Market Insight Editorial & Advice to Tenants: 4Q2003

Message from Dan Mihalovich, Principal of Mihalovich Partners and Founder of The Space Place®

Happy New (Election) Year. We leave 2003 with some mixed blessings. In another soft year for the economy, we enjoyed a successful year at Mihalovich Partners, negotiating the largest lease in San Francisco—on behalf of the California Academy of Sciences. Best wishes to the Academy in their upcoming relocation from Golden Gate Park to their new “transition” location, 875 Howard @ 4th (across the street from Moscone West) in San Francisco. Thank you, to the Academy, and all of our other clients who made 2003 a spectacular year for us. We only wish that the rest of the market and our local economy could have faired as well. In many other respects, ’03 was just brutal. The “recovery” from Recession simply did not materialize, locally. On average, it took 14-16 months to get any space leased. 20 million square feet of available space still hovers on the market in San Francisco. Despite the blip to positive growth in the office market in Q3, the 4th quarter failed miserably into sub-zero territory, and the year as a whole landed in the red.

We did not have job growth in San Francisco, or surrounding areas. We enter 2004 with the same bleak projection, unfortunately. From where will growth in office demand originate? There are no “new” industries in the wings. All the job reports are focused on “off-shoring” employees to reduce operating costs and increase competitiveness. Consolidation in the financial and legal sector (are there other sizeable blocks of tenants in San Francisco?) continues. Our actor-turned-Gov’ is shepherding California into bankruptcy, unless voters pass a $15 billion (capital “B”) bond to save the state. Slashing expenses on a statewide basis, as Schwarzenegger insists, will slam local economies further. There is much pain in our immediate future. Nationally, we are staring down a $500 billion deficit. We are at war, not just in Afghanistan.

But God bless Wall Street, all those analysts, stockbrokers and investment bankers out there; the Dow Jones; the S&P 500; and especially the NASDAQ for hyping the economy and getting our respective stock portfolios into respectable demeanor. IPOs are back. Wall Street bonuses are back. The economy, they say, is BACK! GDP and worker productivity, they say, are off the charts. Consumer confidence is better than it’s been in a long time, but who needs a job to stimulate the economy? Interest rates are at 40-year lows. Bush will keep printing money to keep the dollar low and keep this Election Year economy stimulated, especially to export our unemployment.

We raised a glass to toast our new Mayor, Gavin Newsom, confirmed in the December runoff race against Matt Gonzalez. Surely you read Newsom’s comments to the Business Community [pdf], posted here at The Space Place®. Welcome to the hot seat, Mr. Mayor. There is much to do before you run for President. Keep a copy of Gav’s policy paper handy; we’ll compare notes about it in a subsequent editorial.

A few pundits caution that we should not confuse the almighty stock market with the economy. One cannot look at office market stats for the San Francisco Bay Area and read a “recovery” into it, certainly. The patient appears hardly breathing. Gross market activity levels provided enough stimulus to keep brokers, architects and contractors busy, but the net result was a less-than-zero growth economy, with 56 million square feet vacant.

2004 will be a year of more juggling. Tenants fortunate enough to be active at this time will remain opportunistic, leveraging all of their options until the most aggressive landlord or sublessor puts out the sweetest enticements. Landlords will have to devote greater energies and concessions to renew tenants early - perhaps long before those tenants begin their first negotiation with another landlord. The average downtime (marketing time) for space in San Francisco is 14-16 months. If your landlord isn’t factoring that inevitability into your renewal negotiations, on top of other concessions, you’re working with the wrong tenant rep broker.

We have a lot to be thankful for, but frankly remain tenuous as ever about the economy. We are not encouraging clients to lease any more space than absolutely necessary, unless there are compelling landlord concessions to offset the risk entirely. For those companies and firms who have tenure in their respective fields, this is a perfect time to lock in long-term rental rates, expansion/contraction options, and negotiate very favorable lease documents. Remember, our job (and yours) is not complete when a Letter of Intent is signed; the work continues through lease documentation (and beyond) to ensure that the scores of other issues in the lease are crafted to protect and enhance your interests. Be prepared with back-up alternatives if/when your landlord of choice gets heavy-handed during lease documentation. The markets will support you. We’re here to help you, always with the tenant’s interest in mind.

We are in discussions with prospective new clients, whose leases do not expire until 2004, 2005, and 2006. Each party has its own collection of issues; none, however, are “locked” out of the current marketplace. We provide personal attention (with 25 years of business experience—21 years representing tenants in San Francisco, I commit my time to all of a small number of transactions we work on each year). We listen. We ask questions and bring together the proper Team members (architects, contractors, engineers, real estate lawyers, telecom and moving consultants, etc.) to create a strategy and budget to address our client’s specific needs. We provide objective advice, on all fronts, to maximize our client’s position. We lead the Team through the entire organizational process, managing the tenant-leasing project and conducting all negotiations with all landlords or sublessors. At Mihalovich Partners, we live in a conflict-free environment. We NEVER represent landlords. If you would like to join us at our offices for an intimate and productive working session to review your firm’s situation, please give us a call. We’re conveniently located on Montgomery Street, between Clay and Washington.

Here’s to a great new year. May our concerns for the economy and our safety be proved unwarranted. A speedy and healthy return to our troops overseas. Peace to all.

Dan Mihalovich ([email protected])
Principal of Mihalovich Partners and Founder of The Space Place ®

Office Demand Standstill. “Recovery” Elusive.

Let’s review the stats together. Following are the results from our 4th Quarter, 2003 research. We have a number of comments:

  • San Francisco’s absorption rate (the amount of space leased, after considering new space added to the market) was hugely negative for Q4, at nearly 686,000 square feet NEGATIVE. Vacancy rates climbed 5%, but asking rental rates remained unchanged. Of the 20 million square feet on the market, 22% is sublease space. It is interesting to note how severely the San Francisco, San Mateo, Santa Clara and East Bay markets are impacted by the sublease market. In each case, it was leasing activity in the sublease market which kept each market afloat. Absorption of direct (landlord) space in San Francisco has been negative for 11 of the past 12 quarters.
  • San Francisco wrapped up the year with 233,000 square feet of negative growth and rental rates averaging just over $21.00 per square foot per year, fully serviced. “Recession rates” comes to mind, but today’s rates are actually cheaper than when we started in the leasing business, in the recession of 1982…nearly 22 years ago. Taking inflation into account; and the higher level (and cost) of services which are included in “fully serviced” rent, today’s rental rates are more compelling than ever. That said, landlords must nevertheless aggressively compete with one another to create demand for their space—where there may be none. Rental rates may remain steady, but if they do, concession packages (free rent; tenant improvement allowances; relocation cost reimbursements, etc.) for tenants will necessarily increase. Effective rates, including concessions, cannot sustain at these levels of vacancy and lack of absorption.
  • Santa Clara County was the bright spot along the Bay in Q4 and for the year, at nearly 1.5 million square feet of positive absorption (total of 1.3 million for the year). Thirty percent of their vacancies are in the form of subleases. Santa Clara County’s Q4 absorption would have otherwise been only 200,000 square feet of direct space. It appears that the tenant community is doing a much better job of moving its excess space than the more stout landlord community.
  • We have surveyed completed office lease transactions in each market. Painfully few “large” deals were completed, those exceeding 20,000 square feet:

    Please note: We provide Bay Area market data and analyses for the current year only. To request commercial real estate market data for previous quarters, please contact us.

    Vacancy Rates—Current v. Last Quarter + Forecast

    Please note: We provide Bay Area market data and analyses for the current year only. To request commercial real estate market data for previous quarters, please contact us.

    Trend in Asking Rents—Current v. Year-end 2000

    Please note: We provide Bay Area market data and analyses for the current year only. To request commercial real estate market data for previous quarters, please contact us.

    Contrarian Thinking: Are You Up to It?

    There has been an absolute deluge of hype on television, radio, the Web and in print about the recovering (Election Year) economy…and all the reasons you should throw your money back into the stock market. Perhaps the herd is right on stocks, but in the local office marketplace, where landlords are sounding off to the same tune, we are here to present the flipside. In addition to our comments above, you should note that the “new” supply of space is not dwindling. One would expect the flow of new listings to slow IF a turnaround were imminent. Quite to the contrary. During the last thirty days of Q4, new space was added to each market in the following magnitudes:

    • San Francisco County: 737,000 square feet of new listings, last 30 days.
    • San Mateo County: 430,000
    • Santa Clara County: 546,000
    • East Bay Counties: 412,000.

    We are known to be aggressive advocates for tenants. But we do not fabricate market statistics, nor do we succumb to swallowing illogical arguments from the landlord community. Nor are we bashful at the negotiating table. It is taking, on average, 14-16 months for landlords and landlord brokers to get spaces leased in today’s market. Does that stat speak to you? Being a contrarian is not always popular, but since we have no allegiance whatsoever to the landlord community, we can most aggressively assert positions on your behalf.

    Who Has the Most Space in San Francisco? Surprise…

    When we approach a prospective new tenant client, we tell them that we NEVER represent landlords, always avoiding this conflict of interest. So, which leasing firms do the most landlord representation, and who controls the most space in San Francisco? And, most importantly, would you feel comfortable having them represent YOU?

    Below we’ve surveyed the entire 103 million square foot inventory of San Francisco, and illustrated the companies with the most control of space on the market, the Top 25. You know from our other stats that 20 million square feet is now on the market in San Francisco. The top 3 companies, all office leasing brokerage firms, control over 30% of the City’s vacancy, more than Equity Office Properties (#4), the country’s largest REIT; more than Hines (#7); and Shorenstein (#11) or Boston Properties (Embarcadero Center, #13). Surprised, are you not?

    Top 25 Companies By Space Inventory

    % Market Share Square Feet # of Landlords/ Buildings

    % refers to the percentage of vacant space under exclusive listing by each company. The accompanying figure is the actual square footage available for lease. We have also noted the number of landlords/buildings represented by each entity.

    * denotes listing brokers. All other companies listed are landlordselopers.

    1 *The CAC Group 12.1% 2,429,995 43
    2 *Cushman & Wakefield of California 10.7% 2,157,559 65
    3 *CB Richard Ellis 8.3% 1,664,249 54
    4 Equity Office 4.9% 983,310 11
    5 *Colliers International 4.9% 979,024 80
    6 *Jones Lang LaSalle Inc. 4.8% 964,383 4
    7 Hines 4.0% 803,520 9
    8 Catellus Urban Development Corp. 3.6% 717,548 6
    9 *Grubb & Ellis 3.3% 669,873 72
    10 *BT Commercial Real Estate - NAI 3.0% 605,376 38
    11 Shorenstein Realty Services, LLC 2.8% 565,944 8
    12 Tishman Speyer Properties 2.8% 559,000 1
    13 Boston Properties 2.1% 427,688 6
    14 *Newmark Pacific 2.1% 422,355 6
    15 *Cornish & Carey Commercial - ONCOR International 2.1% 419,120 TBD
    16 *GVA Whitney Cressman 1.7% 339,204 58
    17 *Starboard TCN Worldwide Real Estate 1.7% 338,808 96
    18 The Presidio Trust 1.6% 312,032 45
    19 Catellus Development Corporation 1.4% 283,000 1
    20 Poszots Associates 1.4% 280,000 1
    21 *TRI Commercial/ONCOR International 1.4% 275,132 44
    22 *HC&M Commercial Properties, Inc. 1.3% 260,871 28
    23 *Coldwell Banker Walker Pacific 1.0% 196,218 30
    24 *Transwestern Commercial Services 0.9% 183,476 6
    25 *The Staubach Company 0.9% 173,654 0
    All Others 15.3% 3,069,914
    Total 20,081,253

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