Market Insight Editorial & Advice to Tenants: 1Q2001

Vacancies in San Francisco Bay Area Up 215%

There is no typographical error in the headline. During Q1 ’01, tenants and landlords have unloaded an unprecedented barrage of space onto the Bay Area’s office markets. What has become old news are the ongoing reports of business failures, profit revisions, downsizings, capital calls and stock market delistings. The usually dry market statistics, however, present a telltale yet unreported: Unless the economic environment turns upward almost immediately—highly unlikely—we may see vacancy rates in the San Francisco Bay Area DOUBLE by year end 2001.

Everywhere we turn in the Bay Area, we see negative absorption of space. That is, tenants and landlords—in every market—are putting more space on the market than the markets can absorb. Our San Francisco Bay Area Market Stats, below, illustrate the “red” all around the Bay. San Francisco was 2 million square feet in the hole last quarter; the Bay Area total net absorption: 3.47 million in the red.

In all, vacancies in the Bay Area skyrocketed 215% over Q4 ’00. Amazing, sad but true for the local economies. Worse yet is the clear trend for greater trouble just down the road. As we track scheduled vacancies 12 months out (including space under renovation and newly constructed buildings scheduled for “opening”), those supplies showed a 36% increase over Q4 ’00, now standing at 33.50 MILLION SQUARE FEET. Unless and until the markets return to positive growth, vacancy rates will likely double—and we will see a dramatic change in rental rates and other concessions for tenants, far more dramatic than we have seen to date. Last quarter we forecast a return to 1999 rental levels, a relatively upbeat forecast we can no longer support based upon continuing erosion in our demand base. As vacancies in the San Francisco area push well into the double digits, we could certainly return to markets where landlords try to “buy” demand to meet immediate ownership and lender requirements—by offering more TI dollars, moving allowances, free rent (remember lease assumptions?) and other incentives to lease space NOW. Here at Mihalovich Partners, we can assist you in creating a strategy to address your office lease questions and issues.

Tenants’ Security Deposits: A Bloody Mess

We’ve often told our clients to think of their office leases as dynamic, living instruments, rather than dead documents once you’ve signed them. Current market conditions are begging for creative players to get involved. Rates are dropping, activity levels are painfully slow, spaces are left unleased for long periods of time—What better conditions for renegotiations with your landlord, OR with a new landlord?! What leverage do you have when your lease is well “over market”? Does your landlord really want to have your space back, or will they negotiate to keep you in place? If you’re paying “over market” now, will your landlord entertain an early renewal, and what could you get out of that? We can help sort through these issues with you.

For millions of square feet of tenants around the Bay, the issue, unfortunately, revolves around stopping the bleeding from holding onto space which has been rendered completely superfluous. During the past few years of “my-way-or-the-highway” from the landlord community, landlords racked up enormous security deposits (cash and/or letters of credit) to secure leaseholds and tenant improvement allowances. However, the markets have declined substantially to the point that the security deposits can no longer “make the landlord whole” if the tenant goes into default. What strategy do you hold to negotiate your way through these difficult situations? Remember that most landlords don’t want BLOOD from their tenants. They bargained for RENT. The combination of a skilled broker and real estate lawyer can help you to uncover sources of leverage in your leasing situation. We are here to help you.

500,000 Jobs Lost Since Dec 1…Worried? No Capital?

According to Challenger, Gray & Christmas of Chicago, over 500,000 people lost their jobs in the U.S. since December 1st, the highest rate of job loss in a period since they started tracking employment eight years ago. Should we worry? At 200 square feet per person, that’s 100,000,000 square feet of available space. It appears that a disproportionate share of the availabilities are right here in the Bay Area. That could be construed to be a good thing for those who are bullish on the Bay and tired of all the doom and gloom. After all, the Bay Area is home and Ground Zero to so many of the companies which will drive the “new economy”; the VCs who will fund much of the growth; and our existing built-in platform of highly educated employees, cutting-edge technology, plants, quality-of-life and other resources necessary to jump-start and fuel the Next Wave. In the meantime, however, companies private and public have put the brakes on capital spending, meaning little or no funding for new or expanded leases, tenant improvement construction, furniture, phone systems and the like. Our office markets will continue to work to adjust ALL valuations—lease rates, investment sales pricing, tax bases—until we find some semblance of balance. We have a major market move ahead of us in 2001. We should discuss how Mihalovich Partners/TheSpacePlace® can assist you in your office leasing endeavors this year.

PG&E Bankruptcy: Office Market Impact

We had a great day at Candlestick Park back in ’89 until THE EARTHQUAKE hit. But that was a long time ago and Bay Area tenants have forgotten about that, like market crashes of the past. We have short term memories, do we not? Not so fast. The earthquake put a lot of people to work—brokers, architects, contractors, engineers, real estate lawyers, and others—moving companies out of the area, or planning and and executing migration for expansion to Anywhere but here. The Bay became, to many, an unreliable and unstable economy. Where could you move or expand to find a safer and more consistent supply of natural resources? More business friendly local government? Cheaper resources? The PG&E saga begs the same thought-provoking planning questions.

The supply, quality and cost of power have become major issues for our Internet-driven, always-connected, networked society. While blackouts are upon us, many are reminded of the real pain and economic injury suffered after the last major earthquake. What kind of restitution, if any, will you get from your landlord and/or insurance company if a diminution of power takes your business down? What responsibilities should your landlord have to acquire and maintain a failsafe supply of power? PG&E is on our minds today for many reasons; keeping the lights on is a worthy topic for discussion when you review your office leasing situation. Bay Area companies will react accordingly, and we consider this issue a downgrade for California. All due respect to our Governor, tenants need to protect their businesses.

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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