Market Insight Editorial & Advice to Tenants: 4Q2000

Tenants Turn Out Lights: Vacancies Soar

We’ve been in the brokerage business since 1982 and haven’t seen such a magnitude of tenant dumping since then, when Bank of America unleashed one million square feet in a consolidation move. In just the last 30 days San Francisco tenants have bailed out of more than one million square feet. The pace of new listings is, unfortunately, hard to keep up with. Our statistics speak for themselves. See San Francisco Bay Area Market Stats, below, to study the dramatic decline in our tenant base around the Bay.

Annual activity and net absorption levels look impressive on their face, but digging below the surface we see a clear quarterly trend line since Q2, 2000, in which demand has declined, current and future supplies of space are growing and “asking” rental rates are eroding. While vacancy rates remain low, historically speaking, stocks are consistently and significantly up in every county around the Bay, even in the East Bay region which has benefited from soaring 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.

San Francisco suffered another quarter of negative growth in Q4, although we will not see the corresponding deflating rental rates until Q1, 2001. There are now available more than 100 blocks of space which are 20,000 square feet or greater. Class A space landlords, with only modest vacancies, are doing their best to hold rates steady—while the rest of the market crumbles around them. Major blocks of space have hit the market, resulting from Providian’s move to the East Bay; shrinkage at Nations Bank, CNET, marchFirst, iXL, Scient, Organic, Razorfish, NBCi, Indus Software, DoubleClick, Modem Media, Saatchi, The Industry Standard and others. Keep your hardhat handy. We may be halfway into this cycle, if that far.

Landlords Throw Brokers Parties, Gifts, Trips

If you weren’t sure, landlords can fall “under water” on an investment when rents are in the $60-$80/sq.ft. range, just as they did when rents were in the $20s back in the 1980s. The magnitude and speed of the market’s pendulum swing has caught many an investor by surprise, and there’s no party to report for owners who made recent acquisitions in what is now a falling market. Not so for the brokerage community, however, since building owners who were recently pushing everyone around for free stock, $100+ rent and all-tenant-paid improvements are now throwing lavish open-house parties to lure brokers to have a gander at their wares. A few more notable landlords were opportunistic enough in the tightest of times last year to try to slash broker fees and cut brokers out of transactions involving tenants already in their buildings. These memories are fading quickly, while almost daily announcements are circulated throughout the San Francisco brokerage community inviting all of us to lunch, with expensive prizes for just showing up (golf clubs, Palm Pilots, weekend resort vacations, free monthly parking stalls, and the like).

Bonus commissions are now back in vogue in San Francisco. The typical $5/sq.ft. fee for 5-years deals and $7/sq.ft. fee for 10-year deals has now been pumped up to $7/sf for many 5-year deals, and $9-$10/sf for 10-year deals. In this marketplace, however, it would appear unwise to lock in rates for 10 years…Of course the folks who decided to offer a “bonus” BMW X5 got what they wanted: Attention in the local press, a buzz amongst the brokers and sadly needed focus on their 10,000 square foot listing. In the whole scheme of things, the broker’s fees make up only a small percentage of your leasehold value. There’s nothing wrong with knowing exactly what your broker is being paid to represent you. It’s your money, conveniently paid out by the landlord where you ultimately sign a lease.

Where is Stability? Look to 1999 Rent Levels

Like the NASDAQ, there won’t be a free-fall in rental rates forever. At some point in the future, likely sometime this year, the office markets will return to levels at which sensible businesses can actually function at a profit. “Profit”, after all, is now the focal point of Wall Street and investors. Our forecast for 2001, we say with some humility (we did not predict the “boom” from multimedia and Internet companies, but did you?!), is for rental rate reductions to 1999 levels, during which the “top” of the market rates were $60/sq.ft./year for Class A view space. Our San Francisco Bay Area Market Stats indicate that average current Class A “asking” rates are still in the $70s, which we believe could settle in the mid-$40s to $50s in 2001.

In this environment, look for tenants to be as opportunistic as landlords have been. While brokers are here to facilitate deals and are motivated to get them closed, tenants should be encouraged to adjust their economic proposals in a falling market—to meet the “market” of the moment, as opposed to last week’s market when rates were higher. Every week, now, there are new opportunities for tenants and more motivated sublessors and landlords with whom to negotiate vigorously. As always, leverage is the name of the game. Surround yourselves with a “team”, led by a seasoned broker and accompanied by a skilled space planner. Rents at $40-$50 aren’t by any means “cheap”; this is serious overhead for any business. Your “team” better be out there to save you the big bucks.

Growth @ Sun, Cisco, Oracle, Intel…Place Your Bets

There is always a silver lining in every bearish tale, and there is no exception here. We continue to be eternally bullish on Technology and, therefore, on the community which provides them support. For all of you who are telling us that it’s not time to buy the stock of Sun, Cisco, Oracle and Intel—please don’t suggest that their Bay Area leasing requirements will prevent the looming decay in the office markets. Staring in the face of constant traffic gridlock; earthquake considerations; now power considerations; cost of labor; and local competition for high-end employees, all of these companies have focused growth and acquisitions as much outside the Bay Area as they have locally. It’s the smart thing to do; it’s the economic thing to do.

San Francisco opens its arms to these technology giants, and others. Genentech’s expansion in the area gives rise to encouragement. The venture capital community stands at the ready, armed with multiples more capital than last year. Growth is not dead, it’s just around the corner gestating inside another enormous wave of entrepreneurs. Funding is there for them, just wait. In the meantime, billions of dollars of the public’s money is being pumped monthly into stock market funds of every kind. Capital will, once again, focus on Ground Zero private and public companies…in San Francisco and Silicon Valley.

Who Can Help You Negotiate Through These Turns?

Through most of these Editorials we (Mihalovich Partners) are the quiet and reserved sponsors of The Space Place ® Web Site News. However, Mihalovich Partners is a commercial real estate services firm, focused primarily on tenant representation in the San Francisco Bay Area. Our Clients have a lot to say about the quality of our advocacy. We would appreciate the opportunity to share our experience with you—and always encourage interaction about the topics discussed here. We’ve been at this sport for 19 years; please call or email us (or you can go to our form, "Take Action: Find Space, Get Help Now") to get together and discuss your issues. Few have been around the block so many times.

San Francisco Bay Area Market Stats:

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.

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