Market Insight Editorial & Advice to Tenants: 2Q2011
In this Issue:
If you’re in search of intelligent life in the brokerage community…please enjoy this Editorial with my compliments. And, here are the last 10 years of pearls of wisdom.
Dan Mihalovich
President, Mihalovich Partners
Founder, The Space Place®
Office Leasing Comps. And Your Point is…?
True or false? Office leasing “comps”—the vague, incomplete and alleged details of completed transactions—tell one where the market is. False.
True or false? Comps are reliable information upon which to base one’s renewal of a lease. False again.
True or false? Comps provide an accurate basis for negotiating a lease with a start date of 9-12 months from now. False. See a pattern?
Comps are highly touted by commercial real estate firms. They’re part of the raison d’être to hire that firm, so says the firm with all the market “intelligence”. Granted, comps make interesting reading. If you’re a tenant, however, especially a tenant looking to hire an objective and aggressive broker to represent your interests (such as Mihalovich Partners), read on…
If managed properly, the renewal/relocation process should commence far in advance of the new lease term. The purpose of the long lead-time is not just to allow the luxury of time for tough negotiations with the landlord community, it’s to allow plenty of time for discussion about your business and prospects; team selection; creation of strategy, etc. Reaching out to your landlord, or others outside your building too far in advance can produce misleading information.
Without duress, many landlords will contrive the most hideous of lease comparables—those recently completed transactions—which in the landlord’s view make their case for where the market is headed.
We cannot describe in this space, without writing volume, how manipulative the “comps” data becomes.
Remember that lease transactions are NOT recorded, publicly. Lease transaction data is often shared between landlords, landlord-brokers and tenant-brokers. Nevertheless the data is founded on hearsay and is often reported incorrectly.
Does the landlord have an obligation to share its data and substantiate its claim of “fair” rent for tenants considering exercising a renewal option? Most frequently, not.
The standards of the lease, however, are founded on the spirit of good faith and fair dealing.
Is the door open for the parties to “cook” the “Fair Market Rent” clause? Absolutely. Isn’t there great risk to the tenant, to our clients, subjecting oneself to such a process? Absolutely.
Consider that concessions given to other tenants reflect deals negotiated by other brokers—not your broker; not for the quality/credit/longevity of your tenancy; and probably not for the timing of your tenancy.
We must underscore the likely pitfalls of subjecting one’s financial future to outside “comps” at all. Not only are there authorship issues, insofar as we are likely to negotiate better terms for our clients than other tenant-representation brokers, but the notion that a tenant MUST rely on deals already completed signals a locked-in loss for tenants in a falling market.
Why would a tenant voluntarily subject itself to setting a “fair” rent for a new deal 9-12 months hence (in a declining market) based on deals gone by?! Conversely, in a rising market, tenants should expect landlords to manipulate the comps to reflect only the most recent and most expensive comps.
Most renewal clauses are drafted in a manner which only obligates the landlord to propose “Fair Market Rent” in their reasonable discretion. In a rising market, if a single tenant in a single comparable building pays an egregious amount of rent, you can expect to hear from your landlord that that is the “fair” amount. Is the process contrived? Yes!
For those of you, tenants, who were attracted to your current space because once upon a time your landlord was under pressure to rid itself of an extended vacancy, and/or due to an unusual configuration of the space, perhaps inefficiency beware that the landlord’s view of the same space will change markedly during the determination of “Fair Market Rent” in a renewal or in an arm’s length new negotiation. All the reasons the space sat idly on the market for months or years before you signed on are forgotten. The concessions the landlord made to you at the outset of your lease, because no one else seriously considered that space? All forgotten.
In the “devious” category: “Fair Market Rent” means fair market rent for whom? Is the issue, “What will the market bear for this space, given its as-is condition for the specified length of years, considering comparable space in comparable buildings?” In other words, is the issue, “What will any ready, willing and able tenant be willing to pay….?” Or is the issue, “What should THIS tenant pay for its specific use in this made-to-order space for THIS tenant?”
The notion of “market” and fair determination of value must be determined by considering what a reasonable field of tenants would be willing to pay for such space.
How does one determine the value of an albatross? If a space is so unusual that its salvage value upon re-leasing to the open market is ZERO (i.e. the space will necessarily have to be demolished and rebuilt in order to re-lease the space), then the utility of the space, or lack thereof, must be considered as “Fair Market Rent” is determined. But in the contrived world of renewal-option clauses, landlords may surprise and disappoint you with distorted interpretations of basic English. Generally speaking, if the space looks and smells like a pig (you leased the space because it was a “steal”), it will be slaughtered once you vacate to another location. On the renewal, however, expect the landlord to perfume that pig. It’s in their interest to do so and you should avoid locking yourself into a renewal. Again, buyer beware.
The games continue, ad nauseam. For those of you considering exercising a renewal option, beside stating, “Don’t do it!” consider this:
- Tenant exercises the renewal option. Landlord floats their initial “reasonable” rental rate. Shock sets in. Why? Because the landlord refused to entertain any discussion about forecasted rent prior to the tenant exercising its option. After all, the tenant controls the renewal term, not the landlord.
- The landlord offered to discuss renewal terms, but only after the expiration date for the tenant to exercise its renewal option. The landlord’s shocking salvo appears just at the time the parties are to enjoy one another’s company in a 30-day (or so) period of “negotiations”. If the parties can’t agree to terms, or simply don’t want to, this period will lapse without progress. Typically, what ensues is another debate—this time between representative-brokers or appraisers of Tenant and Landlord.
- Surely they will resolve the mess, or else! Or else what? Or else both parties risk turning over complete control to a 3rd broker or appraiser, whose qualifications are known but oftentimes little more as to how that person will actually resolve the dispute between the parties. One must rely on the negotiated and imperfect language of the lease to spell out the role and process for the 3rd broker/appraiser.
Even if the process were perfect, tenants, how can this contrived process result in a conservative and controlled determination of your company’s financial future?
The reliance upon “comps”, whether for renewal or relocation purposes, can be misleading and does not constitute astute fiduciary duty to one’s shareholders.
Our clients enjoy their financial stature resulting from years of hard, smart work and planning. In an open market transaction, we can negotiate an outcome to a renewal or relocation transaction of far higher quality by blazing our own trail and focusing on what our clients can afford—not based on what others have paid.
Our clients have leverage and we know how to use it. Exercising renewal options simply leaves a lot of money—and time—on the table. And we hate leaving money on the table.
Office Leasing Strategy: Plan. Renew? Relocate? Which Broker and What Should They Do for Me?
“Our office lease is due to expire…Renewal or relocation is possible, but what is the best course of action going forward?” What should you do, tenants?
The Opportunity
Don’t assume that your next office leasing transaction will be anything like your last negotiation. There is FAR MORE AT STAKE in this economy and a great deal more strategy will be required in order that your organization is able to survive—and hopefully thrive—during your next lease term.
Due to the down turn in the economy, some of you may require an early renegotiation of your current lease to allow your company to sustain its profitability, maintain your personnel count and focus on other cost-saving strategies. This will be an opportune time to accomplish these goals.
Strategy Sessions
It normally takes between 12-15 months of planning to either effectively renew one’s lease or execute a relocation to a new site for a tenant of 10-20,000 square feet or so (longer for larger tenants).
However, if your company has encountered critical problems, you’ll need to condense this process dramatically to delve into the really tough issues facing you in your next set of decisions.
- First, hire your tenant-representation broker (conflict-free, never representing landlords) [Mihalovich Partners] and assemble your representative Management team.
- We’ll help you to assemble the rest of a Strategic Team, including an architect/space planner; team general contractor; a furniture consultant; your IT specialist; and any other primary consultants necessary to launch a strategic study about your current and future occupancy needs. Everything about your office leasing needs should be on the table for discussion, since the assortment of expenses have risen so dramatically since your last negotiation.
- HR will play an ever more critical role on this next lease. Careful examination should be made not only of current and prospective employee home-locations, but also to perform a study to detect employee sensitivities to relocating to either “suburban” areas of San Francisco, or to outlying counties or potentially out of State.
- Telecommuting, hoteling and ”hot-desking” should be explored. To what extent, if any, could your organization “export” its full-time and/or part-time employees to either work in the field and/or at home. It may become feasible to build out and furnish work spaces in home offices—potentially to even contribute or pay the entire cost of retrofitting an employee’s home to accommodate a work space. Parking and transportation costs should be considered as well as the organization’s carbon “footprint”.
Furniture
Tenants/clients are relieved to know that we’re here to assist you with Renewal negotiations…not just to orchestrate the competition for your business amongst several outside building owners. Your current landlord must compete for your business, too.
Those of you requiring an early renegotiation should expect that we will approach your landlord, immediately, to make concessions to relieve your pressure. During these strategy sessions, the conversations may focus on what you know best—the space you currently occupy—with all of its benefits and challenges.
Before assuming that your existing space is too large, too small or that it can’t possibly be renovated to accommodate additional growth, let your team explore all the possibilities:
- Fact-gathering has to be done very early on. It may turn out that buying all new furniture and phasing a renovation of your space, while you occupy it, may be less expensive than relocating. You simply won’t know if you don’t do your homework. New furniture systems may be more efficiently laid out than when you last shopped systems.
- Given a choice between new furniture systems and keeping the old, but relocating to an inferior location, your management team and employees may opt to renew and “refresh” the space. You may explore “green” systems, as well as “green” paint and carpet tiles.
- Explore the democratic nature (or lack thereof) of your organization. You may decide to demolish some or all of the private offices in favor of creating more efficient space—adding more people without taking more space—opening up the light and views to more employees, too.
- The new lease—even a renewal—is a good opportunity to purge old files and examine all storage capacities and efficiencies. Off-site storage should be examined. Can more office space be created within your premises by creating either central files and/or taking storage off-site? Is condensed filing an option, even if it takes adding structural elements to the floor/walls/ceiling, if it saves office space rent? New furniture systems are more efficient, all-around. They are built to handle “modern” filing; new telecom equipment and power; and can generally be moved within the office with greater ease than the old systems.
Remember, we are planning for the future, too. One should maintain as much flexibility as possible.
Operating Expenses and Tax Assessments
Long before your lease is due to expire (as we recommended, above), in your strategic assessment of your current building, your broker [Mihalovich Partners] should review the history of operating expenses and tax pass throughs from the landlord. Each and every building you will consider during the landlord-“contest” for your business will provide us with their operating expenses past and projected; and we can verify the tax status and the currently assessed value of the property.
- With many months still running on your lease, it will be time to close out any “old” issues with the landlord before getting on to the “new”. Have you been overcharged for operating expenses all these years? How do you know? Did you ever exercise your right to audit the landlord’s books? We have an article for you to read on this topic, but suffice it to say that you need to “square up” with the landlord and collect on any overcharges before entering into renewal discussions.
- Under Proposition 13, your landlord’s real estate taxes and, therefore, their billings to you should not have increased more than 2% a year. Local San Francisco legislation changed in a recent election. Tax re-assessments on sale or transfer of ownership increased from 1.5% to 2.5%. This issue can be severe for tenants, and must be clearly understood at senior management levels.
- Understanding and quantifying your current building expenses—and the forecasts—will lay the groundwork for your team to assess all of the competing buildings in our comparison matrix. The grass may not be greener as ugly as it may appear in your current building. Total expenses —and the ensuing pass throughs—may be a lot more expensive at other buildings. The process we lead you through will flush it all out.
Operating expenses and tax bills are just a couple of the many line item budget points for us to consider as we calculate your projected total occupancy costs for renewal versus several relocation alternative sites.
The Architect’s Job: What are you after? Efficiency?
Plan, plan, and plan some more, as we described above. It cannot be overstated at this time and in this economy. There is far too much money at stake. In fact, your business is at stake.
The Tenant-Team Architect will assist us in many ways, not the least of which is to interview all key management team personnel to produce a working-document: “The Program” — your space needs, as defined by you and told to your skilled architect/space planner.
Your current space, if at all a possibility for renewal, should be carefully examined by your architect to explore any and all productive ideas for renovating to create additional efficiencies—all juxtaposed to your Program. Your architect will likely see opportunities that the rest of us cannot. They’ll also examine the way you do business…
- How do people and traffic flow in your space? Are the current and projected adjacencies appropriate?
- What are you losing, if anything, being on more than one floor?
- Could it make sense to departmentalize and locate a “support” or “service” group on a lower floor? In a nearby building? In a suburb? Can your IT people support such a split? Will morale allow it, even if the economics make sense?
- What flexibilities are there in your Program? These areas should be well defined, if possible, since many a landlord in the marketplace will be quite rigid about offering expansion or contraction options. How tightly can you manage if you feel compelled during negotiations to gravitate toward lower square footage alternative sites? Your architect will need your direction on these fronts, to be prepared to react to highly expensive construction costs/higher rental rates.
- Examine after-hours usage. In our experience, the vast majority of building owners do not know how to calculate their actual costs for providing after-hours HVAC service, beyond the basics of the cost of union labor to run the system. Power-usage calculations are complicated, but we want to ensure, at a minimum, that you’re only charged at-cost—without markup. Most often these landlord charges are arbitrary. Your architect and contractor should explore ways to create more efficient systems within your premises...all to minimize the extraordinary costs of after-hours occupancy. Using just three hours of “extra” air conditioning per day, at, say $150/hour, would cost you over $540,000 during a five-year lease. Can we save some money…and energy?
Negotiate. Then Negotiate some more. Then…well, just hire us.
If you’re a tenant of size (in San Francisco that generally means greater than 10,000 square feet), you’ll be respected by most of the landlord community. Most of you, though, do not live in the world of negotiating as we do…and it’s not only OK to entrust us with this fiduciary responsibility on your behalf…you should find great comfort in doing so, knowing that our Principal, Dan Mihalovich, has handled over 200 representation assignments in his 29 years in the San Francisco leasing community.
As you’ve read this Editorial, written by Dan, and reviewed his 40+ letters of recommendation, do you get the sense that we’re on to something important—tracking these issues, trying to prepare you for your upcoming project? Negotiating the business terms and lease will be “the meat” of it. We will have you simultaneously pursue at least three buildings, if not five, including a renewal if possible and desirable. Do we need all five to meet the best of the best of terms in order for your project to be successful?
- Only one alternative, assuming that all of your short-listed buildings are serious contenders, needs to be the “perfect fit”. After all, you will sign only one Letter of Intent, not more, in the building where you decide to spend your future.
- The most aggressive, straightforward, eager and forthcoming landlord usually rises above the rest fairly early in the process. However, one must keep one’s options open until you are ready to make a commitment.
- Our letters of intent are usually more thorough than any of our competitors. Why? There are scores of business issues, and the purpose of a Letter of Intent is to flush out and identify ALL of the important business issues…leaving the balance of legal issues to be reviewed during lease documentation. We do not “bury” or defer important points to a later date after LOI execution, when much of the leverage is diluted. Leverage is paramount. Repeat. Leverage is paramount.
- Time, and the availability of time, is paramount to creating a successful negotiation. Do not delay the entire strategy process or subsequent processes because you think your lease expiration date is too far out. It’s never too early to create the strategy we referred to above. Use the extra time to your advantage. We should not be rushed through this process. You’ll have one chance to have your transaction put together on time, on budget, and managed by us in the most methodical and productive way for everyone.
- All options will be considered for renewal and relocation sites, provided that you want to pursue a renewal or relocation within your building. Perhaps the expansion space you desire isn’t currently available through the landlord. OK. But we’ll pursue all options, including those that may become available through other tenants in your building. Your landlord may not be an interested party if the best deal is for you to pursue expansion space into another tenant’s space in the building! Be flexible. Be creative. We’ll explore all the options together
- Creative brokerage is paramount. We have dozens of examples to share with you. We’re here to save you lots of time and lots of money…no matter the market conditions.
- Focus from your broker is paramount. Unlike our competitors, we’re focused on a small number of deals each year—and we always, exclusively, represent tenants.
It’s OK to be demanding. We’re used to it. We’re up to it and we’re ready to help you.
Vacancy Rates: Are Your Options Fading?
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 fading as a result of leasing activity? Review the chart, below, and let’s discuss.
| Blocks of Space Available (sq.ft.) | San Francisco County | San Mateo County | Santa Clara County | East Bay Counties | Total Change in # of Blocks Available | |||||
|---|---|---|---|---|---|---|---|---|---|---|
| Q2’11 | Q1’11 | Q2’11 | Q1’11 | Q2’11 | Q1’11 | Q2’11 | Q1’11 | Q2’11 | Q1’11 | |
| 5,000-9,999 | 283 | 297 | 152 | 151 | 292 | 304 | 451 | 442 | 1,178 | 1,194 |
| ▼ 5% | ▲ 1% | ▼ 4% | ▲ 2% | ▼ 1% | ||||||
| 10,000-19,999 | 203 | 210 | 83 | 88 | 151 | 148 | 188 | 187 | 625 | 633 |
| ▼ 3% | ▼ 2% | ▲ 2% | ▲ 1% | ▼ 1% | ||||||
| 20,000-29,999 | 48 | 54 | 21 | 25 | 56 | 61 | 67 | 62 | 192 | 202 |
| ▼ 11% | ▼ 16% | ▼ 8% | ▲ 8% | ▼ 5% | ||||||
| 30,000-39,999 | 32 | 31 | 18 | 20 | 13 | 20 | 21 | 22 | 84 | 93 |
| ▲ 3% | ▼ 10% | ▼ 35% | ▼ 5% | ▼ 10% | ||||||
| 40,000-49,999 | 18 | 19 | 10 | 11 | 23 | 21 | 19 | 21 | 70 | 72 |
| ▼ 5% | ▼ 9% | ▲ 10% | ▼ 10% | ▼ 3% | ||||||
| 50,000-59,999 | 13 | 11 | 5 | 5 | 13 | 14 | 6 | 4 | 39 | 34 |
| ▲ 18% | 0% | ▼ 7% | ▲ 50% | ▲ 15% | ||||||
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 dan@TheSpacePlace.net.
Who Has the Most Incentive to Drive Up Rental Rates In San Francisco?
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? Who’s marketing the most space in San Francisco?
Below we’ve surveyed the entire 113 million square foot inventory of San Francisco, and illustrated the Top 25 companies listing the most space on the market. Of the top 9 companies, 8 are office leasing brokerage firms, controlling 65% of the City’s vacancy!
These brokerage firms are beholden to more than 400 local landlords, paid to drive up rental rates and drive down concessions for tenants.
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 Tishman Speyer, Shorenstein, RREEF, Boston Properties and Hines. 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 | 14.2% | 2,942,528 | 69 |
| 2 | *Cornish & Carey Commercial Newmark Knight Frank | 10.4% | 2,148,885 | 42 |
| 3 | *Cushman & Wakefield of California | 9.1% | 1,896,245 | 57 |
| 4 | *Jones Lang LaSalle | 7.1% | 1,477,074 | 35 |
| 5 | *Colliers International | 6.0% | 1,246,326 | 79 |
| 6 | Shorenstein Company, LLC | 5.2% | 1,069,959 | 9 |
| 7 | *Kidder Mathews | 5.0% | 1,037,203 | 38 |
| 8 | *Grubb & Ellis | 5.0% | 1,029,180 | 58 |
| 9 | *CB Richard Ellis | 4.4% | 906,128 | 26 |
| 10 | Tishman Speyer | 2.7% | 558,165 | 5 |
| 11 | TMG Partners | 2.2% | 447,892 | 2 |
| 12 | Boston Properties Limited Partnership | 1.6% | 336,888 | 4 |
| 13 | Hines | 1.6% | 334,413 | 7 |
| 14 | Beacon Capital Partners, LLC | 1.5% | 307,000 | 1 |
| 15 | Stockbridge Capital Group, LLC | 1.4% | 281,982 | 1 |
| 16 | McCarthy Cook & Co. | 0.9% | 196,284 | 2 |
| 17 | The Presidio Trust | 0.9% | 186,067 | 44 |
| 18 | *TRI Commercial / CORFAC International | 0.9% | 180,893 | 51 |
| 19 | *Cassidy Turley BT Commercial | 0.8% | 166,982 | 18 |
| 20 | *Sansome Street Advisors | 0.7% | 141,430 | 9 |
| 21 | *Starboard TCN Worldwide Real Estate | 0.6% | 121,751 | 53 |
| 22 | McLellan Commercial Real Estate,Inc | 0.4% | 85,629 | 4 |
| 23 | QAV Realty Services | 0.3% | 63,869 | 1 |
| 24 | JRT Realty Group, Inc. | 0.3% | 59,633 | 1 |
| 25 | *Colton Commercial & Partners | 0.3% | 58,984 | 20 |
| Total | 20,739,553 | |||
