Market Insight
Editorial & Advice to Tenants: 2Q2005

Editorial from Dan Mihalovich, Principal of Mihalovich Partners and Founder of The Space Place®

The Forest Through the Trees. The Return of Voodoo Economics

If you’re a commercial tenant in the San Francisco area, you’ve come to the right place, The Space Place®. Thanks for being with us and for taking the time to read through this report—our quarterly in-depth study of the marketplace and compilation of observations and recommendations for you, our clients and prospective clients—all, tenants! As usual these days, world news is “heavy”, but landlords and their listing brokers would simply have you be good consumers and react to the hyped-up press; the myopic news of several tenants paying over $50 per square foot for space; and the prospective return of “landlord control” of markets tenants have controlled during 21 of the 23 years I have been representing tenants in San Francisco. If you are a first-timer at our site, know that we are totally and unequivocally committed to serving the tenant community—and that my Editorials are not only meant to be instructive; they are a written record of our market analyses and recommendations; and, from my perspective, an easy way for you to differentiate the quality of our thinking and strategy with those of our competitors.

In last quarter’s Editorial, I devoted tremendous energy to illustrating point by point, “Why Your Landlord is Wrong About the Market (How Can So Many Investors Be Wrong?!)”. I will expand on that analysis, below, focusing on fundamental market changes during Q2.

The Forest Through the Trees.

  • The War On Terror rages on, at stellar costs both in human and economic terms. As we’ve discussed, here, repeatedly, we do not believe that the effects of the War are accurately reflected “in the market”, to use Wall Street nomenclature. Unlike previous wars, we do not come home every night to hear TV news reporting of deaths and casualties. The Administration doesn’t permit it; and television ratings plummet if the effects of the War are conveyed too frequently. Business and our economy are at stake, after all. If we rattle the almighty Consumer, two-thirds of our GDP may seize up. Likewise, the Administration has engineered a way to bury the financial cost of the War, since these figures are not included in deficit calculations. For the record, since the War began over two years ago, the U.S. has spent $318 Billion supporting 140,000 troops in Iraq and Afganistan. On a monthly basis, we’re spending $7 Billion ($50,000 per troop per month), with no end in sight. There are more than 1,700 U.S. soldiers dead; more than 13,000 wounded. There are more than 2,400 dead Iraqi police and military; and more than 22,000 dead Iraqi civilians. These costs are nearly beyond human comprehension. Perhaps that’s why we’re being shielded from the reality. We might develop a bad attitude. Worse, we might get pissed off.

  • The Legacy of Alan Greenspan is, of course, all about him. He’ll go down as a hero if the economy—on his watch—remains afloat. Dancing on the head of a pin, he continues to maintain his story (it’s too late to change this swan song) that inflation is under control and the economy is growing. Adjusting wages and income for inflation, we’re actually at a standstill (or net loss) at best. The job market is flat. However, commodity prices are soaring. Increasing interest rates (three times during Q2 and more to come) is intended to remove speculation from the economy. Al, you’re a little late for that. But then, what Fed Chief wants to be known as the death knell of the economy? To all of you on interest-only mortgages, are you feeling the pinch of multiple quarter-point increases? Shall we place bets on consumer confidence and spending declines?

  • “Soft Landing” is Really a Pain in the Ass. In May, U.S. employers added the fewest jobs to payrolls in nearly two years, according to the Gov…far weaker than Wall Street predicted…only 78,000 jobs, sharply down from 274,000 in April. This is an economic “soft landing”?

    CNN/Money reported that job cuts jumped 35% in June, pushing the monthly total to its highest level since January, 2004. Challenger, Gray & Christmas ( reported 111,000 job cuts in June, vs. 82,000 in May. June’s rate is 73% higher than last year. John Challenger, CEO, stated, “The fact that job cuts are rising in the summer is not even the most surprising trend. The surprise is that we are seeing a growing number of mass job cuts…the by-product of numerous trends, including the changing consumer demand, outsourcing, mergers and acquisitions, automation and consolidation. We are also starting to see job cuts resulting from higher health care costs as well as higher oil and natural gas prices. The pace of job cutting in the second half of 2005 is expected to stay ahead of last year, as employers continue to close facilities and consolidate in order to achieve maximum efficiency.”

    Silicon Valley’s Job Loss is National News: The New York Times reported that in the last three years, profits at the seven largest companies in Silicon Valley by market value have increased by an average of more than 500% while Santa Clara County employment has declined to 767,600 from 787,200. The area is coming back, but still has 10,000 fewer jobs than a year ago. The increase in profits has been dramatic, but job growth is slow. Who’s to blame? Increased productivity (value added) per employee. Automation. Outsourcing. Intense focus on profitability.

The Return of Voodoo Economics

The Jobless Recovery. Tax cuts during record deficit periods and War time. Government restating of jobs, jobless, GDP and other reports. It smacks of something sinister, does it not? Local, State and National deficits beyond recognition. But we should fret not. Right? Wall Street, always a purveyor of stocks and rarely a “short”, continues to sugar-coat the equity markets. But how does all the news smell to you? We’ve quoted a couple of nimble soothsayers, below, to offer up additional opinions to ours (they’re not brief but their points are well worth the read). We’d love not to be cynical about Government reporting, but we believe in the smell test—and it just smells foul:

  • Barry Ritholtz, Chief Market Strategist for Maxim Group, had some provocative pearls about the economy:

    “I do not want to become a ’nattering nabob of negativity’, but I cannot shake the idea that yesterday’s GDP numbers had a certain odor about them. Maybe I’m just an economic curmudgeon. Perhaps I am too “reality-based” in my perspective. I simply cannot compromise my belief in hard data (versus hedonics and seasonal adjustments and/or revisions).

    “Nor can I manage the suspension of disbelief so common amongst the economic cheerleading crowd, both in the private sector, at the Fed, and amongst the elected and appointed government officials.

    “Look, I understand that a certain degree of economic positivity is required—for consumer confidence, as well as to prevent the gold bugs and survivalist crowd from scaring everyone into the bomb shelter. I have no desire to cross over to the tinfoil hat wearing fraternity. I accept the necessity of some measure of ’happy’ bias in the government models.

    “But at what point do we cross the line from maintaining a healthy optimistic outlook to cynically manipulating data in boldfaced contradiction of reality?

    “Unfortunately, I think that line was crossed in yesterday’s revised GDP data:”

    GDP Components: Q1 Final (Est. 3) Q1 Prelm(Est. 2) Q1 Adv(Est. 1) Real GDP +3.8% +3.5% +3.1%

    “Here’s the thing: Within GDP data, the revision of the Residential Housing is simply too hard to believe: This is data that’s widely available from the NAR amongst others. To get there, you need a significant DROP in home prices. That’s right, a drop in home prices. The revision from +8.8% to +11.5% is simply enormous. I cannot say for sure that it’s unprecedented—but I cannot recall it being this huge in recent memory.

    “I am not the only one: The (subscription only) MNSI specifically observed:

    “The Commerce Department said exports and investment in residential structures were revised higher in Q1…The structures revision was due to downward revision to the one-family house price index which resulted in more real sales and less inflation—an almost unbelievable result given that the housing market is on fire with home prices posting double-digit appreciation on the year in some areas (emphasis added). Yesterday’s upwardly revised GDP data is believable only if you accept the premise that HOME PRICES WENT DOWN IN Q1 2005.

    “Otherwise, the data was gamed.

    “Follow the bouncing ball: The revisions to GDP inflation accounted for virtually all the net positive revisions to growth. How? The GDP implicit price deflator. For the quarter, it was was revised downward from 3.16% to 2.89% (a drop of 0.27%). That accomplishes a neat little trick: By (artificially) reducing the rate of inflation, the BEA spikes real GDP growth by the same amount, and total GDP growth revised upward from 3.48% to 3.76% (rounded up to 3.8%), an increase of 0.28%.

    “The deflator was revised downward from an annualized 3.3% to 1.1%, an astonishing drop of 2.2%, and real housing growth revised from 8.8% to 11.5%, an increase of 2.7%. Yet year-over-year housing inflation in the GDP is at just 5.2%. Cranking that number up to reality raises inflation, lowers GDP, and spoils everyone’s party.

    “Forget taking the punchbowl away, this crowd is spiking it with LSD. It’s not like I do not admit when I am wrong. Hell, I expect to be wrong. But this is beyond the pale. GDP numbers, IMHO, have now entered the realm of Santa Claus, the Easter Bunny, and honest politicians. They are all fictional characters.”

    Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm’s portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries, and is a member of the board of directors of, a streaming media software company. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

  • Alan Abelson, former Editor of Barron’s had this to say after the 6/05 report of jobs:

    “The June jobs report we read was far from bright. All told, 146,000 new jobs were added last month, which was anywhere from 40,000 to 50,000 fewer than Street economists had been predicting, and a number of those perennially cockeyed seers who ebulliently foresaw a 200,000 increase in employment openly worried about “upside risk” to their guesses (not to worry, we’d have told them if they had asked us).

    “May’s feeble gain of 78,000 slots was revised upward to 104,000, and April’s relatively strong showing was even stronger than first tallied by some 18,000. And the unemployment rate dipped to 5% (from 5.1%), the lowest in nearly four years. That was pretty much the full extent of the good news, and even some of that, on closer inspection, wasn’t as good as it looked.

    “The dip in unemployment, for example, was actually less than 1%, but got the benefit of “rounding.” Even so, the gain was helped by the fact that the category entitled “not in labor force—want job now” increased by more than 500,000 to well over five million. Moreover, as the Liscio Report’s Philippa Dunne and Doug Henwood point out, the work week came in at 33.7 hours, unchanged from May’s downwardly revised total and just 0.1 hour higher than the all-time low set in June 2004. The diffusion indexes, which depict how widespread the job gains are, also were nothing to write home about and are now 12-16 points below their 1994-1999 averages. Manufacturing continues on the skids, dropping 24,000 jobs, helped along (if that’s the phrase) by auto layoffs. And a ponderable bunch of the jobs added were in health care, employment services and bars and restaurants, not notoriously high-paying sectors.

    “Our savvy duo expresses surprise at the “enthusiastic tone” of some of the commentary that met the report. But, hey, what are cheerleaders for if not to cheer? Philippa and Doug further note that employment gains have averaged 172,000 a month so far this year, but based on the 1948-2000 averages, “we should be adding 233,000 jobs a month.” And that extended stretch, of course, includes recessions; using just expansions—and, remember, we are in an expansion—the monthly job totals should be swelling by around 360,000. Or twice as much as they are.

    “If the Fed keep tightening, Philippa and Doug sniff, “It’s not because the job market is getting frothy.” They can say that again.”

Tenants: Get it Straight

Mihalovich Partners represents tenants, only. Our core business is driven toward educating and objectively and aggressively representing TENANTS, only. If you are looking for biased market information serving the LANDLORD community, please see one of Cushman & Wakefield; CAC Group; Colliers; or CB Richard Ellis—whom collectively represent over 40% of the 15 million square feet of space currently on the market. Those four firms have pledged their allegiance to over 225 local landlords.

Strange as it may seem, bearing in mind their conflicts of interest, we compete with them every day for YOUR business—for the opportunity to represent you, the tenant, in leasing negotiations. C&W, CAC, Colliers, and CB control more space than any landlord in San Francisco. Mihalovich Partners’ business and approach is diametrically opposed to that of brokers who represent landlords. Are you, the tenant, looking for advice and counsel? You can count on straight talk from us. Advice for tenants, pure and simple. Serving the tenant community in San Francisco for 23 years.

San Francisco Market Overview

Trends Taking Shape

Let’s review the stats and see if we can nominate a few “trends”:

  1. Vacancy rates, which peaked in recent history in Q2, 2003 at 16.8% (direct + sublease space, Citywide), are now down to 14.0%. So, for the past ~8 quarters, vacancies have trended lower.

  2. Following the trend in reduced vacancies, one would expect a corresponding increase in asking rental rates. Lo and behold, Citywide San Francisco average asking rates bottomed at $21.12/square foot per year (fully serviced average for direct and sublease space), ~Q3, 2003 and have settled now at $23.62, a trend established over five straight quarters. Many of our competitors who would have been in kindergarten at the time don’t realize that today’s average rates are still cheaper than in 1982, our Principal’s first year as a broker in San Francisco.

    Before we jump to too many conclusions about vacancy rates trending lower in San Francisco, let’s take careful note of the fact that asking rates for direct space in San Mateo, Santa Clara and East Bay counties DECLINED in Q2. As long as 30+ million square feet of vacancies surround San Francisco in neighboring counties, it will be difficult, if not impossible, for San Francisco’s tenants to avoid the pursuit of suburban landlords. Likewise, for every landlord in San Francisco, suburban rental rates will keep the pressure on you.

    Asking rents in Santa Clara County have trended downward from a high of $52.65/sf/yr in Q1, 2001, to the current low, $23.30. The same can be said for all East Bay counties, which have trended downward from a high of $32.52/sf/yr in Q2, 2001, to the current low, $21.63. San Mateo County, a much smaller inventory, peaked in Q4, 2000 at $66.35, but now resides near its low in the trend, at $24.61.

  3. Absorption (demand) of space, net positive in all counties, scored 508,000 square feet in Q2. What trend, if any, can we spot? Sublease space, historically marketed at a huge discount to direct space, fared exceptionally well in recent years, posting 12 of the past 13 quarters of positive net absorption. However, during the same period, landlords haven’t fared anywhere near as well, posting only 6 of 13 quarters in the black. Tenants, therefore, have trended toward capturing more advantageously priced sublease alternatives. In the meantime, direct space has NOT established a clear trend. Overall, landlords have been pained by the discounts in sublease pricing over the years. The market now maintains lower inventory of sublease space than in the past 4.5 years. In other words, sublease spaces have either “burned down”, meaning that the master lease terms expired; or the sublease spaces were “leased”. In any event, landlords are holding more of the bag, relatively speaking, than in the past 4.5 years. There remains 1.8 million square feet of sublease space available. How much of the 1.8 million would you like today?

    Just for kicks: Of the past 26 quarters, looking at both direct and sublease space, how many quarters represented positive net absorption? Answer:

    Direct space:11 of 26 quarters were positive.
    Sublease space:17 of 26.
    Total, all space:14 of 26.

Welcome Bloomingdale’s, Fall 2006.

Thanks for more office space. 235,000 square feet. And another 160,000 square feet at the Merchandise Mart, coming just in time to compete. Mid-Upper Market Street will never have been such a sloppy market.

Pacific Exchange.

It was nice knowing you. What a rich and colorful history—an absolute cornerstone of the San Francisco business community. With the sale of the Exchange, what will become of the 260 employees and the scores of related companies (traders, clearing firms, Wall Street firms, local and regional investment firms) in the Mills Building and surrounding blocks?

Build it and Biotech Will Come: On Being Alexandria

Building more biotech infrastructure, space for biotechs to move into San Francisco, is a nervy endeavor. Who better to take the shot than grey-haired Alexandria Real Estate Equities, life sciences REIT behemoth. Alexandria recently purchased land from Catellus to develop 2.1 million square feet. But to develop on spec, without signed leases in hand? Perhaps lightening will strike and UCSF will find a group of Angels (winged financial variety) to fund an even more massive expansion than currently contemplated into the Mission Bay foray. Perhaps, instead, some of the City’s hospitals—under deadline to upgrade—will choose to relocate to Alexandria’s campus. In any event, though, biotech movement from South San Francisco could amount to a trickle. According to Ernst & Young’s 2004 report on biotechs, 330 public companies reporting registered a $4.3 billion LOSS on $42.7 billion in revenues. These 2004 losses were up 33% from 2003. The combined market cap of all companies? $330 Billion. Would you like to buy a few shares? They could use some help.

California: 37 Million Mouths to Feed

According to the New York Times, California’s population is more than double the size of New York. Population estimates indicate that we’re heading from 37 million people to 46 million within the next 25 years…an increase about the size of Illinois. So, get out there. Stand in line. Buy a farm and start building homes. Of course the research could be imperfect. Schwarzenegger won’t raise taxes to pay for all the necessary upgrades to the State’s infrastructure to support such growth. The fastest growing counties? None in the San Francisco Bay Area, of course:

  1. Riverside.
  2. Placer.
  3. Imperial.
  4. Madera.
  5. Tuolome.
  6. Kern.

All more supply of competing commercial space. What companies will be drawn from the Bay Area to fill those vacancies? History has shown how the dramatic expansion, if not the outright creation, of our suburban markets in the 1980s effectively killed or at least capped rent appreciation in San Francisco for nearly two decades. To this day there remain scores of alternatives for City tenants in the awaiting-suburban markets. When City rates reach substantial enough premiums, tenants have shown that they know the way out of town.

Vacancy Rates: Are Your Options Fading?

Landlords, their listing brokers and developers dance to the tune of lower vacancy rates, so tenants should watch carefully to detect how and to what extent your field of options declines. In the City, Q2 vacancy rates decreased by 3%. The evangelists, to whom we referred in a recent Editorial, would have you believe that only “bad space” remains, which is of course, nonsense. 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 fading, as a result of recent leasing activity? Review the chart, below, and let’s discuss:

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

Take Me Straight to the Numbers: San Francisco Bay Area Rental Rates. Supply/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.

Who Has the Most Space in San Francisco? Surprise…

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, and who controls the most space in San Francisco? And, most importantly, why would you feel comfortable having them represent YOU?

Below we’ve surveyed the entire 102 million square foot inventory of San Francisco, and illustrated the companies with the most control of space on the market, the Top 25. You know from our other stats that 15.3 million square feet is now on the market in San Francisco. The top 5 companies, all office leasing brokerage firms, control over 40% of the City’s vacancy! These brokerage firms are beholden to more than 280 local landlords. 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 5 companies on the list control more of the City’s vacancy than Equity Office Properties, the country’s largest REIT (#6); Tishman Speyer Properties (#8); Boston Properties (#9); Shorenstein (#15); and more than Hines (#16). Surprised, are you not?

% Market Share Square Feet # of Landlords/ Buildings

% 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 landlordselopers.

1 *Cushman & Wakefield of California 12.2% 1,869,594 54
2 *The CAC Group 10.1% 1,543,634 41
3 *CB Richard Ellis 9.8% 1,496,918 43
4 *Colliers International 7.7% 1,186,082 89
5 *Grubb & Ellis 5.2% 800,069 61
6 Equity Office 4.5% 685,331 12
7 *Cornish & Carey 4.4% 675,872 12
8 Tishman Speyer Properties 4.1% 623,068 3
9 Boston Properties, Inc. 3.5% 541,519 5
10 *BT Commercial Real Estate - NAI 2.9% 448,774 27
11 *GVA Whitney Cressman 2.5% 383,508 39
12 *Starboard TCN Worldwide Real Estate 2.5% 380,219 104
13 *Jones Lang LaSalle Americas, Inc. 2.4% 375,649 8
14 *HC&M Commercial Properties, Inc. 2.3% 345,285 41
15 Shorenstein Company, LLC 1.9% 297,135 8
16 Hines 1.8% 280,226 7
17 *Ritchie Commercial 1.8% 279,954 49
18 *TRI Commercial/CORFAC International 1.4% 221,211 38
19 *Newmark Pacific, Inc. 1.2% 180,301 7
20 Studley 1.1% 164,775 6
21 The Presidio Trust 1.0% 160,836 40
22 Pacific Eagle Holdings Corporation 1.0% 156,545 2
23 Bently Holdings California, LP 1.0% 151,942 1
24 The Staubach Company 0.9% 132,967 6
25 Blatteis Realty Co. Inc. 0.8% 127,474 80
  All Others 11.9% 1,831,572  
  Total   15,340,460  

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