Market Insight Editorial & Advice to Tenants: 1Q2002

Here to Represent You, for 20 Years. Our Recent Client Deals.

Thank you for dropping by our website. Now in my 20th year representing tenants in office leasing transactions, I want to remind you that we’re here and available to discuss your firm’s office leasing issues; the scores of opportunities available to accommodate your needs; the leasing process, and our role as your representative; and our recommendations for your firm, considering where the market is and where it’s heading. Please feel free to call us!

This website, an integral part of our resources, serves as an example of the quality you can expect from our representation services—but also as a tenant community builder. We offer free educational articles in our Guest Articles, written by many of the community’s most talented professionals. (e.g. How will the terrorist acts of 9/11 potentially affect your lease?) The articles are written by real estate lawyers, architects, contractors, tax consultants and others, whom I have come to know through direct experience over the years. After 20 years representing tenants, I recognize invaluable advice when I hear it, and do everything possible to encourage contributions to this site for your benefit. Please enjoy, and participate.

We’re pleased to have represented the following clients during Q1, 2002:

  • RiverSoft, Inc.: Mihalovich Partners represented this network management software company in its lease termination at Embarcadero Center.
  • Mannion & Lowe PC: Mihalovich Partners represented the firm in its new lease at 655 Montgomery Street.
  • Rockman et al: Mihalovich Partners represented this education consulting firm in its new lease at 49 Geary Street.
  • We are proud to represent the following tenants, now in the marketplace:
    • Regional Cancer Foundation
    • Rouda, Feder, Tietjen & Zanobini
    • Latterell Management Company
    • Davidovitz & Bennett LLP
    • Vx Capital Partners
    • Lawman Promotions, Inc.

How Do YOU Spell “Bearish”?!

All due respect to Mr. Greenspan, the recovery may have begun, but not in the San Francisco Bay Area. The stagnant local economy prior to 9/11 only atrophied further after the tragedy. Office markets continued to plunge, in spite of hopeful landlords’ prayers for the beginning of a decent reversal. There is no reversal in sight. For Q1, 2002, every Bay Area county reported negative absorption (less than zero growth) of space. Companies continue to dump existing space; renege on or renegotiate future commitments to space; consolidate offices; layoffs are ever popular; and few tenants of size are in the market to take advantage of plummeting rates and leasing inducements.

For those searching for recovery, the numbers are a cold wake-up to market dynamics reminiscent of 1987-1988. Vacancies—spaces which are currently on the market for occupancy between now and 12 months from now—hit 20% in San Francisco, up 9% from last quarter, now standing at 20.31 million square feet. Absorption was negative 769,000 square feet.

The supply/demand imbalance and corresponding statistics are totally compelling to us. Market rates have no chance to remain in place, only to decline substantially. Large blocks of contiguous space—both direct and sublease space—remain on the market for many months, if not exceeding a year, in this type of economy and imbalance. Public apprehension about the ongoing recession; the undercurrents in our securities markets causing indigestion; Middle East turmoil; and job market instability are all pointing to further sagging of confidence and market activity. Market rates, as you can see below, have dropped precipitously over the months—so the market IS working, but we have another 20% or more to go until absorption of space turns positive. Until we return to the black, rates and terms will continue to improve for tenants. It’s that basic. Historically, brokerage professionals used to consider a 1 million square foot net absorption level for the year to be a decent year in San Francisco. From where we sit, once we reach that level again—we’ll have an 18-year supply of space on hand.

Vacancies Continue to Soar, Past 45 Days. Here’s the Count.

Skeptics and others who believe the dumping trend is over, please note that all Bay counties continue to unload office space in major magnitudes. Here is the count of direct and sublease office space, new to the market in the past 45 days:

San Francisco County: 2,320,000 square feet
San Mateo County: 600,000 square feet
Santa Clara County: 800,000 square feet
East Bay Counties: 785,000 square feet

It is both interesting and mystifying to note that landlords in San Francisco, under these market conditions, have only lowered their asking rates (see our in-depth analysis below) from $29.75 to $29.61/square foot per year, since last quarter. Sublease rates offer a 10% discount. We offer the following rationale:

  1. Many landlords believe that lowering rates will not create demand in a market largely void of demand. We strongly disagree and will soon be able to point to the most aggressive landlords as those who went the extra mile to offer yet unheard of incentives to tenants willing to sign on the dotted line. Those landlords willing to “lead” the market instead of “meet” the market will win business in these times.
  2. Some of our largest landlords are publicly traded REITs, who have steadily been recording profits on the backs of tenants paying enormous cancellation fees for deals gone sour. These landlords will not feel the pain of the market until sometime later in the year, or perhaps in January, 2003, when asset managers will be on the line to report expectations for the New Year.
  3. Space that is returned to the landlord through an early termination or bankruptcy was never budgeted to be vacant this year. Therefore, the downtime associated with the new vacancy may not impact the owner until it’s properly entered into the operating budget. Are there accounting games being played in this regard? If you are a shareholder, try calling the Board liaison for an explanation.
  4. Many landlords share an attitude that they don’t have to, and don’t want to compete with sublease space. So, let tenants do the discounting. If the landlord has the right to recapture a tenant’s space (terminating the lease), they can do so with an adjustment from the sublease rate to the landlord’s “market” rates—or approve of the sublease, keeping the underlying tenant’s credit and security in hand. Landlords oftentimes have the right to disapprove of subleases, especially if such interference drives the new tenant into the arms of the landlord and the direct space being offered. If a sublessor’s credit is shaky, sublessees will approach the landlord for a non-disturbance agreement. Will the landlord go out of their way to accommodate this request when the landlord has competing space to offer? There is a litany of issues to consider when subleasing. We’ve posted a great article to enlighten you on the topic: “A Subtenant’s Guide to Subleasing”, by Douglas Van Gessel, Esq., Cox, Castle & Nicholson LLP.

Keep in mind that vacancies are still understated since many struggling tenants have yet to come to grips with disposing of excess space. Normally, it is the human resources announcements (layoffs) which prelude the change in space status—and we read every day about thousands of pink slips throughout corporate America. Our core tenant base continues to erode or consolidate (securities firms, investment banking, basic banking, accounting firms, law firms, ad firms, software companies, telecom and tech companies). Where is there a sector in or even near expansion mode? We’d love to talk to you.

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.

Renegotiating Current Leases—Lease Assumptions Are Back.

We are calling our clients and tenant prospects early—perhaps a few years prior to scheduled lease expirations depending on the size of the tenancy. Leases are “live” instruments, not stagnant agreements to leave in the filing cabinet until 6-12 months before they expire. In the face of mounting vacancies and enormous lead times to get spaces leased, landlords and sublessors (yes, there are scores of long term subleases available) must look to tenants with leases expiring in 2003 and 2004 to pull demand into the current marketplace, since demand is now negligible. Since the markets are growing weaker, and will continue to do so unless and until a significant body of users materializes, lease assumptions will factor into negotiations as they once did in the late ’80s and early ’90s—whatever it takes to make a sale today. By the same token, offering an existing landlord the opportunity to renegotiate an existing lease presents an opportunity for the landlord: Renew your credit tenants today, offer them financial inducements to do so, and forego the risk that you will lose them tomorrow in a heavily tenant-oriented marketplace.

Deals today are not easy to make, especially where early renegotiations or lease assumptions are involved. You need a highly-skilled and experienced broker to effectively leverage these negotiations. We would like to assist you, and are available to meet to discuss your unique situation.

Name Your Rent. Credit is King.

This is an editorial comment…Indicative of our aggressive attitude at the negotiating table, and the fact that “asking rates” are just that—especially in markets void of healthy demand. These are falling markets, so you’ll notice that landlords are happy to tell you about the few small deals they completed within the last month or two—since they likely won’t be able to replicate those deals again. If your business is well-seasoned, with a strong financial statement, it’s time to be extremely aggressive. We can take you there and are proud of our negotiating history and track record. Landlords and sublessors need more than just warm bodies in this type of market, they need the security of a good credit tenant and to know that their pain will be over once the lease is signed. Your good credit will save you dollars per square foot per year. No kidding.

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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