Market Insight Editorial & Advice to Tenants: 2Q2002

From Dan Mihalovich, Principal of Mihalovich Partners and Founder of The Space Place: 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. A Subtenant’s Guide to Subleasing ) 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 Q2, 2002:

  • Regional Cancer Foundation, in their new lease at 1200 Gough
  • Rouda, Feder, Tietjen & Zanobini in their lease renewal at 44 Montgomery
  • Vx Capital Partners, in their new lease at 915 Front
  • Secret Studios, in their lease renewal/expansion at 2200 Cesar Chavez
  • We are proud to represent the following tenants, now in the marketplace:
    • California Academy of Sciences
    • Davidovitz & Bennett LLP
    • Latterell Management Company
    • Lawman Promotions, Inc.
    • The Ruben Law Group

Office Market Bankruptcy: Tenants, Landlords Dump Space

We continue to remain in unchartered waters, where such commercial vacancy levels have never arisen. Our economy and confidence are shaken, and what many hoped to be a localized San Francisco Bay Area problem—exploded into a national epic drama. Corporate America is on trial, in the courthouse and at the kitchen table, where investors are writhing in fear. The recession, shortly ago pronounced dead by Mr. Greenspan, appears alive and particularly unforgiving in this part of the country. In the meantime, equities exchanges and office markets alike are working to re-write all the fundamentals. Like the raging floodwaters of Texas, commercial real estates values are seeking their own new levels. At some pricing level, attitudes and confidence will be restored, and activity levels will again surge. Locally, however, we have just experienced our 6th consecutive quarter of negative absorption of commercial space.

County for county, along the San Francisco Bay, tenants and landlords have continued to dump space. As you can see from our chart, below, direct and sublease asking rates are down 2-12% from last quarter; immediate supplies of space are up 3-10%; and delayed occupancy vacancies are up 3-16%. We now have a staggering 57 million square feet of office space available on the market in the San Francisco Bay Area. Underutilized and yet to be marketed space from bankrupt or bailing tenants is not factored into these vacancy rates.

The pace of new vacancies is not slowing. Here is the count for direct and sublease office space, new to the market in the last 45 days:

San Francisco County: 1,580,000 square feet
San Mateo County: 260,000 square feet
Santa Clara County: 1,135,000 square feet
East Bay Counties: 985,000 square feet

Un(der)employment Reigns. There is No Recovery.

We continue to look for signs of improvement in the local economy, and find little of substance in the positive category. You may take note of slightly higher, gross leasing activity in San Francisco and Santa Clara counties; gross activity was flat to lower in East Bay and San Mateo counties, respectively. The net of all activity, however, was less than zero growth in all counties—again. San Francisco locals are mourning the loss of one of the City’s stalwart anchors—Fleet/Robertson Stephens, one of our largest and most prestigious investment banking firms. They are the latest of major tenants to add space available to Class A buildings. Arthur Anderson’s space, unofficially available, comprises another 140,000 square feet at 101 Second Street. The horizon is justifiable bleak, with daily front page reminders from the press. Let’s hope that the Government does not re-state its financial history, as have so many in the private sector.

Wall Street’s effects on the local economy are widespread, all of which has contributed to lower net absorption of space—a trend that will likely continue for 3-4 more quarters. Job loss, ongoing business closures and pending workouts/lease terminations are also pressuring the construction, design, furniture and telecom industry. Tenant improvement allowances are beginning to soar. As we’ve reported earlier in previous Editorials, landlords and sublessors are cranking out the concessions (architectural fees for “fit” plans and pricing; lease assumptions; free rent; free furniture; TI allowances of $35-$65/square foot, etc.) to entice near term demand.

For many landlords, and certainly sublessors, deals today are net present value negative. The challenge for most is to predict when their space may be leased, since 12-18 month downtime has become common. Office buildings are definitely on the list of underemployed resources. Changes of use are likely, but to what? The magnitude of foreclosures, or deeds in lieu of foreclosure, will rise significantly in the next 6-9 months without an economic miracle. Many buildings currently in strong hands will become economically unviable, so we expect distress sales to pick up. We are not blind to the magnitude of real estate capital on the sidelines, waiting for sensible opportunities. However, with tenant demand eroding as we speak, buyers will be in no hurry, and conservative as ever, at that.

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.

Arbitrage: Finding a Motivated Landlord

When we are exclusively retained to represent a tenant, we orchestrate a competition among landlords for our client’s business—whether it be a renewal or relocation to new premises. Historically, many landlords treat their existing tenants as captive—since employee downtime, moving costs and related nuisances often deter a decision to relocate. However, leveraging the renewal discussions and negotiations by using a seasoned real estate professional compels the existing landlord to step up and offer at least comparable enticements they must offer to new tenants. So, what is the value of your tenancy in the marketplace, for space comparable to your existing space? Motivated landlords are offering huge incentives to move, these days; but you need to engage them in active and meaningful negotiations, with the intent to move. The result of this competition is a set of well developed alternatives—including renewal, if appropriate in the end—and proof of your company’s value. At lease signing, tenants who have scoured the marketplace for the compelling opportunities rest more comfortably with their final business decision. Arbitrage - testing one landlord against another - is the only way to bring out the best of concessions for your negotiations.

“Musical Chairs”, a Repetitive Tune for Tenants

Our tenants and markets are obviously not in growth mode. Instead, we can look forward to the next several quarters of “musical chairs”, where tenants are enticed by competing landlords to relocate to similar—if not less—square footage. Tenants should keep in mind the ongoing level of net absorption, since it is possible, if not likely, that chasing after an alternative today will only get cheaper or more plentiful next month. Unless and until net absorption climbs into positive territory, there simply won’t be a rush to make long term commitments. We recognize, however, that real estate is not completely fungible, meaning that certain clients are more sensitive to site selection, ambiance, neighborhood amenities and the like—than others. When requirements are more generic, though, enjoy the negotiations, since there are over 50 million square feet to choose from in the San Francisco Bay Area!

Can You Afford “Asking” Rental Rates?

Most landlords and sublessors are reluctant to publish asking rental rates. Why? Mainly out of fear of losing an interested tenant. We need to qualify landlords, though, to determine right away whether or not the playing field is right for our clients. The old rule of thumb, which has applied to most tenants is that rent should not comprise more than 8% to 10% of gross revenues. When considering budget-making, try this litmus test, but also bear in mind that “rent” also includes the following: operating and tax pass through increases over your Base Year; amortization of any tenant improvements not paid for by your landlord; moving, telecom and other related costs with fit-out of your space; legal fees associated with lease documentation, etc. If your company’s tenancy and great credit will provide a value-added benefit to your new landlord (or existing landlord), this is the time and type of market to make your case: You must articulate what you can afford, and let the landlord community compete to meet your needs. We can assist you with this evaluation.

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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