Market Insight Editorial & Advice to Tenants: 3Q2006

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

If you’re a commercial tenant in the San Francisco area, you’ve come to the right place, The Space Place. If you are a first-timer at our site, know that we are totally and unequivocally committed to serving and representing 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.

We begin, as usual, with a broad-brush about the larger economy and fundamental issues which continue to concern us and dampen our enthusiasm. We prefer that you take pen in hand as you read this. Write to us.

All the Great Economic News & Now This…

  • 45 million uninsured Americans. According to the National Coalition on Health Care, about 500,000 Americans ventured overseas last year for cheaper treatment. Fortune 500 companies are researching outsourcing health care. Kaiser Family Foundation reported that company-provided health care costs have soared 87% during the past 6 years.
  • Election-Season Stats from The Gov: “Lowest Jobless Rate in 5 Years”. So much for a slowing economy…But the economy only added 92,000 jobs in October. According to DOL, not ONCE since 11/05 did the monthly new-job postings reach 250,000—the average target for a “healthy economy” both Bush and Kerry chanted during the last presidential campaign. Perhaps there’s something afoul with the Gov’s measurement methods. Wall Street and the rest of us have altered our expectations of what’s “healthy”. Average time to get a new job? Only four months…assuming that one actually wants a job. Weakening Demand: Challenger, Gray & Christmas made some interesting observations in September…Planned job cuts of over 100,000, up 54% from August and up 40% from year ago. Overall, though, cuts are 18% behind last year…but we’re heading into the job-cutting “season”, when they expect to see another 30,000 losses.
  • The world’s largest lobby: Wall Street! Will they ever recommend a short position or package and sell any bad news? Not on your life. We read reports of “growth in wages”, for the quarter, which would fuel our consumer-driven economy, of course. But other government reports indicate that real growth in wages ñduring the past 30 years, adjusted for inflation’has been flat. Inflation, as the Gov measures, is only about 3.5%. The rate doesn’t include energy, food, college or housing costs…and more. Your average Joe/Jane in America is paying nearly 50% of their net income on housing. Where does the money come from to support the economy? Finally, an easy one: Debt! Less than zero savings. And what of Joe & Jane’s college loans? Effective July, interest rates on Stafford and Plus student loan rates soared by 35-39%! “Inflation is likely to stay above the comfort zone for some time…It could take several years (for the economy) to come back.” So said SF Fed Reserve Bank President Janet Yellen recently. Sounds like an understatement.
  • The U.S. trade deficit is running in its 5th straight year of record-horrible-performance: about $70 billion per month. We’ve discussed this before—It’s a good thing that the Saudis and Chinese are financing our deficits! But can we keep our interest rates high enough to sustain their buying binges? Enticing foreigners seems to be Job #1 in this debt-laden economy. Remember when nearly every building on California Street was owned by the Japanese?
  • WOT factoids worth pondering: Not that ANY of these expenditures will EVER affect our local burgeoning economy…The Senate agreed to spend another $63 billion on WOT in Iraq and Afghanistan, for a grand total of about $500 BILLION so far. Add another $200 mil for a new CIA unit to hunt down Osama…and another $700 mil to combat the opium trade out there. SO, where does the money come from? According to our sources at Citigroup Global, the money comes from YOU and yours…and your children’s offspring through the financing of U.S. Treasury securities. The Gov’s costs are “fungible”, so there are no special revenues or bonds for WOT. The current Treasury debt outstanding? $4.2 trillion. Your WOT funds are buried in there, somewhere, and the Gov has no obligation to tell you where. Could this debt find you in San Francisco? Don’t think about it.

A Requiem for a Housing Bubble (by Eric Sprott & Sasha Solunac of Sprott Asset Management)

This was one of the most compelling economic analyses and soothsaying I’ve encountered in quite a while. Here, we’ve posted the entirety of Eric and Sasha’s article. This is a MUST READ about our economy…and our plight.

Eric Sprott; Sasha Solunac
Markets at a Glance August 2006
A Requiem for a Housing Bubble

We’ve written about the housing bubble on quite a few occasions this year—and for good reason. The difference between the US housing market this summer and last is like night and day. Last year at this time homebuyers were falling over themselves outbidding each other in a sizzling housing market—one that had all the earmarks of a market consumed by greed and mania. This frenzied activity often resulted in bidding wars, which led to homes selling for well above asking price merely days after being listed. What a difference a year makes! Today the situation on the ground (or the lawn, if you will) is completely the opposite. The unsold inventory of new and existing homes is blowing out at an alarming rate. Buyers seem to have packed their bags and left. Bids are getting increasingly difficult to come by, forcing asking prices to drop precipitously. Rather than days, it can now take several months (even a year or more) to sell a home. Median existing home prices are now down year-over-year in three-quarters of the US. Homeowners are levered to the gills, with imminent interest rate resets threatening to substantially increase their monthly payments. Refinancing options are becoming increasingly scarce due to rising interest rates and the end of price appreciation. Just like a balloon that has inflated to the breaking point, the pop in the US housing bubble has been quick and decisive. Every week seems to bring more bad news from the housing market.

The speed of the reversal has been stunning, but such is the nature of bursting bubbles. There can now be no denying that the first half of this decade witnessed a housing bubble of unprecedented proportions. According to the federal housing index, average home prices have increased almost 60%—far greater than people’s incomes and far greater than supposedly tame core inflation. Like all bubbles, it burst under its own weight and is now in freefall. As students of the psychology of market manias, we aren’t reticent to boast that we saw this coming. Just like the NASDAQ of the late 1990’s, the housing market of the 2000’s had all the makings of a mania. A chart of the homebuilders’ index is eerily reminiscent of the NASDAQ six years ago, with much further to fall (see for such a chart). Recall that, seven years ago, we were one of the few on the street to warn of a pending stock market crash whilst the vast majority were claiming that “things are different this time.” We’ve been making the same foreboding claims about the housing market, and the dangers of the financial schemes being used to fuel it, in these articles. For alas, things are never different. All manias play out the same way. They are dynamics of greed and fear. The greed of making easy money. The fear of missing the boat. Manias are designed to draw people in and, once everybody is in, to pull the rug out from under them leaving them high and dry. The housing market was a textbook bubble. It was dÈj‡ vu all over again.

The trigger for the housing bubble was falling interest rates thanks to the Fed’s ultra-aggressive easy monetary policies that began in 2001. But this was by no means sufficient to sustain the bubble for as long as it has. When a bubble begins to gather steam, the immutable human characteristic of greed transforms the financial system itself to facilitate the bubble’s expansion so that the bubble gets inflated to well beyond reasonable levels. Financial institutions, among others, aided and abetted the housing bubble, as did anyone who had a vested stake in its existence. Even the protestations of regulators, who saw the financial risks mounting, proved meek and ineffective—as is the case in any bubble. Why spoil the party? Even the revelation of questionable accounting at Fannie Mae failed to stem its book of business from doubling in the past five years. Abuses of the system run rampant whenever a bubble is in progress. Regulatory overhaul tends to occur only in the aftermath of a bubble, never during. There is too much at stake and too much money to be made. The housing bubble, like any bubble, spawned abuses of the system. As we’ve mentioned in the past, real estate appraisals were being inflated as appraisers were being asked to “hit the number” on mortgage applications, or else risk losing business. The real kicker for the bubble, however, was when banks and mortgage lenders came up with a slew of creative (some would say reckless) financing options, or “hybrid” mortgages, which (pre-bubble) were considered too risky to be deemed prudent lending practice. To the extent that such mortgages existed before the housing bubble, they comprised a very small percentage of a mortgage lender’s business. Furthermore, they were only extended to people with the best credit ratings. Today, these types of mortgages have become the norm, not the exception. Furthermore, they were being extended to people with poor credit ratings, also known as sub-prime. This is recklessness that can only occur in a bubble. (As an aside, we are now seeing “sub-prime” referred to as “near-prime”—yet more evidence of the bubble.) New fangled mortgage schemes included: Interest-only loans that required payment of only interest and no principal in the early years of a mortgage. Teaser mortgage rates that offered mortgage rates as low as 1% in the first year of an adjustable rate mortgage. 2/28 mortgages that offered low rates in the first two years of a fixed-rate mortgage, followed by a substantial step up in the remaining 28 years. (If the step up proved too onerous for the borrower after the second year, they were allowed to refinance into another 2/28 mortgage!) Option-ARM’s that gave borrowers the option of negative amortization whereby the principal outstanding was allowed to increase over time by making minimal mortgage payments in the first five years that weren’t even enough to cover interest. Piggyback loans that allowed homebuyers to borrow money for the downpayment through a home equity loan. Downpayments in low-income neighbourhoods being paid for by charities funded by homebuilders. Even mortgages that didn’t require any downpayment whatsoever were being offered in quantity. (We’ve seen estimates that 43% of first-time homebuyers made no downpayment in 2005.) These financing schemes were the tip off that we were in a housing/mortgage-finance bubble of massive proportions. There were endless television ads enticing people to take out mortgages or withdraw equity from their homes in one form or other. All these schemes were designed to facilitate getting everybody into the mania, using as much leverage as possible, and into homes and/or mortgages that they could not otherwise afford. But the question is: When everybody has already been drawn in, where will the incremental source of demand come from to sustain the bubble? There’s nobody left. It’s a classic bubble-ending scenario.

This is the situation the US housing market faces today. Everybody is in, and it’s getting increasingly difficult to get out. The number of listings is exploding. In some markets it is double, even quadruple, what it was last year. The inventory of unsold homes now averages 7.3 months nationally and rising, versus 4.6 months last year at this time. In some markets there is one, two, even four years of inventory waiting to be sold. Buyers are getting increasingly scarce. There are many anecdotal stories in the Wall Street Journal of late. In today’s paper, a woman put her 5-bedroom house up for sale for $1.1 million last September. In March she dropped the price to below $900,000 and still no takers. Now, in desperation, she’s putting the house up for auction. In another recent WSJ article, there’s the story of a Detroit woman who couldn’t get out of an option-ARM. She put her house up for sale last summer, asking nearly $400,000. No takers. Now she’s willing to accept as little as $270,000, even though her mortgage has $324,000 outstanding. In Florida, homes in a new housing development had a contract price of $490,000 but some buyers/speculators walked. One of these homes was recently sold by the builder for $315,000. The evidence is everywhere. There is a hard landing taking place in the US housing market as we speak. To make matters worse, apartments rents are increasing across the US after a 5-year lull in rental prices. This does not bode well for inflation, even with housing prices coming down. (Even though housing is 30% of CPI, it’s not housing prices that get counted—rather implied/owner-equivalent rents.)

The troubles aren’t just in the housing market, but in the financial world as well. Creative financing schemes cease working when interest rates go up and housing prices stop rising. Now the plethora of aggressive lending is threatening to derail the entire US financial system. 10% of homeowners now have zero or negative equity in their homes. 30% of homeowners who took out mortgages last year now have zero or negative equity. There is over $9 trillion of mortgage debt outstanding in the United States. Needless to say, a substantial amount of that debt is now at risk.

The main danger is with adjustable-rate mortgages, or ARM’s. It is estimated that over $2 trillion of these mortgages are due for an interest rate reset in the next two years. The ARM rate has risen substantially in the past year or so. Now the 1-year rate is 6%, whereas last June it was just over 4%. Many borrowers will be imminently faced with substantially higher mortgage payments. But this is not the worst of it. Two of the most popular hybrid mortgages in the past couple years have been interest-only and option-ARM mortgages. As we’ve mentioned above, these loans promised low mortgage payments in the initial years by delaying principal repayment. We’ve seen estimates that a third of new mortgages issued last year were of this variety. It is these borrowers that are due for the biggest shock. Not only are they facing higher interest rates, but also the repayment of principal which, in the case of an option-ARM, could be higher than the initial loan outstanding thanks to negative amortization. At least half a trillion dollars of these loans are due for a reset within a year. Countrywide Financial, the largest mortgage lender in the US, is sufficiently concerned to have sent thousands of letters to its customers warning them of a pending payment reset. Those with interest-only loans can face a payment increase of 50% or more. Those who have been making the minimum payment on an option-ARM (more than 7 out of 10 borrowers have chosen to do so) can face a mortgage payment that doubles or more! How’s that for sticker shock? Mortgage insurers are now pleading with regulators to place restrictions on these types of hybrids… but to no avail. It’s what invariably happens in a bubble—people are lured in only to have the rug pulled out from under them. We believe interest rate resets and the end of teaser financing periods not only threaten lending and insurance markets, but also threaten to flood the housing market with even more inventory for sale. This can only lead to a crash in housing prices.

Rising interest rates were bound to lead to the housing bubble’s demise, made all the worse by the financial recklessness that has pervaded the mortgage finance industry these past few years. Robert Toll, the CEO of homebuilder Toll Brothers, claims to have never seen a downturn like this one in the 40 years he’s been in business. He claims that each of the prior slumps he’s witnessed were preceded by a downturn in employment or some other macroeconomic variable. “This time, you’ve got low unemployment, you’ve got job creation, you’ve got a stable stock market and relatively low interest rates.” For how much longer, we would ask? Bruce Karatz, the CEO of KB Homes, recently called the housing market “very, very bumpy” with “tremendous hesitation” among buyers. Angelo Mozilo, the CEO of Countrywide, recently said “I’ve never seen a soft landing [in housing] in 53 years, so we have a ways to go before this levels out.” Ameriquest Mortgage, the biggest US subprime mortgage lender, plans to cut a third of its 11,000 workforce. Washington Mutual has also announced mortgage-related job cuts. Will these laid off workers be able to pay their mortgages? They won’t be alone. The fact of the matter is the housing bubble was a boon for the US economy. It is estimated that 50% of job growth in the US over the past five years has been housing bubble related, i.e., homebuilding, renovation, construction, real estate brokerage, mortgage finance, etc. The spin-off effects of this newfound wealth pervaded all aspects of the economy, consumer spending included. Now that the mania has come to an end, is it any wonder that the US economy is starting to show signs of sickness? Employment is slowing. Consumer confidence is weakening. People have leveraged themselves to the hilt, having used rising home prices to extract equity from their homes. Given the extent of the rise in housing prices, many average Joes were able to extract, say, $50,000 in cash. Think of how difficult it is for the average American to save $50,000 through normal means, namely, employment income. Very few are able to do it, even those with six-figure salaries. Now imagine this windfall gone, and the effect that is bound to have on the economy. With no equity, people are already starting to feel poorer. Wealth creation via a housing bubble will ultimately prove to be a sham. In our view, it’s a tautology that a hard landing in housing will mean a hard landing in the economy… and with it, a rough ride for the stock market as well.

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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; The CAC Group; Colliers; CB Richard Ellis; Grubb & Ellis; or Cornish & Carey—whom collectively represent over 45% of the 12.5 million square feet of space currently on the market. Those six firms have pledged their allegiance to over 270 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, CB, G&E and C&C control more space than nearly 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 24 years.

Dan Mihalovich (
Principal of Mihalovich Partners and Founder of The Space Place®

San Francisco Market Overview

Teflon Economy: Drinks On the House!

The feeling around town is a bit intoxicating. Everyone is bullish! Businesses are booming! VC funds are flowing! Tenants have been signing expensive deals around town—over 600,000 square feet of net growth in Q3—well into the old dot-com range of $60+ per square foot annual rates. Asking rental rates are up for direct and sublease space’throughout the Bay Area—and the euphoria in the landlord community can hardly be contained. Tenants, just give it up, shall we?! If you paid $35/sf for space last week, well, get ready! It will cost you $40/sf this week! Everyone enjoys a good party. Even biotech made a splash in the City this quarter with FibroGen’s 240,000 square foot, $50+ deal with Shorenstein in Mission Bay. Tishman Speyer has broken ground on its new 555 Mission office building and just announced its plan to “green” a 700,000 square foot new highrise on 2nd Street. Never mind that it will take an average of $60-$65/sf rent to justify new construction and that the current average asking rate for Class A space is ~$39.50/sf (slightly higher than when I started in this business, in 1982). Also ignore that, on average, Class A spaces-just-leased sat on the market for 21 months. Build on!

DÈj‡ vu, Tenants. An enormous wave of Kool-Aid drinking investors is ready to plow another $400-$500-$600+ per square foot into purchasing more of our highrises. Very deep in the pocket; very shallow on the market research to determine how much tenants can and will actually afford to pay for space. These will be your new landlords (if they haven’t come knocking already). Buyers are promising their investors rent increases of $10 per square foot per year within a few years; an additional $10/sf/yr just 3-5 years hence! Better be prepared, Tenants! Where shall we look around the country for an example of how much pain can be extracted from tenants? Local landlords say, “New York!” “$80/sf on average!” More Kool-Aid, please…and, yes, their numbers are incorrect.

Buyers of buildings have been rationalizing pricing with comparisons to the cost of new construction. If it now costs over $500/sf to build new, then anything less represents a coveted “discount”. But why does the market need more new buildings? Where is the research to prove out the demand base? Which of you are planning to pay $65/sf for space?!

We suppose that no one noticed that during the last 30 days of the quarter, each of our neighboring regions dumped a lot of new office space on the market:

  • San Francisco put over 700,000 square feet on the market;
  • San Mateo County put over 250,000 sf on the market;
  • Santa Clara County put over 1.1 million sf on the market;
  • Contra Costa & Alameda Counties put over 600,000 sf on the market.

Shouldn’t these additional supplies on the market weigh in your favor in negotiations? How many options do you have, now, in your marketplace? We’ve tracked this data for you. The ongoing supply of space is impressive (12+ million sf in San Francisco; 43+ million sf including San Mateo, Santa Clara and East Bay Counties), although the news of the upward trend in absorption has been dominating the news lately. The reaction? Over-reaction, if not mania-like. There’s no need to panic, folks.

By the way, you’ll note from our stats, below, that San Francisco average asking-rent for all-classes of space is running around $28.90/sf/year in our 103 million square foot market. CoStar reports these data points for a few other major cities around the country:

  • New York City: $47.46/sf/year (501 mil sf marketplace)
  • Boston: $23.26/sf/year (304 mil sf marketplace)
  • Chicago: $23.25/sf/year (370 mil sf marketplace)
  • Atlanta: $18.93/sf/year (237 mil sf marketplace)
  • Los Angeles: $26.89/sf/year (382 mil sf marketplace)

So, do you wonder where the hype comes from, suggesting that San Francisco tenants ought to be paying New York City rates? Historically the Big Apple trades at a huge premium to San Francisco…as it is now. But will the economy support either market’s gains?

Meanwhile, some economists and notable stock market pundits are talking about the “R” word. Will we discover six months from now that we’re in a recession today? GDP in Q3 was only 1.6%. The housing market—largely responsible for the largest slug of new jobs in the economy—has been crashing elsewhere, but alas, not in our local Teflon neighborhoods. Trends in unemployment figures are made by The Gov to look rosy as ever, at 4.4%…but after six weeks on the dole, you’re out of the survey. Why would The Gov ignore millions out of work? Well, if you couldn’t find a job within six weeks, then you’re either unemployable…or too wealthy to really need a job! Not to worry. Those factors never affect us here, in San Francisco. Right?

Raging Inflation May Stifle Tenant Demand

The Gov’s method of determining “Inflation” doesn’t do justice at all to what all of us are facing here in the San Francisco Bay Area marketplace. Low single-digits would be a godsend, but the harsh reality is that real inflation has been raging and it’s taking its toll on nearly everything we do. Business is competitive as ever. So, if your competitors signed their office leases in 2005 at $25 per square foot (representing 8% of their gross revenues) and you are compelled to sign in ’06 or ’07 at $35/sf (representing 11.2% of your gross revenue), you’ll have paid a forty percent premium for space vs. your competitors. It is really an understatement to say that rental rates have increased during the past 12-18 months. In fact, this local inflationary factor may bury some of your competitors. Inflation (which we’ve written about many times) eats into our 70%-consumer-driven economy. We fight harder to stand still, or we lose ground. In the example above, the party signing in ’06/’07 has far more to lose when one considers the raging inflation in building materials costs. Tenant buildout costs, which we focus on below, have soared—and landlords, in this tightening marketplace, have done little to absorb the change. TI allowances may have paid for nearly all of the tenant’s buildout in 2005. For the tenant signing in ’06/’07, perhaps 50% of the cost will be borne by the tenant. Let’s not forget that interest rates are substantially higher these days, too, so financing one’s TIs will be all the uglier.

Pity the tenant who has to come out of pocket ~$35/sf to pay for the balance of TIs not covered by the landlord’s allowance. Amortizing the expense over a 7-year lease, for example, will add another ~$6.25/sf/year to effective rent. Now your $35/sf lease really costs you $41.25/sf/yr (13.2% of your gross revenues)—vs. the $25 deal your competitors did in 2005. All in costs for the ’06/’07 tenant vs. the ’05 tenant? A sixty-five percent increase. Now that’s inflation.

Far in advance of your lease expirations, tenants, you should begin to do your research and plan out a strategy to deal with the dramatically rising costs of doing business in San Francisco. Landlords would be wise to do the same—but our job is to advise tenants, only. Landords and landlord-brokers (The CAC Group; Cushman & Wakefield; CB Richard Ellis; Cornish & Carey; Colliers; Grubb & Ellis; BT Commercial; etc.) will extract every pound of flesh possible from tenants in the marketplace. We can help you with your homework—and surround you with experts to advise you on all aspects of your planning and execution of an office lease renewal or relocation. Heavy negotiating experience will be required—and we are long in that particular area. We believe that the market is over-bought, over-excited and inflated to a level of unjustifiable expense for most businesses.

Landlords and landlord-brokers believe that tenants will “have to pay” higher rates because they say so. If you don’t pay more, the City will run out of space. Really?! If you don’t pay more, developers won’t be able to justify the $60-$65/sf rates necessary to build new buildings. That’s why you should pay more? Why not focus on what you can afford, and negotiate from that perspective. Perhaps you’ll enjoy a more successful result if you walk away from a deal or two in the course of negotiations. We strongly believe in free-market economics. Through our management of a competition amongst landlords for your business, we’ll flush out the most aggressive and sensible transaction terms for you. But subscribing to the hype ignores the most basic of fundamentals. There remains 12 million square feet on the market in San Francisco—and the number of options for most tenants is plentiful.

Stop Leasing Space in San Francisco

Tenants, the market is speaking to you and it’s saying: “Stop leasing space!” The markets are overheated and over-hyped by our friendly competitors (landlord-brokers, who will represent you, if you let them) who specialize in representing landlords’ space. Here are some of the telltale signs:

  • You learn that your neighbor in the same elevator bank recently signed a 5-year lease at $33/sf/year…but now the landlord is asking $40 for an adjacent parcel.
  • You’re interested in renewing your lease, which expires in Q1, 2008 and your landlord isn’t interested in talking with you. Why? It’s too early. Translation? The market is going to roar in their favor, so why give you a deal now?
  • Your landlord is eager to put your space on the market to see how tightly they can squeeze you, rather than first taking a healthy shot at figuring out how to renew your tenancy.
  • The building owner is contemplating selling your building, and assumes that they’ll get more for it if your space is vacant…than if you were to renew.
  • You realize that construction costs have skyrocketed and that you can’t possibly build out new space for anything less than $80/sf, plus all the soft costs. And landlords you negotiate with have no interest in contributing more than $40-$50/sf, if that.
  • Landlords start to get very sticky fingers when it comes to security deposits (3-6 months of rent +) or worse, personal guarantees; supervision fees (4-5% of the total job cost…and for what?); passing the buck to tenants to pay for common area improvements (PLEASE don’t do this); sharing of net profits from subleasing goes to anything other than 50/50; requiring restoration of the space to anything other than what you initially built; giving tenants audit rights to review the landlord’s books; giving tenants any protection against tax increases due on the reassessment of the building.

Until tenants do a better job to reign in over-exuberance at the negotiating table, landlords will consistently tighten the noose. Calm down. Call us. Let’s discuss your situation and begin to plan accordingly.

The Great Divide: Cost to Build Your Space vs. Landlord TI Allowances

With credit to Gary Wells of NOVO Construction, and several other contractors and architects we interviewed, let us enlighten you about the raging costs of building out space in this part of the country:

We asked a half dozen prominent general contractors and architects to describe their “average” project for us. If they could venture a guess, what is the average total cost of the construction? And how much of that total is coming from the landlord’s TI allowance? The numbers are, unfortunately, real…and will be shocking to some of you. Job costs—for professional firm buildouts in San Francisco—are averaging over $100 per square foot, with a maximum of $40-$50/sf coming from the landlord’s TI allowance. According to NOVO, the construction industry spent record amounts in 2005 ($1.12 trillion vs. $1.03 trillion in 2004)…and unprecedented demand will fuel soaring costs further. Hurricane damage and China’s dramatic expansion are leading sources of the rise in costs. NOVO’s tracking shows an 18% annual hike in costs for the past three years. Union labor charges are only increasing at 3-5%/year, but other cost increases are far more dramatic…Crude oil, up over 100% in three years—leading to a 15% increase in floor covering materials; and a 30% rise in plastics costs. Particle board and melamine up 30%, just this year. Steel up 38% since ’04. Copper up 125% in the past year. Cement and gypsum board up 12-15%. NOVO projects these costs to continue rising, taking their current $100/sf average cost buildout to over $150/sf in 2011!

NOVO’s research also asserts that schedules will be comprised, as tenants should expect delays in the delivery of materials; potentially resulting in holdover costs. They stress (as do we) the early mobilization of a Project Team to identify long-lead items, and the early procurement of critical materials. As we mentioned above, FAR in advance of your lease expiration you should give us a call to begin planning and strategizing how to deal with the soaring costs of doing business in San Francisco.

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, Q3 vacancy rates declined from 12% to 10.1%…a 19% change! But which size blocks of space are getting leased? 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.

Here’s an intriguing statistic for you. Bet you’ll be baffled:

In Q2 of 2001, Bay Area Counties had a supply of 42 million square feet available for lease on the market. Today the Bay Area markets have 44 million square feet on the market. Tenants in San Francisco have a LARGER number of parcels to choose from in today’s market than in Q2 of 2001—the period just before our markets crashed. Today, of course, the trend for absorption is “up”…but the stats should give you reason to wonder—what kind of Kool-Aid is the landlord community drinking? [In Q2, 2001, there were only 202 parcels of spaces available in the 5-10,000 sf range; only 173 parcels in the 10-20,000 sf range; and only 67 parcels in the 20-40,000 sf range.]

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 103 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 12.5 million square feet is now on the market in San Francisco. Of the top 7 companies, 5 are office leasing brokerage firms, controlling over 45% of the City’s vacancy! These brokerage firms are beholden to more than 270 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 leasing companies on the list control more of the City’s vacancy than Boston Properties (#9); Equity Office Properties, the country’s largest REIT (#10); and more than Hines (#12). 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 *The CAC Group 15.4% 2,029,099 45
2 *Cushman & Wakefield of California 12.8% 1,683,733 62
3 Shorenstein Company, LLC 7.9% 1,036,927 13
4 *Colliers International 7.5% 989,423 84
5 *CB Richard Ellis 5.3% 691,612 23
6 Tishman Speyer 4.6% 598,800 2
7 *Grubb & Ellis 4.4% 584,307 60
8 Cornish & Carey Commercial - ONCOR 3.8% 497,223 15
9 Boston Properties, Inc. 3.7% 489,381 4
10 Equity Office Management, LLC 2.9% 383,623 10
11 *TRI Commercial / CORFAC International 2.6% 343,606 36
12 Hines 2.4% 319,268 8
13 *Jones Lang LaSalle Americas, Inc. 2.2% 285,700 9
14 *Starboard TCN Worldwide Real Estate 1.7% 219,984 98
15 *Cushman & Wakefield Inc. / Letterman 1.5% 202,251 2
16 *Studley 1.5% 194,616 12
17 The Presidio Trust 1.0% 132,790 18
18 Charles Dunn Company, Inc. 1.0% 125,232 18
19 Strom & Associates 0.9% 122,631 9
20 The Staubach Company - Northern California, Inc. 0.9% 115,603 10
21 *Ritchie Commercial 0.9% 114,237 44
22 Pacific Eagle Holdings Corporation 0.8% 110,485 2
23 *GVA Kidder Matthews 0.8% 117,422 51
24 NAI BT Commercial 0.8% 102,533 23
25 Blatteis Realty Co. Inc. 0.7% 95,025 72
  All Others 12.0% 1,581,377
  Total   13,156,888  

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