Market Insight Editorial & Advice to Tenants: 4Q2010
In this Issue:
- Beware the Herd
- San Francisco Market Overview
- 62 Million Square Feet on the Market
- City by City, Only Glimmers of Growth
- Higher Rents Without “Recovery”
- Fundamentals of Local, State & Fed Economies
- The Office Markets are Frothy
- Quality of Life in America
- China—the World’s Manufacturer
- FDIC Bank Failures
- Federal Deficit
- Federal Trade Deficits
- Dead Cat Bounce
- Prop 13 Tax Pass Through—Tenants Should Howl
- Vacancy Rates: Are Your Options Growing?
- Who Has The Most Incentive To Drive Up Rental Rates In San Francisco?
Beware the Herd
Any essential economic analysis comes with warts. That is, the bias of the source and objectivity (or lack thereof) of the data. Out of respect let me say “thank you,” immediately to those of you who’ve been following my economic analysis and recommendations during the past 28 years. It is the exception and not the rule that business owners listen to the economic prognostications of office leasing brokers. You might appreciate that (a) my record of market calls and analysis has been damned solid over this span; and (b) I’ve earned my stripes, first from negotiating $1 billion of basis trades while part of the team of the sharpest traders in the business—Louis Dreyfus Corporation; and then leveraging the knowledge of fundamental market analysis for the benefit of our tenant-clients in office leasing negotiations.
With 2010 in the rear view and 2011 brimming with flowery forecasts from all around the landlord community, it is timely to separate the wheat from the chaff and focus on providing you with a meaningful understanding of current office market fundamentals that you can bank on.
There are compelling opinions to contradict mine, notably from CBRE, JLL and several of the other largest landlord-broker companies; CoStar (whose market data we use, as does most of the commercial real estate community); and the Business Times (whose most significant advertisers are those listing the most space available). Equally aligned are the REITs and other members of the investment community, busy trying to trump one another’s bids to catch their perceived “bottom” of the market.
If you’re in search of intelligent life in the brokerage community…please enjoy this Editorial with my compliments. And, here are the last 10 years of pearls of wisdom.
President, Mihalovich Partners
Founder, The Space Place
San Francisco Market Overview
62 Million Square Feet on the Market
Market fundamentals don’t lie, but surely every market player with risk at stake will bend the numbers, given the opportunity. And so they do. 2010 in the San Francisco Bay Area wrapped up as follows:
|square feet available (millions)||average time on market (months)|
|San Mateo County||7.4||23.7|
|Santa Clara County||18.6||25.9|
|Contra Costa &
There is nothing bullish in these figures. In fact, our markets crashed under the weight of less supply during the Dot Bomb, in Q2 of 2001, when only 42 million square feet were available for lease. Tenants have a larger number of parcels to choose from in today’s market than during the Dot Bomb crash.
City by City, Only Glimmers of Growth
Peruse through the Year-End 2010 chart below. Tracking net absorption (growth) in office leasing transactions, the figures are unimpressive—to negative—in all communities. The Bay Area’s tightest markets continue to be Palo Alto, Menlo Park and Mountain View. Remarkably, though, these markets contain only 27 Class A buildings (vs. 147 in San Francisco, for perspective). Every other market shows negative growth in Class A and/or Class B sectors for the year 2010.
In San Francisco, net absorption for the year was “positive” 519,000 square feet, but Class A “growth” was cumulatively “negative” for the year. The growth came from Class B and C sectors—cheaper and, perhaps, more “creative” space.
Again, note the “average time on the market” for all of this space. In a rising market, spaces don’t sit idle for 1-2 years!
|# of buildings||total inventory
|% leased||avg time
|All||2,158||112 million||17.4 million||85%||25.6||519,000|
|Class A||147||53.4 million||9.1 million||83%||24.1||-75,000|
|Class B||969||44 million||7.2 million||84%||29||467,000|
|All||1,647||32.2 million||5.1 million||88%||26.6||134,000|
|Class A||52||8.5 million||2.2 million||81%||26.1||85,000|
|Class B||464||13.5 million||2 million||88%||28.4||-14,000|
|All||1,006||27.6 million||4.1 million||85%||24.1||-210,000|
|Class A||28||8.7||1.2 million||87%||24.2||-134,000|
|Class B||250||12 million||2.2 million||81%||24.7||-19,000|
|All||588||12 million||1.2 million||95%||12.8||280,000|
|Class B||359||8.2 million||775,000||95%||12.5||172,000|
|All||709||12 million||2.4 million||80%||22.9||-23,000|
|Class A||18||1.8 million||532,000||70%||32.9||-12,000|
|Class B||233||6.67 million||1.65 million||75%||21||-78,000|
|All||400||10.8 million||2.2 million||79%||21.3||-118,000|
|Class A||20||3.4 million||752,000||78%||22.7||-40,000|
|Class B||228||5.8 million||1.34 million||77%||20.7||-77,000|
|All||307||8.5 million||1.46 million||83%||23.2||13,000|
|Class A||25||2.9 million||497,000||83%||23.7||70,000|
|Class B||95||4.2 million||882,000||79%||23.4||-48,000|
Menlo Park(Sand Hill Rd, etc.)
|Class A||16||1.3 million||146,000||98%||10.8||18,000|
|All||102||5.3 million||1.6 million||69%||21||8,000|
|Class A||6||1.5 million||589,000||61%||10.1||7,000|
|Class B||30||2.7 million||940,000||65%||28.3||-9,000|
|Class B||90||2.4 million||340,000||93%||15.2||20,000|
|Class A||13||2.8 million||244,000||91%||11.1||36,000|
Higher Rents Without “Recovery”
The office markets certainly aren’t void of activity, as you can see from our Absorption charts. But the more fundamental question is whether tenants are justified paying higher rental rates…as paid-rates have trended upward in some parts of the Bay Area…although nowhere near as rapidly as asking rates have risen. When tenants pay up for space, is this evidence of “recovery” in the economy? When landlords demand higher rates due to their own higher costs to renovate space for tenants; or higher operational expenses; or higher bases of ownership, must tenants pay up to make the landlord “whole”? Why? Is there any correlation between (a) the recessionary economy; (b) commissioned brokers looking for paydays; and (c) higher rental rates?
Fundamentals of local, State and Fed economies remain at historic low performance. Whether considering unemployment/under-employment; bankrupted Governments, many facing shutdowns including the Fed (we’ve become accustomed to shutdowns and IOUs in California); education and social services funding in the tank; soaring debt across the board, with no prospects for resolution; trillions of emergency loans still to be repaid since the crisis of 2008…where is the “recovery” to justify higher rental rates?
The office markets are frothy with stories about Google, Zynga, Salesforce.com, Facebook, Twitter, LinkedIn…but there was nothing bullish about the economics of the Facebook transaction. If Twitter would like to lease the entire SF Furniture Mart, be our guest. That site is hardly holy ground for the base of San Francisco tenants. The same can be said for Zynga’s building, which sat largely vacant for years. Twitter’s relocation from 795 Folsom (formerly AT&T) will free up what was never perceived to be a “cool” building. The Salesforce purchase of land in Mission Bay is much more interesting, since Mission Bay WAS intended to be holy ground for biotech companies. With Salesforce’s purchase, however, the message is clear that the biotech community’s participation in San Francisco will be limited—favoring SSF and suburbia instead. Once Salesforce withdraws from the Financial District, they’ll leave a huge void in multiple buildings. The Salesforce acquisition in Mission Bay is not a bullish telltale.
Quality of Life in America: According to Reuters, household debt stands at around 123% of disposable income. And, at the current dismal savings rate, it will take most Americans four years just to get it down to 100%. With a backdrop of high unemployment; lack of real growth in wages; and recession amongst our trading partners, our quality of life will likely languish for many years to come. Reuters adds a bit of salt to that wound: Expect stagnant or even lower standards, as Americans try to deal with a loss of $10.7 TRILLION of household net wealth since 2007.
China—the world’s manufacturer—maintains huge infrastructure at fixed costs. With a global recession, China’s income falls faster than it is able to cut its costs…so they lose money very quickly. The US Government has replaced China (and Japan) as the largest buyer of our own Treasury bonds. When the US stops buying, then what? As the Chinese and Japanese economies slip, if they begin selling off their massive holdings of US debt…bar the doors. Interest rates will have to rise to attract buyers; a move that could kill any recovery of the US economy.
FDIC Bank Failures:
2011: 22 halfway into Q1
2007: fewer…and none in 2006 or 2005.
According to the New York Times, the FDIC’s troubled bank list includes 860 institutions; ~600 of these have yet to pay back bailout funds.
Federal Deficit for 2011 projected to be $1.5 TRILLION, according to the Congressional Budget Office.
Federal Trade Deficits: Here is the Gov’s report, dismal as ever:
Dead Cat Bounce
The focus, above, was on domestic problems—highly abbreviated for this space. But we are far from alone in the island of the Bay Area, more exposed than ever to sovereign defaults amongst our trading partners. Like the US bailouts of Wall Street, will foreign bailouts simply defer the inevitable? It is possible if not highly likely that any resurgence in the economy will soon be met by another setback. Printing money is just not a sustainable solution. Markets could seize again. Locally, California’s bond rating is the lowest of all states. If states and sovereignties begin renegotiating bond debt, watch out below. San Francisco faces a $400 million deficit. These are not growth economies…so be weary as ever chasing after office space.
The office planning process—at its core—has to be about affordability. How much can your business afford to pay in “rent” relative to gross revenue? This decision is to made in context, however, of your interpretation of economic trends. Should you chase the market, or wait for it to come to you? Beware of the herd, as we’ve said repeatedly. Repair to this economy is far from sight. We’ve seen the cliff, right behind us. Measuring or predicting tenant demand is also a questionable science. The notion that we, the commercial real estate industry, can accurately amass that confidential data and forecast demand has proved imperfect at best. Yet most of the commercial real estate brokerage giants take stabs in any event, which unsurprisingly are rarely bearish in sentiment. You wouldn’t expect a Wall Street firm to issue bearish forecasts, would you?
Prop 13 Tax Pass Through—Tenants Should Howl
San Francisco Voters: What have you done, passing Measure N?! You’ve voted in a 67% increase in real estate taxes for local businesses to pay when their commercial real estate landlords sell their office buildings…as those buildings are reassessed. ALL large commercial real estate properties in the City will be affected, since any building of size exceeds a value of $10 million—the trigger value at which the tax rate has increased from 1.5% (of the total assessed value) to, as a result of the election, 2.5%. Here’s a quick example of the impact of the change:
Your company has 50 people, or 10,000 square feet of space in a 250,000 square foot building.
Between the time you signed your lease (when the building had an assessed value of $150 per square foot) and the time of a new sale (at $350/sf), the building will be reassessed to reflect the $200/sf increase in value.
Under the old tax law, your tax increase would be 1.5% of the $200/sf increased value—or $3.00 per square foot per year…each and every subsequent year of your lease ($30,000/year, in this example).
Under the new tax law (Measure N), your tax bill will be 2.5% of the $200/sf increased value—or $5/sf/year = $50,000/year!
This is a 67% increase in real estate taxes owed by tenants. And for what purpose or value to your company? NONE.
These calculations, of course, assume that you did NOT negotiate for Prop 13 tax protection at the time you negotiated your original lease agreement.
Word to the wise: don’t take “no” for an answer from your prospective new landlord—or in a renegotiation of your current lease—if humanly possible. Avoid taking responsibility for paying for Prop 13 tax increases.
Vacancy Rates: Are Your Options Growing?
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?”
- Are your options growing, as a result of leasing inactivity?
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.
Who Has the Most Incentive to Drive Up Rental Rates In San Francisco?
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? Who’s marketing the most space in San Francisco?
Below we’ve surveyed the entire 113 million square foot inventory of San Francisco, and illustrated the Top 25 companies listing the most space on the market. 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 350 local landlords, paid to drive up rental rates and drive down concessions for tenants.
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, Shorenstein, RREEF, Boston Properties and Hines. Surprised, are you not?
|% Market Share||Square Feet||# of Landlords/ Buildings|
The % in the chart below 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 landlords/developers.
|1||*The CAC Group||11.9%||2,596,700||62|
|2||*Jones Lang LaSalle||11.2%||2,444,597||33|
|3||*Cushman & Wakefield of California||10.2%||2,226,680||62|
|4||*Cornish & Carey Commercial — Newmark Knight Frank||8.3%||1,814,954||36|
|5||*Grubb & Ellis||6.6%||1,430,192||68|
|7||*CB Richard Ellis||4.2%||906,528||25|
|10||Shorenstein Company, LLC||2.4%||512,340||8|
|12||Boston Properties Limited Partnership||1.9%||410,270||4|
|14||Beacon Capital Partners, LLC||1.4%||307,000||1|
|16||McCarthy Cook & Co.||1.0%||212,887||3|
|17||The Presidio Trust||0.9%||189,057||44|
|18||*TRI Commercial / CORFAC International||0.8%||169,515||54|
|19||*Cassidy Turley BT Commercial||0.7%||154,687||20|
|20||*Johnson Hoke Ltd||0.7%||152,150||7|
|21||*Sansome Street Advisors||0.6%||124,476||9|
|22||*Starboard TCN Worldwide Real Estate||0.5%||103,613||51|
|23||*Colton Commercial & Partners||0.4%||87,314||22|
|24||JRT Realty Group, Inc.||0.4%||79,332||1|
|25||*HC&M Commercial Properties, Inc.||0.3%||74,958||18|