The
State of the Bay Area Office Market
Jeffrey
S. Weil, MCR.h,
CCIM, SIOR
Senior Vice President
Colliers International
1850 Mt. Diablo
Blvd., Suite 200
Walnut Creek, CA 94596
Ph. 925.279.5590 Fax 925.279.0450
jweil@colliersparrish.com
www.officetimes.com
There are an amazing number of great elements currently in
place which benefit the San Francisco Bay Area office and leasing markets, but
there is an also another list of less-favorable elements also impacting this
same marketplace.
Let’s take a look at what is positive in the sales side
of office buildings. One of
the top factors is super-cheap money as interest rates haven’t been this low
in 30 years. To think just a few
years ago that today we’d be looking at 6½% long-term fixed commercial
financing or even lower for fairly-stable variable rates is truly astounding. If you buy a building that truly caps at 8½%, and your
financing is only 6½% you have one heck of a great spread to work with.
Helping this further is how poorly the more traditional
investment vehicles are doing-I mean, who wants a negative return by investing
in the stock market, or a 1 or 2% yield in CD’s or a 4 to 5 % return in
corporate bonds, when you have no idea who will be the next Worldcom or Enron
and wipe you out? So there is lots
and lots of money chasing commercial real estate, hundreds of billions of
dollars.
The office market above 10 million dollars is mostly strong
institutional investors with deep pockets.
These folks are the Real Estate Investment Trusts like Equity Office, the
pension funds like CALPRS and RREEF, insurance companies and wealthy investors.
Usually they buy with low leverage, have long-term holding plans, and
have plenty of cash to renovate the property, wait out the slow times, and pay
for the turnover costs to get new tenants.
Another factor benefiting today’s office market is the
faded memories of all those in our business who saw the office market crash and
burn for eight years back in the 1980’s.
I mean, we’ve forgotten that Pleasanton had a 35% vacancy factor,
office rents were $0.70 a square foot, I remember doing a 90,000 square foot
Class A office lease in Concord in a 15-story mid-rise next to the BART station
for a buck a foot, fully-serviced, turn-key and flat for five years, and another
Class A building offered to do the deal, fully-serviced, for ninety cents!
This was when proforma was two bucks, so they were just cutting their
losses. At one point about 25% of
all Class A office buildings up and down the I-680 Corridor were in foreclosure,
but here we are in the year 2002 and investors cannot find enough office product
to buy.
There is more transparency in today’s office industry,
and this is a good thing. With so
many large publicly-traded institutional investors disclosing what their
expenses are, what their property is worth based on 3rd party appraisals we
don’t have the hype, smoke and mirrors we had back in the 1980’s when a
lender would give a cowboy developer a 120% loan with no recourse, meaning the
developer would pocket the 20%, have 100% of the project financed, and if it
didn’t work out be able to walk away without losing his assets.
Another good thing in today’s market is there are still a
lot of office buildings 80, 90 or even 100% occupied, so even if Pleasanton
might have an overall vacancy rate of 20% there are specific office projects in
Pleasanton that are still almost fully-leased, and if you are conservative in
the underwriting of any leases coming up, any tenant credit types that might
pose a future problem, you’re honest to yourself on what the releasing time
tenant improvements, leasing fees and actual effective rates will be you should
be reducing your acquisition risk appropriately.
One other good thing about today’s office industry is the
higher level of professionalism in commercial property management, asset
management, and even the caliber of the leasing and sales brokers-take a look at
how sophisticated the marketing packages put out today.
Thanks to today’s software technology the management reports done by
today’s high tech property managers are also first-caliber.
Ok, so now we’ve painted the rosy side of the office
sales and leasing picture. No
surprise, but the Greater Bay Area currently has 75 million square feet of
available office and flex space. Most
of this, almost 50 million feet, is in Santa Clara where they are sitting on a 7
or 8 year supply. What compounds
this problem is almost no tenant activity, especially new net absorption.
It’s great to announce ADP leased 106,000 sf in Bishop Ranch but they
are vacating 100,000 sf across the road in ADP Plaza so no net leasing.
Who wants to bet that building will get a name change?
I’m giving a 9,000 sf tour this afternoon in Pleasanton
and I promised my client we would only look at less than 25% of what’s
available, but now we will be looking at 9 spaces out of about 40 available.
As I specialize in exclusive tenant representation and office sales, my
client will be in a very fortunate position in deciding to renew in an older
Class B building with ten-year old carpet, or move to a Class A building at the
same or probably even a lower rental rate and all new custom interiors.
Buyers today are having a tough time finding product to
buy, and when something comes on the market it is not uncommon to have 8 or 10
purchase offers on one building. When
I sold 150 North Wiget, a 55,000 sf office building I sold in Walnut Creek about
a month ago we had 8 offers. Last
week I closed the sale of 3730 Hopyard, a 12,000 sf office building in
Pleasanton which I sold to an owner-user for $2,000,000, and we had 240 inquires
on just this one building. So
buyers have to invest a lot of time looking hard for the opportunity, then
invest a lot of upfront due diligence to compete with multiple buyers.
Sellers are getting away with inflated prices, and low
returns, because of this huge demand and because other investment vehicles do
comparatively worse. What’s
so bad about an 8% cap rate as long as the building stays leased?
A large detriment to the office market is our economy, and
there isn’t a day that goes by where another announcement of lay offs - Schwab
lays-off another 1800, which means another 360,000 sf of vacant office space or
this week SBC announces 11,000 layoffs which means over two million feet of
office space will be internally naked. And
the e-commerce and tech companies don’t see any hope for a few more years –
some of my clients haven’t even told their employees but are already figuring
out space disposal strategies for millions of feet of space.
It might be relatively easy to get a low-interest loan on
an office project that is long-term leased to credit tenants, but maybe not so
easy to get one on a 50% vacant building, one with upcoming vacancies, or a
property in currently troubled areas like San Francisco South of Market, or
Santa Clara. We do expect to see
foreclosures start to show up in these sub-markets beginning in 2003.
Insurance is a negative factor, especially terrorism
insurance which might be required by trophy property owners or their lenders and
might be highly exorbitant-kinda like trying to get earthquake insurance right
after Loma Prieta. Even regular
commercial property insurance has gone up 100 to 300% but fortunately it’s
only a few cents a foot in the monthly rental rate.
The sublease market, particularly the plug and play sector,
has brought office leasing to a new dimension.
In Downtown Walnut Creek, three doors from the BART station, Class A, I
have a 22,000 square foot plug and play office sublease, 7 year term, $2.15/sf
fully-serviced. Your client walks
in, sits at their desks, or in the state of the art workstations, top-line
systems, computer racks, phone systems, file cabinets - the works, all at no
extra charge and that saves a company hundreds of thousand of dollars.
It makes it tough for a landlord with direct space to compete with this.
I asked one landlord how he sleeps at night with so much
vacancy, and he told me he sleeps like a baby.
He gets two hours of sleep, then wakes up and cries for the rest of the
night.
So, you’ve heard the positive and the negative elements
of today’s office market. We are
still in a tenants market and might be until 2004~2005.
To quote Ken Rosen form the Rosen Institute, “We are now
scraping the bottom. There isn’t
much lower to go, we have until mid-2003 before we see positive job creation,
though the worst layoffs are over. We
won’t see net positive absorption until mid-2003.
The best case for a recovery is three years, the worst case is five years
from today. The East Bay will come
back first because it didn’t have as much bubble effect.
The slowest recovery will come in the Silicon Valley where there is so
much excess space.”
My entire presentation will be posted next week at www.officetimes.com
on the home page, I’ll let you know at one of our future IMF meetings exactly
when the office market has bottomed or at least my best guess and until then
feel free to call me if I can ever be of service to you or your client.
So, stay alive until 2005, learn new tricks to get you to
2006, and landlords may be back in heaven in 2007.