,871 1.3% 12,290,754 70,858,481 14.8% 14.7% 95,255 95,255 - 182,073 320,000 6,383,520

Q4 - 09 529 82,991,151 10,946,694 13.2% 1,267,118 1.5% 12,213,812 70,777,339 14.7% 14.4% (270,140) (1,649,181) - 157,929 320,000 6,383,520

Q3 - 09 529 82,894,721 10,498,280 12.7% 1,445,392 1.7% 11,943,672 70,951,049 14.4% 14.1% (136,702) (1,379,041) 157,929 157,929 260,000 6,383,520

Q2 - 09 528 82,894,721 10,298,220 12.4% 1,350,821 1.6% 11,649,041 71,245,680 14.1% 13.2% (688,514) (1,242,339) - - 417,929 6,383,520

Q1 - 09 528 82,894,721 9,992,192 12.1% 968,335 1.2% 10,960,527 71,934,194 13.2% 12.6% (553,825) (553,825) - - 417,929 6,383,520

Existing Properties U/C & ProposedAbsorption New Supply

research & forecast report | Q2 2010 | oFFice | San FranciSco

collIeRs InteRnAtIonAl | p. 3

Rents

Although vacancy continued to climb over the quarter, average rental rates have approached stable levels, with increasing upward pressure. The most telling indicator of the market is the direct Class A average effective rent, which averaged $33.33 per square foot in the second quarter, a 1.8 percent increase from $32.74 per square foot the previous quarter.

The large swings experienced in average weighted rents were the result of a void of large -sized transactions in the first quarter (none of which were more than 55,000 square feet) and a series of large renewals locking in premium space for a historically low rate during the second quarter. As a result, overall Class A weighted averages dropped nearly 25 percent to $30.48 per square foot in the first quarter and spiked 27 percent to $38.70 per square foot in the second quarter.

We are beginning to see a resurgence of transactions in premium view space. Whereas lease transactions on upper floors in trophy buildings were sparse during the majority of 2009, demand for these types of opportunities is being driven by tenants eager to capitalize on some of the city’s best space at record-low rates. During the quarter six transactions took place with rents greater than $50 per square foot, all with lease terms of five years or greater.

Although the Financial District contains a handful of value-driven sublease offerings, overall rental rates saw a slight uptick during the quarter. Rents in the South Financial District, in particular, increased 9.4 percent to $33.28 per square foot Largely influenced by the six transactions that took place in Market Plaza for well over $40 per square foot, average effective rent for direct Class A space in the South Financial District is $3.15 per square foot higher than that of the North Financial District. South Financial District Class A rents are $36.25 per square foot versus North Financial District Class A rents, which average $33.10 per square foot.

As tenant demand and activity continues to gain momentum through the remainder of the year, we expect average rental rates to increase, with tenants signing longer term lease transactions.

InvestmentInvestment activity increased over the quarter, as predicted. While less than 300,000 square feet of commercial office properties sold in the first quarter, sale transaction volume totaled more than 1.6 million square feet in the second quarter.

The most notable sale of the quarter was 333 Market Street. The building sold for $333 million, or $507 per square foot to a group of Korean investors, including the Korean Teachers’ Credit Union and Korean Federation of Community Credit Cooperatives. The building is 100 percent leased to Wells Fargo through 2026. Hong Kong based investor Goodwin Gaw helped facilitate the sale and will manage the tower.

In addition, Kilroy Realty Corporation acquired 303 Second Street for $237 million or $326 per square foot. The price is close to exactly what the seller, Multi-Employer Property Trust, paid for the property five years ago.

Other notable investment sale activity includes Highridge Partners, which is in contract to buy the 170,000-square-foot office building at 255 California Street for nearly $43 million or $247 per square foot. Highridge is buying the property in a joint venture with the Baupost Group. The property received multiple offers and is expected to close within the next month.

The wave of well-leased assets for sale is causing frustration to investors who have been waiting for distressed properties to hit the market. To date, few of these opportunities have materialized. Though distressed buildings have returned to their lenders, in many of these cases, lenders have elected to hold on to these properties for more favorable conditions rather than dispose of them. The pace of investment sales will accelerate as the supply of formerly distressed assets are brought to the increasingly eager marketplace.

San FranciSco:

Alan CollenetteManaging Director 50 California Street 19th Floor San Francisco, CA 94111tel +1 415 788 3100FAX +1 415 433 7844

ReseARcheR:

Tove NilsenResearch Director tove.nilsen@colliers.comtel +1 415 288 7827

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research & forecast report | Q2 2010 | oFFice | San FranciSco