Market Insight Editorial & Advice to Tenants: 2Q2008
In this Issue:
- Editorial from Dan Mihalovich, Principal of Mihalovich Partners and Founder of The Space Place®
- San Francisco Market Overview
- Take Me Straight to the Numbers: San Francisco Bay Area Rental Rates. Supply / Demand.
- Who Has the Most Space in San Francisco? Surprise…
Editorial from Dan Mihalovich, Principal of Mihalovich Partners and Founder of The Space Place®
If you’re a commercial tenant in the San Francisco area, you’ve come to the right place, The Space Place®. If you are a first-timer at our site, know that we are totally and unequivocally committed to serving and representing the tenant community—and that my Editorials are not only meant to be instructive; they are a written record of our market analyses and recommendations; and, from my perspective, an easy way for you to differentiate the quality of our thinking and strategy with those of our competitors.
Office Tenants Pay for More Phantom Space than Ever
Fair warning: Touching this radioactive topic could be hazardous to your landlord. And pretty much every professional in the commercial real estate sector. The issue revolves around the proper, fair and legal way to measure office space you’re leasing every day. Tenants: WHY are you paying for more space than you’re using within the walls of your demised space? Landlords, real estate lawyers, brokers, architects and BOMA have a litany of answers for you. But to a significant degree it comes down to this: “Because we said so.” As we open up this can of squirrely measuring sticks, let’s first flush out some observations:
- This topic is so utterly hot, contested and complex that we simply cannot get our hands around the entirety of the issue in this writing. So, we’ll be digging further into it in subsequent writings for our readership within the tenant community. This is a landmark issue; tenants are unprotected and exposed to over-reaching by the landlord community.
- We’re assuming a high level of understanding at the readership level. You know what we’re talking about: Load factors. Common area calculations, oftentimes imposed on tenants in a completely arbitrary manner. Building measurements and re-measurements which ALWAYS find for the landlord. More space is ALWAYS discovered when a building is re-measured. The ever-expanding definition of what is a “common area”. The notion that a lease is NOT a partnership between Tenant and Landlord; rather that the tenant must pay for all of the areas outside its walls, whether for the landlord’s equipment areas, janitorial and electrical closets, Building Management offices…nearly everything that is not a vertical penetration. And, when the time comes for the landlord to sell the building, you’ll likely be on the hook to pay the landlord’s real estate tax increases when all those areas within and outside your walls increase in value!
- In our years of representing tenants, we’ve noticed that virtually all of San Francisco’s office buildings have been re-measured and “grown” in rentable area. The most opportune time to re-measure arrives when the new building owner takes possession. Time to find some easy money. Of course their tax basis with the City will increase with the newly measured asset, but the tenants will foot the bill anyway. In theory, the amount of usable space remains the same. But ask 20 architects to measure the usable area of your space and you’ll get 20 different answers. The point is that load factors have soared over the years. This is indisputable. But how is it possible that an entire industry has swallowed this form of inflation without so much as a whimper?
- On the topic of space measurement, the entire commercial estate industry has aligned to impose this set of logic on tenants: “Tenants, you will lease space X but will pay 120% of X in rent. The extra 20% is for space which you may not occupy (although you may pass through from time to time); you do not lease or own such space nor will you ever directly benefit from the sale of such space. In addition to paying full Fair Market Rent for the extra 20%, you will also pay for any and all costs —as such costs increase from year to year…and you know they’ll increase every year—to maintain, retrofit and otherwise service such space and the equipment contained therein.” WHO thought up such a landlord-centric system upon which tenants must pay “Rent”???
- “BOMA: The standard for measuring tenant’s space.”
“BOMA (Building Owners and Managers Association): 16,500-plus members own or manage more than nine billion square feet of office space, which represents more than 80 percent of the prime office space in North America. Throughout BOMA International’s 100-year history, its goal has always focused on actively and responsibly representing and promoting the interests of the commercial real estate industry.” So says the BOMA website. Based on BOMA’s objectives, summarized on their website, it remains to be seen how their system of space measurements benefits tenants. Perhaps TENANTS should offer as strong a lobby on an international front and their own standard for measuring space.
BOMA publishes research documents and “how-to” guidebooks, including: Standard Method for Measuring Floor Area in Office Buildings (ANSI/BOMA Z65.1). Tenants, you’ll notice that BOMA calculations, while NOT based on Code or any Law, are the de facto standard for the system of measurement used throughout the landlord community. This doesn’t make the method correct or fair, however. But the ANSI/BOMA system provides a common ground; landlords who use a “modified BOMA” system of measurement must defend their maverick approach. Under pressure in negotiations, those landlords often succumb to using the BOMA standard.
BOMA also offers landlords their “Insider’s Best Commercial Lease Clauses” guide, in which “America’s top leasing attorneys help you maximize your revenues, reduce your liability, and protect your commercial real estate interests.” Tenants can see whose rights are advanced and protected, below.
BOMA makes no bones about its cause célèbre: Serving the LANDLORD:
Detailed Description (Quote from BOMA website, below) The best model lease clauses and advice for owners, managers, attorneys, and other real estate professionals, gathered for you in one handy source to skyrocket your commercial real estate profits and solve your biggest leasing headaches. Now you can have at your fingertips:
- Hundreds of model lease clauses to help you maximize income in virtually any commercial leasing situation
- In-depth commentary and how-to advice in plain, easy-to-understand English
- Proven tips to help you negotiate more effectively, plug loopholes, protect yourself legally, and stop trouble before it starts
- Complete 2-volume loose-leaf set showing you how to handle SCORES of commercial leasing problems
- Fully categorized contents for instant access to any answer you’re looking for
It’s all in the Insider’s Best Commercial Lease Clauses.
Why reinvent the wheel every time you need new lease terms? Save time and money. Get the best model lease clauses and advice from over 17 years of the Commercial Lease Law Insider newsletter. Draft smarter leases faster. This invaluable leasing tool lets you benefit from the proven techniques and tested lease language from America’s foremost commercial lease experts. You’ll learn how to:
- Maximize rent and operating expenses/CAM costs
- Control sublets and assignments for greater profit
- Reduce the impact of tenant bankruptcies
- Address terrorism and security issues
- Protect yourself from damage and destruction
- Limit or block tenant audits
- Prevent environmental hazards
- Get a grip on tenant rights and options
- Beef up your default protections
- Satisfy lender demands more quickly
- Limit exclusives
- And much, much more!
- Who benefits from higher load factors? Landlords. All brokers, since both landlord and tenant brokers are paid on the basis of the rentable square footage leased. Architects and contractors, since the landlord’s contributions toward fees and construction are a function of the size of the space. Appraisers. Property Managers. Everyone benefits, right? Except the tenants.
- So, BOMA calculations (NOT based on code or law) assist the industry in establishing “rentable” square footage areas.
Gross area calculations ARE governed by the specific city or county’s planning code.
Exiting and Occupancy area calculations ARE governed by Building Codes. This calculation seeks the minimal area necessary to meet allowed occupancy loads (think of public assembly areas…and their capacity). By the way, as the Building Code defines these areas, the code measurement does NOT include the space taken up by columns and wall thicknesses…but RENTABLE calculations DO, according to BOMA.
In contrast, RENTABLE area calculations (the task set out by BOMA to calculate) seek the MOST AREA available for MAXIMUM REVENUE. NOT favorable to tenants.
- What are “Building Common Areas”? The theoretical answer to this question is that these are areas shared by tenants throughout the entire building. The reality, however, is that most tenants rarely access most of these spaces! Many of the “common areas” are never accessed by tenants. Yet tenants are expected to pay the same Fair Market Rent for these spaces as tenants do for their demised office space. Here are some examples of “Building Common Areas”:
- Basement-level utility, engineering and storage spaces
- Roof-level utility and machinery areas
- Mechanical floors
- Fuel tank and pump areas
- Recycling areas
- Ground floor lobby areas and all circulation
- Telephone rooms and janitorial closets
- BOMA Measurement fine print: Neither BOMA nor ANSI (the American National Standards Institute) certifies, approves or endorses any space measurement firm or measurement device. Good luck with your interpretations and concoctions. More to come on this landmark topic…
Thanks, Clients: Making the Most Out of a Weakening Economy
While 2008 has been a challenging year, it’s been particularly rewarding to work with extremely responsive clients. We’ve set ourselves apart from our competitors on the basis of the deals we negotiate and our proven organizational methodologies; but we also try to lead our clients to smart transactions—founded upon our analysis of the economic factors at play in the marketplace and sound advice stemming from our 30 years of business experience. Of course it takes great clients who listen to our advice. Thank you for listening and for being part of our family:
International Association of Business Communicators
Jewell & Associates
Luscutoff, Lendormy & Associates
Pacific Coast Staffing
Sandler O’Neill + Partners
SF Commerce Bank
What Cost, or Premium, to Build LEED® “Green” Interiors?
At a Bay Area Green Forum, the panel of speakers led a discussion about building LEED “green” projects. Panelists included representatives from Skyline Construction; Autodesk; PG&E; and SKS Investments, a major developer. As more of our tenant-clients take the initiative to explore building “green”, the budget discussion always comes down to affordability. Can we afford to build green? How can we not? How important is LEED certification in our scheme to be green? Here were the findings of the panelists; although we note that every project should be explored independently:
Green Cost Premiums:
For 20,000 square feet or larger projects in Non-LEED buildings:
LEED Silver Certified ~3-4% premium
LEED Gold Certified ~4-5% premium
For 20,000 square feet or larger projects in LEED buildings:
LEED Silver Certified ~1-2% premium
LEED Gold Certified ~2-3% premium
For 20,000 square feet or smaller projects:
Costs are roughly double. This range of premium will be problematic for virtually all of San Francisco Bay Area’s average size tenants—about 6-7,000 square feet each.
Other notes from the panel:
- If LEED is not integrated into the site selection and design process, cost premiums soar to ~25-40%.
- LEED tracking, certification process and commissioning on a 20,000 square foot project is 65% of cost premium.
- LEED Silver and above projects typically save 30% on energy and 40% on water consumption.
- Building “green” premiums for larger projects have dropped from ~7% a few years ago to as low as 1% today.
- The highest ROI for green initiatives is for energy savings measures. The most noted effect is employee satisfaction (93% for LEED projects vs. 76% non-LEED).
- A lot of firms that can’t meet LEED prerequisites are going for “Shadow LEED”, e.g. doing the LEED things they can do, without filing for certification.
- Autodesk is focusing on their facilities but also on their air travel (50% of their carbon footprint is due to air travel). They are implementing “Teleprescence”
San Francisco Market Overview
Vacancy Rates: Are Your Options Fading?
Landlords, their listing brokers and developers dance to the tune of lower vacancy rates, so tenants should watch carefully to detect how and to what extent your field of options declines. Which size blocks of space are getting leased? Discussing vacancy and absorption rates can be confusing to some. What language makes sense to tenants? Tenants ask, “Tell me about my specific options. How many choices do I have?” Are your options fading, as a result of recent leasing activity? Review the chart, below, and let’s discuss.
Here’s an intriguing statistic for you. BET YOU’LL BE BAFFLED: In Q2 of 2001, Bay Area Counties had a supply of 42 million square feet available for lease on the market. Today the Bay Area markets have 53 million square feet on the market. Tenants in San Francisco have a LARGER number of parcels to choose from in today’s market than in Q2 of 2001—the period just before our markets crashed. Today the trend for absorption has turned “down”…and the stats should give you reason to wonder—what kind of Kool-Aid has the landlord community been drinking? [In Q2, 2001, there were only 202 parcels of spaces available in San Francisco in the 5-10,000 sf range; 173 parcels in the 10-20,000 sf range; and only 67 parcels in the 20-40,000 sf range.]
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.
You can request a free space survey, containing all direct and sublease space meeting your specific requirements. We can also provide building photographs, floor plans, leasing histories and more. You’ll receive your survey within one business day. To discuss your space needs in person, call 415-434-2820 or email dan@TheSpacePlace.net.
Global Consumer Confidence: Lowest In Several Years
The Nielsen Company, active in more than 100 countries, published its mid-year findings on consumer confidence. If you think it’s just American shoppers strapped for cash and worried about the credit pandemic, think again. Nielsen reported that global consumer confidence plunged to 88, down 6 points in six months—the largest single drop in three years. 56% of consumers around the world believe that they are currently in a recession. Of the remaining 44%, one in four believes that a “full-blown global recession” will occur within the next year.
According to their global head of Customized Research, “The last six months have been the most turbulent period for the global economy in several decades. When the USA sneezed at the outset of the subprime disaster nearly a year ago, the rest of the world quickly caught a cold. No region or country has been spared the domino effect of the US subprime and credit crises. Consumers around the world are struggling with the same global issues that are impacting their daily lives. It’s an unfortunate pendulum. On the one hand we are seeing soaring global oil prices, rising commodity prices which are impacting grocery prices, rising interest rates and increasing inflation. This is happening in tandem with falling property prices, weakening labor markets, decreasing industrial output levels and growing unemployment rates which have all resulted in less spending power for the average person. Overall, it’s not a good picture.”
Is it terrible for everyone? Of course not. In oil-rich Norway, for example, rising fuel prices have been terrific for their economy. Their consumer confidence soared to 129 points. And in India, beneficiary of outsourcing from around the world, consumer confidence has also soared.
But in the good old USA, 66% of the respondents to the Nielsen survey have a pessimistic view of the economy. Only 3% of American consumers thought their job prospects were “excellent” (the figure is 6% on the global scale). In Japan, 89% are pessimistic about their job prospects.
Nielsen also measured savings. 25% of American consumers reported that they have no cash left after monthly essentials have been paid.
Highrise Financing: Lending Shortage Will Pressure Landlords
Look around the room. What lenders are left to finance real estate deals that don’t make sense? Building acquisition pricing —to our way of thinking— hasn’t made ANY sense relative to what tenants are paying for space during the past several years. Indeed, our San Francisco Bay Area markets experienced significant absorption of space and rising rental rates during the past few years, but the prices paid and the over-blown assumptions required to buy buildings were non-sensical. Well, the lending community has certainly caught on. During the past year, fundamental changes in lending will remove a lot of the speculation in buying…and there will be a lot more pressure on building owners to meet the rational needs of tenants looking to lease space.
During the past year, loan underwriting now focuses almost entirely on the actual cash flow of the property. Until recently, lenders merely considered the purchase price, or appraised value.
Loan to value lending was 75-80%, but now is closer to 50-65%.
Buyers looking for interest-only loans used to borrow for 10-year terms. Now the duration is closer to 3-4 years.
Lenders also used to bite off on buyer’s rapid-growth assumptions for space projected to turn over in the building after purchase. Now, lenders rely on rent-growth only if under existing lease contracts. This is one of the reasons, tenants, that landlords like to offer free rent and/or gradually escalating rent (instead of flat rent) during the lease term. Landlords benefit in the financing of their buildings when they have higher rates to show; and they’ll look particularly good when they sell the building after your higher rates have kicked in.
Making a Case for Rising Rental Rates Amongst All the Deficits
Sorry, we can’t do that. Fed, State, local deficits are at record numbers. You sure wouldn’t know it listening to the landlord community trying to dictate rental rates around the San Francisco Bay Area. Is there anything bullish about this scenario? We don’t think so. UC Business professor Peter Navarro put it this way:
“California’s unemployment rate is more than 6.8% and well above the national average of 5.7%. At least some economists believe California may already be experiencing negative growth. The economy is likely to get a lot worse before it gets better. If there is any one civics lesson to be learned from this fine mess, it is that the state’s politicians must learn to resist overspending in good times so that the state won’t face bankruptcy when bad times hit. It should be equally clear that any damn fool can issue bonds to balance a budget. However, it takes real political courage and economic foresight to put a state budget on an even keel through fiscally conservative tax-and-spend policies. At this juncture, California is nowhere close to that – and the rest of the country, and perhaps the world, may soon pay Golden State’s piper.”
San Francisco’s budget deficit: Over $300 million
California’s budget deficit: Over $17 billion (17% of total budget)
New York’s budget deficit: Over $5 billion (10% of total budget)
Federal deficit: $410 billion planned for ’08 (spending 8.3% ahead of last year)
National trade deficit: Mid-year, $108 billion.
Economy: A Giant Sucking Sound
We’ve been bearish on the economy for so long (check our record) that our sense from readers is that we don’t need to drub on, here, about the lousy job market; the credit crises; the hundreds of billions in corporate and bank losses; cash-strapped consumers; foreclosures and the rest of the gory mess. But what’s really appalling is the lack of good advice from the brokerage community. Tenants, if you’re not driving a really hard bargain during these times, change brokers. What is holding up rental rates in the San Francisco Bay Area? YOU ARE. Be ever mindful of the economic conditions surrounding the City. There is plenty of pain to go around, which is all the more reason to be best-prepared and equipped to negotiate concessions. Take your time in a falling market, like this one, and be ready to quickly walk away from an unrealistic landlord. You’ll find the right-minded and aggressive building owner; we always do.
You must leverage the news and state of the economy in your negotiations. Can this notion be over-emphasized?
- The collapse of our credit markets has produced over $300 billion in investor losses. This does NOT include the estimated $125 billion shareholders will have lost when the Fed takes over failed Fannie Mae and Freddie Mac. Who’ll pay for the losses on foreclosures and faulty mortgages? You will.
- New York’s AG, Mario Cuomo, has been going after numerous financial firms to recover what he can of the $330 billion market collapse in auction rate securities. Investigations are ongoing. Who’s involved? All big names you know. Who’ll wind up paying for the losses? People you know. The age-old question persists: Did the firms knowingly misrepresent the safety of the securities they sold to investors? (Tenants might draw an analogy, here, considering that many of you take advice from the same commercial real estate firms which represent most of the landlords in San Francisco.) Let the buyer beware.
- 900,000 foreclosed homes are sitting vacant around the country, albeit only a small fraction in San Francisco—but an alarming number surrounding the City.
In fact, where ARE the advice columns at Cushman & Wakefield? CB Richard Ellis? Jones Lang La Salle? Colliers. The CAC Group. Unlike our firm, perhaps they have to be secretive about sharing their wisdom with the tenant community through the web. The point is that tenants need guidance and counsel about the supply/demand landscape and how best to leverage their requirements in anticipation of certain economic events occurring. We’re in a declining economy. Landlords and their brokers who delay the inevitable concessions only frustrate those genuinely shopping for space. If you’re a motivated landlord, better to take the lead and make deals happen. Otherwise you’re just wasting money counting the lost months of rent.
Lead, follow or get out of the way.
Tenants: Get It Straight
Mihalovich Partners represents tenants, only. Our core business is driven toward educating and objectively and aggressively representing TENANTS, only. If you are looking for biased market information serving the LANDLORD community, please see one of The CAC Group; Cushman & Wakefield; CB Richard Ellis; Grubb & Ellis; Colliers; or Jones Lang LaSalle—whom collectively represent over 54% of the 13.2 million square feet of space currently on the market. Those six firms have pledged their allegiance to over 300 local landlords.
Strange as it may seem, bearing in mind their conflicts of interest, we compete with them every day for YOUR business—for the opportunity to represent you, the tenant, in leasing negotiations. CAC, C&W, CB, G&E, Colliers and JLL control more space than any landlord in San Francisco. Mihalovich Partners’ business and approach is diametrically opposed to that of brokers who represent landlords. Are you, the tenant, looking for advice and counsel? You can count on straight talk from us. Advice for tenants, pure and simple. Serving the tenant community in San Francisco for 25 years.
Dan Mihalovich (dan@TheSpacePlace.net)
Principal of Mihalovich Partners and Founder of The Space Place®
Take Me Straight to the Numbers: San Francisco Bay Area Rental Rates. Supply/Demand.
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.
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 of our competitors—leasing firms—do the most landlord representation, and who controls the most space in San Francisco? And, most importantly, why would you feel comfortable having them represent YOU?
Below we’ve surveyed the entire 110 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 14.9 million square feet is now on the market in San Francisco. Of the top 7 companies, all seven are office leasing brokerage firms, controlling 65% of the City’s vacancy! These brokerage firms are beholden to more than 300 local landlords. Since their allegiance is committed to so many landlords, how can they possibly represent YOUR interests—the tenant’s interests—objectively and aggressively? The top brokerage companies on the list control more of the City’s vacancy than Tishman Speyer (#8); Hines (#9); RREEF (#10); Boston Properties (#11); and more than Shorenstein (#12). Surprised, are you not? In the case of Studley, our friendly tenant-representation competitors, they represent 123,000 square feet of space available in 8 different buildings. How can they objectively represent YOU, the tenant, if you choose to pursue any of their sublease space?!
|% 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||*Jones Lang LaSalle
|2||*The CAC Group||14.4%||2,260,579
|3||*Cushman & Wakefield of California||9.2%||1,447,988
|4||*CB Richard Ellis||8.5%||1,331,400
|5||*Grubb & Ellis||7.9%||1,245,482
|7||*Cornish & Carey Commercial||3.3%||526,604
|10||RREEF America LLC||2.5%||400,000
|13||McCarthy Cook & Co||1.6%||252,470
|14||*GVA Kidder Mathews
|15||*TRI Commercial / CORFAC Intl||1.4%||223,234
|17||*NAI BT Commercial||1.2%||182,783
|18||*Starboard TCN Worldwide Real Estate||1.0%||156,713
|19||*Colton Commercial & Partners||0.9%||144,198
|20||The Presidio Trust||0.9%||141,800
|24||JRT Realty Group, Inc.||0.8%||119,756