Market Insight Editorial & Advice to Tenants: 4Q2009

Why I’m Still Bearish…

  1. Office Market Fundamentals Are Weak and Getting Weaker.
    Read “Office Markets: The Crash Is ON”, below.
  2. Ten-Year Supply of Office Space.
    Homes sales were “up” 5% in 2009, yet there remains a “glut” of 3.2 million new and existing unsold homes. Adjusted for inflation, pricing was the lowest in 12 years. Sales prices for median existing homes hasn’t risen since 2005…in real dollars. New single family home sales in 2009 were at the lowest level since 1963. “Glut” is in quotation marks, since the 7-8 month supply of housing looks like a cake-walk relative to the massive glut of commercial office space on the market around the country—and in San Francisco. The City has 20 million square feet on the market, surrounded by 45 million square feet available in competing neighboring counties. Without any further downturn in tenancies, we may be witnessing a 10-year supply of office space.
  3. How Can the Economy Possibly Grow?

    How can the economy possibly grow when the banking industry has drained more than $3 trillion of credit during the past fifteen months? Yes, interest rates are historically cheaper than ever, which has been a huge windfall for the banking community; but banks have not fundamentally changed the way they do business.

    How about the “Making Home Affordable” program…intended to help troubled homeowners to modify their mortgage terms? According to the Treasury Department, less than 1% of the applicants’ mortgages have actually been permanently modified.

    The nation’s largest banks are doing exceptionally well, with over $50 billion in profits and bonuses during the first three quarters of 2009. But 140 banks failed (vs. 25 in 2008). FDIC expects failures to peak in 2010, with a projection of $100 billion toward bank failures 2009–2013.

    Estimates are that banks, during the next few years, will have to absorb ~$900 billion in real estate losses. It’s no surprise that there is a steady flow of news reports of massive commercial real estate defaults around the country. And what of the banks too big to fail? What fundamental change or protections have originated from Washington? As I’ve said many times—it’s all about the most powerful lobby on the planet: the Wall Street Lobby. They have things well tied up in DC.

  4. California Junk / Cost of Financing Trillions of Fed Debt

    California’s State deficit bottom line is bottom-less: After slashing and burning last year to close a $62 billion gap, this year’s legislators are facing another $26 billion in the hole…and likely growing as business receipts decline and tax income declines from lower, reassessed property values. And the national debt, now over $14 trillion?

    Here’s what Edmund Andrews, NY Times, had to say about it:

    The government faces a payment shock similar to those that sent legions of overstretched home-owners into default on their mortgages….The White House estimates that the government’s tab for servicing the debt will top $700 billion a year in 2019, up from $202 billion in 2009…even if annual budget deficits shrink drastically….In concrete terms, an additional $500 billion a year in interest expense would total more than the combined federal budgets this year for education, energy, homeland security and the wars in Iraq and Afghanistan.”
  5. “…Little Hope of Escaping Rehab” by William H. Gross, Managing Director, PIMCO:

    Now that a semblance of stability has been imparted to the economy and its markets, the attempted detoxification and deleveraging of the private sector is underway. Having survived due to a steady two-trillion-dollar-plus dose of government “Red Bull,” Adderall, or simply strong black coffee, the global private sector is now expected by some to detox and resume a normal cyclical schedule where animal spirits and the willingness to take risk move front and center. But there is a problem. While corporations may be heading in that direction due to steep yield curves and government check writing that have partially repaired their balance sheets, their consumer customers remain fully levered and undercapitalized with little hope of escaping rehab as long as unemployment and underemployment remain at 10-20% levels worldwide. “Build it and they will come” is an old saw more applicable to Kevin Costner’s Field of Dreams than to today’s economy. “Say’s Law” proclaiming that supply creates its own demand is hardly applicable to a modern day credit-oriented society where credit cards are maxed out, 25% of homeowners are underwater, and job and income creation are nearly invisible….

    Each of several distinct developed economy bond markets presents interesting aspects that bear watching: 1) Japan with its aging demographics and need for external financing, 2) the U.S. with its large deficits and exploding entitlements, 3) Euroland with its disparate members—Germany the extreme saver and productive producer, Spain and Greece with their excessive reliance on debt and 4) the U.K., with the highest debt levels and a finance-oriented economy—exposed like London to the cold dark winter nights of deleveraging.

    Of all of the developed countries, three broad fixed-income observations stand out: 1) given enough liquidity and current yields I would prefer to invest money in Canada. Its conservative banks never did participate in the housing crisis and it moved toward and stayed closer to fiscal balance than any other country, 2) Germany is the safest, most liquid sovereign alternative, although its leadership and the EU’s potential stance toward bailouts of Greece and Ireland must be watched. Think AIG and GMAC and you have a similar comparative predicament, and 3) the U.K. is a must to avoid. Its Gilts are resting on a bed of nitroglycerine. High debt with the potential to devalue its currency present high risks for bond investors. In addition, its interest rates are already artificially influenced by accounting standards that at one point last year produced long-term real interest rates of 1/2 % and lower.”

  6. “Fed Reserve’s Flow of Funds Report…All Starting to Resemble One Giant Ponzi Scheme” by Eric Sprott & David Franklin

    In the latest Treasury Bulletin published in December 2009, ownership data reveals that the United States increased the public debt by $1.885 trillion dollars in fiscal 2009. So who bought all the new Treasury securities to finance the massive increase in expenditures?

    The first was “Foreign and International Buyers”, who purchased $697.5 billion worth of Treasury securities in fiscal 2009—representing about 23% more than their respective purchases in fiscal 2008. The second group was the Federal Reserve itself. According to its published balance sheet, it increased its treasury holdings by $286 billion in 2009, representing a 60% increase year-over-year.

    So who was the third large buyer? Drum roll please,… it was “Other Investors”. After purchasing $90 billion in 2008, this group has purchased $510.1 billion of freshly minted treasury securities so far in the first three quarters of fiscal 2009. If you annualize this rate of purchase, they are on pace to buy $680 billion of US treasuries this year—or more than seven times what they purchased in 2008.

    This is undoubtedly the group that made the US deficit possible this year. But who are they?

    Do you think anyone in that group had almost $700 billion to invest in the US Treasury market in fiscal 2009? We didn’t either.

    To our surprise, the only group to actually substantially increase their purchases in 2009 is defined in the Federal Reserve Flow of Funds Report as the “Household Sector”. This category of buyers bought $15 billion worth of treasuries in 2008, but by Q3 2009 had purchased a whopping $528.7 billion worth… which puts them on track purchase $704 billion for fiscal 2009.

    Amazingly, we discovered that the Household Sector is actually just a catch-all category. It represents the buyers left over who can’t be slotted into the other group headings…. amounts held or owed by the other sectors are subtracted from known totals, and the remainders are assumed to be the amounts held or owed by the Household Sector. To quote directly from the Flow of Funds Guide, “For example, the amounts of Treasury securities held by all other sectors, obtained from asset data reported by the companies or institutions themselves, are subtracted from total Treasury securities outstanding, obtained from the Monthly Treasury Statement of Receipts and Outlays of the United States Government and the balance is assigned to the household sector.” ….So to answer the question—who is the Household Sector? They are a PHANTOM. They don’t exist. They merely serve to balance the ledger in the Federal Reserve’s Flow of Funds report. Our concern now is that this is all starting to resemble one giant Ponzi scheme.

    It serves to remember that the whole point of selling new US Treasury bonds is to attract outside capital to finance deficits or to pay off existing debts that are maturing. We are now in a situation, however, where the Fed is printing dollars to buy Treasuries as a means of faking the Treasury’s ability to attract outside capital. If our research proves anything, it’s that the regular buyers of US debt are no longer buying, and it amazes us that the US can successfully issue a record number of Treasuries in this environment without the slightest hiccup in the market. Perhaps the most striking example of the new demand dynamics for US Treasuries comes from Bill Gross, who is co-chief investment officer at PIMCO and arguably one of the world’s most powerful bond investors. Mr. Gross recently revealed that his bond fund has cut holdings of US government debt and boosted cash to the highest levels since 2008….The fact that he is now selling US Treasuries is a foreboding sign.

    As we have seen so illustriously over the past year, all Ponzi schemes eventually fail under their own weight. The US debt scheme is no different. 2009 has been witness to spectacular government intervention in almost all levels of the economy. This support requires outside capital to facilitate, and relies heavily on the US government’s ability to raise money in the debt market. The fact that the Federal Reserve and US Treasury cannot identify the second largest buyer of treasury securities this year proves that the traditional buyers are not keeping pace with the US government’s deficit spending. It makes us wonder if it’s all just a Ponzi scheme.

Office Markets: The Crash Is ON.

I assume that our readers are very well read and versed on major matters of the economy—nationally and locally. However, much remains to be analyzed and articulated in ways that benefit you—our clients and prospective clients (all commercial tenants)—at the negotiating table with landlords. The result is a market commentary and editorial combining my 30 years of business and negotiating experience and the sage advice of a number of outside experts like Bill Gross, Eric Sprott and other high-level sources you’ll respect. The business “news”, murky and depressing as it may be, must be reduced and crystallized for our purposes in negotiating office leasing transactions. If you can’t effectively argue your positions with a building owner, you’ll be run over long before you’ve pounded the first nail of your new improvements. So, here you are:

Building owners will need to look to 2012 and beyond for signs of any true “recovery” from the Great Recession. In the meantime, that spells opportunity for you. Let’s talk over lunch about the impact on your tenancy.

  • Of the 64 million square feet of office space currently on the market in the San Francisco Bay Area, nearly all of it has been sitting on the market for over 21 months.
  • As you’ll see from our statistical reports (covering all San Francisco Bay Area counties), total Net Absorption in EVERY market throughout 2009 was…negative…meaning less than zero. All told, taking into account all office leasing activity quarter by quarter, tenants and landlords combined to put more space on the market than the total of what was leased. Got it?
  • Landlords would prefer the Dot-Bomb markets to present conditions. Why? Not only do tenants have more options to choose from today than back in 2001, but landlords are suffering with negative absorption far more as a percentage of total negative absorption than they did back then. Look:

    Today, landlords’ losses in direct space in San Francisco accounted for 91% of the total loss; tenants’ sublease net absorption loss accounted for 9%. Back in the Dot-Bomb period, however, landlords’ losses only accounted for 56% of the total loss of growth. This comparison holds true for neighboring counties as well. Landlords are taking the brunt of the losses, relatively speaking. It should be noted, however, that sublease vacancies have been steadily rising every quarter since 2Q 2008.

  • Vacancy = % of what? Pay attention to the overall size of our markets—because they’ve grown! So, when we talk of 20% vacancy, what does that really mean? Look…since 1997:
    • San Francisco’s office market grew by 6M s.f. to 113M (up 6%)
    • San Mateo County’s market grew by 16M s.f. to 46M (up 53%)
    • Santa Clara County’s market grew by 28M s.f. to 107M (up 35%)
    • Alameda & Contra Costa Counties’ grew by 19M s.f. to 111M s.f. (up 21%)
  • Average asking rental rates for all classes of space are too high and should decline to at least pre-Dot-Com levels. Overall economic fundamentals today are far weaker than during 1997/1998. In addition, the overall basis of ownership of commercial real estate lies in the hands of weaker and more troubled principals and lenders today—than ever before. Tenants, who control the supply-demand balance, are struggling for their livelihoods at these rental levels.
    San Francisco avg. annual asking rates, gross: $27.50
    San Mateo County: $31.01
    Santa Clara County: $25.18
    Alameda & Contra Costa Counties: $22.28

    “Guarding the Henhouse…” cont’d

    On last quarter’s topic of “Guarding the Henhouse: Absurd Conflicts of Interest”, we add the following from Andrew Ross Sorkin of the New York Times:

    For years, Wall Street whispered that Goldman Sachs profited handsomely by trading ahead of—or even against—its own clients….A Goldman executive made an unusual admission that, in some cases, the rumors were true.

    Is this an ethical standard of openness and integrity that you expect from your office leasing broker and his/her company? Tenant beware.

    Hiring the Young, Investing in Our Future

    Real unemployment continues to climb; and to be grossly under-reported. Consumers are out of gas…and credit. But as you contemplate unemployment in the U.S. and abroad, consider that our young people (under 25) are now nearly 20% unemployed—and more than twice that rate in Spain. And what does that have to do with the price of office space in San Francisco? Everything. Approve or not, young folks were our base during rapid growth periods like the Dot Com. If we can’t afford to hire these bright and well educated youngsters in the Bay Area, they’ll move somewhere affordable or resort to work for minimum wage and live at Mom & Dad’s until the smoke clears. Think organically. Buy local.

    If Your Lease Will Expire Within the Next Three Years…

    Or if there is another compelling reason to discuss your firm’s office leasing situation, please call us. For qualified tenants, we offer the following pre-contract services:

    • Free preliminary office lease and operating expense review;
    • Free consultation to discuss project management, team formation and project schedule;
    • Market surveys and our specific tenant-driven leasing recommendations; and
    • Assistance in selection and coordination of all team members throughout planning and negotiation phases.

    Vacancy Rates: Are Your Options GROWING?

    Tenants should watch carefully to detect how and to what extent your field of options changes. 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 growing, as a result of leasing inactivity? Review the chart, below, and let’s discuss.

    Here’s an intriguing statistic for you…I 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 64 million square feet on the market. Tenants in San Francisco have a much larger number of parcels to choose from in today’s market than in Q2 of 2001—the period just before our markets crashed. Today the trend for absorption has turned “down”…and the stats should give you reason to wonder—what kind of Kool-Aid has the landlord community been drinking?

    [In Q2, 2001, there were only 202 parcels of spaces available in San Francisco in the 5-10,000 sf range; 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

    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 113 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 19.49 million square feet is now on the market in San Francisco. Of the top 8 companies, ALL are office leasing brokerage firms, controlling 65% of the City’s vacancy! These brokerage firms are beholden to more than 300 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 brokerage companies on the list control more of the City’s vacancy than Shorenstein (#9); RREEF (#10); Hines (#11); and more than Tishman Speyer (#14). Surprised, are you not?

    % Market Share Square Feet # of Landlords/ Buildings

    The % in the chart below 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 landlords/developers.

    1 *The CAC Group 13.3% 3,155,092 58
    2 *Jones Lang LaSalle 11.7% 2,777,484 27
    3 *Cornish & Carey Commercial—ONCOR 8.1% 1,907,342 24
    4 *Cushman & Wakefield of California 7.5% 1,766,978 60
    5 *Colliers International 7.2% 1,708,089 78
    6 *CB Richard Ellis 6.7% 1,573,643
    7 *Grubb & Ellis 5.7% 1,357,574 28
    8 *GVA Kidder Mathews 4.8% 1,130,273 38
    9 Shorenstein Company, LLC 2.1% 506,473 7
    10 RREEF America LLC 1.7% 400,000 1
    11 Hines 1.6% 386,682 9
    12 Newmark Knight Frank 1.6% 383,133 14
    13 Beacon Capital Partners, Inc. 1.3% 307,000 1
    14 Tishman Speyer 1.3% 298,021 3
    15 Boston Properties Limited Partnership 1.2% 283,536 4
    16 Retail West 1.0% 240,000 1
    17 McCarthy Cook & Co. 1.0% 234,097 3
    18 The Presidio Trust 0.9% 209,966 46
    19 *NAI BT Commercial 0.9% 206,698 27
    20 *TRI Commercial / CORFAC International 0.8% 178,343 50
    21 HC&M Commercial Properties, Inc. 0.6% 136,470 19
    22 Johnson Hoke Ltd 0.5% 127,167 7
    23 *Colton Commercial & Partners 0.5% 121,440 22
    24 Starboard TCN Worldwide Real Estate 0.4% 98,062 69
    25 JRT Realty Group, Inc. 0.3% 82,185 1
      Total   23,659,064  

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