News Clipping Office Tenants Shun Tenants’ Market Some landlords resist taking steps to entice business to commit to space. By John McCloud
The Registry
March 2009

From a technical standpoint, the Bay Area office market is a tenants’ market in 2009. Vacancy is climbing, rents are falling and landlords are looking for innovative ways to lure new tenants and to keep the ones they have. But try telling a broker specializing in tenant representation how great things are, and you’ll hear a different story.

“Business is pretty slow right now,” says Eric Risberg, principal of the Skyscraper Group Inc., a tenant rep firm in San Francisco. “Space is available, and you can get some good rates, but not much is happening.”

The main problem he sees is that businesses are afraid or unable to act. The first group is reluctant to commit because of uncertainty about their own prospects, combined with the difficulty of securing loans or capital to fund growth. The second group is facing cutbacks if not actual dissolution. Rather than seek new space, these tenants want to rid themselves of what they have, or at least a part of it.

The result is stalemate. Deals may be out there, but few tenants are stepping forward to take advantage. Most tenants, says Risberg, opt to stay put rather than scout the market for the best opportunities.

“Tenants are in a position where they can renew their leases at better rates if they want to. And most of them choose that route, especially since landlords are willing to offer space shortterm,” says Risberg. Th is provides companies the chance to delay major business decisions until the economy settles enough for them to feel confident about their future.

A secondary problem, he says, is landlords’ reluctance to face reality, particularly landlords who bought at the market’s top.

“They have to justify their purchase price, which is astronomically high. They’re still asking $60 [a square foot] and up in a market where it’s hard to get $40. They’re going to have to drop the rates if they’re going to get tenants,” he says. But landlords in general are slow to take the steps needed to land tenants, he says.

“The market is still lagging behind on giving concessions. There are times in the past when landlords have given much more. You can get free rent, but there’s not a lot of tenant improvement dollars. There’s still a ways to go to make buildings really attractive to tenants,” he says.

Tenant improvement money, however, may be the least likely concession, says Vincent Schwab, vice president of investments at Marcus & Millichap Real Estate Investment Services in San Francisco. Landlords typically depend on their lenders to underwrite TI design and construction, but lenders today generally refuse to pour additional funds into buildings that are not performing well.

Dan Mihalovich, a tenant rep and principal of San Francisco-based Mihalovich Partners, believes landlords will ultimately be forced to adapt to tenant demands, though he concedes they may have to be dragged to that point.

“It’s the consumer and commercial tenants who will dictate the plight of the commercial real estate markets, not building owners, no matter how much landlords paid for their buildings,” he says. “The market fundamentals will always prevail over time.”

In Mihalovich’s opinion, tenants have significantly more clout than they realize, not just now but most of the time. He considers brokers partly at fault for this, because they do not press landlords for more on behalf of the tenants.

“In the 26 years I’ve been in the real estate business in San Francisco, probably 21 years have been a tenants’ market,” he says. “The exceptions were the dot-com boom and ‘06 and ‘07. Tenants can definitely get more than they’ve been led to believe.”

According to the fourth-quarter report from CB Richard Ellis, San Francisco and Silicon Valley respectively posted 1.4 million square feet and 800,000 square feet of negative office space absorption from October through December. It was the worst quarterly performance for both markets in seven years. The loss drove the city’s vacancy rate up some 220 basis points to 12.6 percent, while the valley’s rate jumped to 16 percent. The East Bay showed positive absorption of 116,000 square feet, but the vacancy rate nonetheless rose between 80 and 90 basis points to 12.8 percent.

Not much is expected to change this year. Few Bay Area employers seem destined to expand, while many are preparing to contract. A November survey by the Bay Area Council found that 40 percent of area businesses plan to cut jobs within six months. In San Francisco, the figure was 51 percent, and in San Mateo County it was 60 percent.

In recent years, the region has particularly benefited from an entrepreneurial environment that encouraged creation of myriad new companies, especially in the high-tech, biotech and alternative energy fields. But in the coming year not only are many of those companies set to downsize, a report from the National Venture Capital Association in Arlington, Va., indicates there will be significantly less venture capital to fund startups and expansions.

NVCA president Mark Heesen blames the decrease on the comparatively small number of venture-backed companies to go public last year. He says the inability of existing firms to make use of the standard exit strategy discourages investors from putting more money into novel ventures, fearing they will not be able to get a desirable return.

Neither Risberg nor Mihalovich is willing to predict how low rents would have to drop before landlords can persuade tenants that it’s worth their while to make a move. However, both maintain deals will need to be substantially more attractive than they are now if property owners want to get their spaces rented.

“We’re obviously going to be in a tenants’ market for the next three to five years and potentially longer,” says Mihalovich. “Property owners are going to have to bend at some point.”

©2009 The Registry

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