Market Insight Editorial & Advice to Tenants: 4Q2008
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.
2008: Last Gasp For Landlords
What will you do with all the office market stats from 2008? Landlords might consider framing them because the next few years—perhaps longer—won’t look so good. Tenants, on the other hand, should just forget last year’s performance since history is a trap—and we should never look at transactions of yesteryear as a telltale for what’s to come. As predicted, office markets and the economy took a serious dive during Q4. We can define the market in many ways, but this message should clarify things for tenants:
The economy—globally—is experiencing its worst metrics in over 50 years. Tenants will have more options and leverage than during any time any of us can recall. That means, tenants, office leasing economics should be more attractive for you than during the Dot-Bomb or any previous recessionary period. As we’ve stated here for the past two years, our local markets previously offered more options to tenants than during the Dot-Bomb period*—one of many reasons we’ve been so bearish to this point. However, as the economy has fundamentally collapsed beyond all projections, we can comfortably predict that the 57 MILLION square foot supply of available space now hanging over the Bay Area (17 million square feet in San Francisco) will soar during 2009–2010…and the “Recovery”, whenever that comes, will be a recovery from rental rates FAR south of current levels. (*Recall that the San Francisco office market was crushed during the Dot-Bomb, when “only” 42 million square feet were available in SF Bay Area counties.)
Class A rental rate range for San Francisco/2009: Expect $25 to $40/square foot/year, fully serviced (the upper end of the range for unobstructed Bay view space—direct from landlords).
Class A sublease space, especially with term length of less than five years/2009: Expect heavy discounting from struggling sublessors and a range of $teens to $30.
Marketing Time: ALL counties in the SF Bay Area report average downtime of 16–19 MONTHS for spaces now on the market.
Space Wars: Here we are again: Landlords and sublessors (tenants) will fight one another for those tenants shopping for space. Tenants, please call us to review your lease language and advise you on subleasing issues (and see our articles from real estate counsel [140K pdf ] on this topic).
Killing The ’Vendors’ Who Serve You
In the current economy, there’s pressure all around. Pressure to cut costs, pressure to squeeze “vendors” and figure out how to do a lot more with a lot less. And why not? What downside is there?
Streamlining the process vs. skipping steps: At the inception of every tenant–rep project, we help our clients to organize them, to assist with the selection of a Team to handle all aspects of their project, and to begin creating a strategy and budget to reflect that strategy. To this point, we’ve probably taken our client further than where 99% of tenant-rep brokers go. Tenants are oftentimes too fixated on the execution and outcome of the leasing process and, to the detriment of the transaction, take advice from inexperienced or maligned brokers all too happy to skip to the commission payment.
Your Team professionals vs. “vendors”: Tenants, you need to grasp this concept right away: Trust runs in both directions and once we’re beholden to one another, you’ll understand and appreciate why we must get inside your organization to most effectively advocate for your interests. A “vendor” is someone who sells. Your office leasing Team, on the contrary, should be comprised of a broker, an architect, a general contractor, an IT specialist, a furniture specialist, a real estate lawyer…and, occasionally, others, but NONE who sell. In all cases, your Team members are professionals who must collaborate—and collaborate well—to produce the most optimal results for you. All should be advocates, with the proper skill set, time commitment to you and your project and share the unconflicted mission to serve you. Nothing about your Team should smell of “sell”. Don’t be swayed by salespeople, as compelling as they are.
Establish fair fees for services you need vs. bidding wars: Here’s the tragedy, tenants: If you don’t resist the temptation to take advantage of service providers, you’ll wind up cutting some of the most necessary menu items from your architect and contractor—to spite yourself. If you bid architects against once another; GCs against one another; even real estate lawyers against one another…what result should you expect? Architects will have to forego job supervision—a highly recommended task to ensure the quality of design and construction you deserve. Architects will plug fewer hours on design. Their finished design drawings may not be as complete as usual, leading to misinterpretation by your contractor—producing erroneous pricing.
General contractors, in our view, should rarely be competitively bid. (We favor selecting a GC after interviewing and establishing a fair fee; all of the subcontractors will be competitively bid thereafter.) But in this environment, tenants believing themselves to be clever will send their job out to bid to 4–5 GCs. And with what result? Although the GCs’ bids may look attractive on their face, the lowest bid won’t necessarily be the most complete…nor qualified. Tenants should be particularly alarmed when you see wide ranges of estimates.
The Tenant-Team from the start vs. the usual hack-jobs and money left on the table: What do you do, tenants, when everything goes RIGHT?! The right combination of professional team members makes ALL the difference in the outcome of your project. Try this, when interviewing: After you’ve asked a broker about the deals they’ve negotiated, ask them to refer you to the other team members (architect, contractor, real estate lawyer…). Do they even know each other? Did they spend much time in the room together during the entire process? You’ll be shocked to learn how little coordination took place. But don’t be shocked to learn that massive sums of money were left on the negotiating table.
Negotiating for the extras vs. cutting from your budget: Here’s the point: Rather than compromising your ethics and your budget for office space related professional services and tenant improvements, count on your leasing broker to negotiate more substantial concessions from the landlord to make it all work for you. That’s what we do for a living! ALL of your Team members will have your budget at heart, but you’ll make a difficult time for yourself by cutting your “vendors” off at the ankles to try to save a few bucks. Let your broker earn their fee. And get what you want!
Law Firms: The Next Shoe To Drop?
Law firms, like any other service provider to the giants of Wall Street and the banking industry, are far from impervious to our economic tailspin…but do they do a good job accepting advice, planning office leasing moves and are they properly represented in office leasing negotiations?
Heller, Ehrman and Thelen may have failed for different reasons than Bear Stearns, Lehman Brothers and WaMu. But perhaps the common thread among them was a structurally amped up, highly leveraged organization…led by individuals out of touch with their constituents, the marketplace for their services and a lack of foresight. Did the market need so many law firms or wealthy investment banking firms? Would the market continue to pay their exorbitant fees? Should first-year associates earn $160,000? Did the market need so many banks, retailers, office buildings, hotels and second homes?
As we analyze the markets, we must ask: “Will the economy continue to support the existence and fee structure of law firms as we know them?”
If commercial real estate decision-making from the legal community is any litmus test for law firms’ viability…the future for them looks very poor, indeed. In spite of all the signs of a slowing economy, some of our largest local law firms signed leases in 2008 well into the $60s per square foot per year. One would expect more shrewd negotiations from the likes of Managing Partners and brokers for O’Melveny & Myers; DLA Piper; Gibson, Dunne; Lieff Cabraser; and Squire Sanders. Making matters worse, some of these firms are spending between $150–$250 per square foot for their new office improvements (just for construction; not including furniture, fixtures and equipment). Are these sensible expenditures at this time? Absolutely poor decision-making.
Latham & Watkins hasn’t pulled the trigger, yet, on its San Francisco office leasing requirement…but they did commit to expanding in 2008 with new offices in Dubai and Qatar. Seriously, what were they thinking? According to Cal Law, L&M advised Qatar Holding on their investment in soon-thereafter bailout-victim Barclays Bank. Dubai’s economy subsequently imploded. Latham was also a regular provider of services to Bear Stearns and Lehman Brothers…and reported profits off 21% for 2008.
How is law firm management different from the management of banks, auto manufacturing companies or Wall Street firms? It’s difficult to see much difference. The most senior, tenured and highly paid individuals “chair” the real estate decisions, with little to no input from the balance of the partnership. In the largest firms, oftentimes the Branch office has no decision-making authority at all with respect to negotiation of the lease or selection of local representatives (broker, architect, contractor, etc) to advocate the interests of the firm. In any event, the entirety of the firm will pay the price for any sloppy decision and deal-making of the few at the top of the organization. Since the office lease is likely the second most expensive line item on the law firm’s books, wouldn’t you imagine that law firm management teams would be most diligent in handling their commercial real estate commitments? Think again.
International law firm consulting firms like Altman Weil and Hildebrandt provide a multitude of services to law firms, large and small. Following is a list of services they provide—BUT notice that they do NOT advise on office leasing matters. Why not? Because their law firm clients do not require their advice. According to our sources, the firms state that they already have expertise in office leasing matters and don’t require outside help. Then why, pray tell, do so many law firms severely botch their lease negotiations? Why do law firms overpay, over-extend themselves with personal guarantees and letters of credit, and over-spend on tenant improvements? Why do law firm deal “comps” results consistently float at the top of the list? Perhaps law firms should perform more due diligence as they assemble prospective local brokers/architects/contractors for review. We can all take a lesson from the Madoff catastrophe: Let the buyer beware…Do your homework…And ask for advice from vetted sources before leaping into long-term commitments.
- Mergers & Acquisitions
- Practice Management
- Management & Governance
- Law Firm Finance
- Marketing and Business Development
- Client Surveys
- Custom Surveys and Benchmarking
- Law Firm Succession Planning
- Leadership Development & Performance Management
- Training Programs
- Expert Witness
- Law Department Structure and Performance
- Law Department Cost Control
- Outside Counsel Management
- Law Department Client Service and Satisfaction
- Career Management and Professional Development in Law Departments
- Managing the Global Law Department
- Key Person Coaching
- Government Legal Offices
- Paralegals and Paralegal Programs
- Executive Search Services
- Market Research
- Legal Vendor Advisory Services
Wish You Read This…
In Q4 2006, we wrote:
American Comparative Advantage: Consumer Spending & Debt
We’ve written on numerous occasions about the tenuous state of our economy, hinged 2/3 on consumer spending. But one has to admit that consumers have done a hell of a job of it lately, albeit at the cost of hawking one’s grandchildren. Last quarter we hosted a spectacular article about consumer debt, “Requiem for a Housing Bubble”. We hope that you read it. This was quite an intro to the Bush Administration’s announcement of the proposed federal budget, starting October 1, 2007…a $3 Trillion Fed Budget. The Pentagon, by the way, will get an 11% raise to $481 billion…plus another $235 billion in WOT (War On Terror) costs for the next 18 months…
In Q3 2006, we wrote:
Teflon Economy: Drinks On the House!
The feeling around town is a bit intoxicating. Everyone is bullish! Businesses are booming! VC funds are flowing! Tenants have been signing expensive deals around town’over 600,000 square feet of net growth in Q3’well into the old dot–com range of $60+ per square foot annual rates. Asking rental rates are up for direct and sublease space’throughout the Bay Area’and the euphoria in the landlord community can hardly be contained. Tenants, just give it up, shall we?! If you paid $35/sf for space last week, well, get ready! It will cost you $40/sf this week! Everyone enjoys a good party. Even biotech made a splash in the City this quarter with FibroGen’s 240,000 square foot, $50+ deal with Shorenstein in Mission Bay. Tishman Speyer has broken ground on its new 555 Mission office building and just announced its plan to “green” a 700,000 square foot new highrise on 2nd Street. Never mind that it will take an average of $60–$65/sf rent to justify new construction and that the current average asking rate for Class A space is ~$39.50/sf (slightly higher than when I started in this business, in 1982). Also ignore that, on average, Class A spaces–just–leased sat on the market for 21 months. Build on!
Dèjá vu, Tenants. An enormous wave of Kool-Aid drinking investors is ready to plow another $400–$500–$600+ per square foot into purchasing more of our highrises. Very deep in the pocket; very shallow on the market research to determine how much tenants can and will actually afford to pay for space. These will be your new landlords (if they haven’t come knocking already). Buyers are promising their investors rent increases of $10 per square foot per year within a few years; an additional $10/sf/yr just 3–5 years hence! Better be prepared, Tenants! Where shall we look around the country for an example of how much pain can be extracted from tenants? Local landlords say, “New York!” “$80/sf on average!” More Kool-Aid, please…and, yes, their numbers are incorrect…
San Francisco Market Overview
Vacancy Rates: Are Your Options Soaring?
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 changes. 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?” Your options are soaring, as a result of recent poor market performance. 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.
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; Cornish & Carey; GVA; or Jones Lang LaSalle—whom collectively represent over 65% of the 20 million square feet of space currently on the market. Those eight firms have pledged their allegiance to over 370 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 26 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 16.58 million square feet is now on the market in San Francisco. Of the top 8 companies, ALL are office leasing brokerage firms, controlling 65% of the City’s vacancy! These brokerage firms are beholden to more than 370 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 Hines (#9); Tishman Speyer (#10); RREEF (#11); and more than Boston Properties (#14). Surprised, are you not? In the case of Studley, our friendly tenant-representation competitor, they represent over 160,000 square feet of space available in 11 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||*The CAC Group||12.0%||2,501,790||58|
|2||*Jones Lang LaSalle||11.0%||2,302,732||29|
|3||*CB Richard Ellis||7.0%||1,467,065||30|
|4||*Cushman & Wakefield of California||6.8%||1,420,592||60|
|5||*Grubb & Ellis||6.0%||1,261,867||58|
|6||*Cornish & Carey Commercial||5.5%||1,154,150||24|
|8||*GVA Kidder Mathews||4.9%||1,020,871||33|
|11||RREEF America LLC||1.9%||400,000||1|
|12||*Newmark Knight Frank||1.5%||319,517||5|
|13||Beacon Capital Partners||1.4%||290,000||1|
|15||Fremont Development Funding Corp||1.2%||250,000||1|
|17||McCarthy Cook & Co||1.2%||240,712||3|
|18||*TRI Commercial / CORFAC Intl||1.1%||230,761||43|
|19||*NAI BT Commercial||1.1%||228,468||28|
|21||The Presidio Trust||0.7%||155,432||44|
|23||*Starboard TCN Worldwide Real Estate||0.7%||139,153||85|
|24||*Colton Commercial & Partners||0.6%||135,387||24|