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Flat is the new up: a mid-year analysis of the commercial leasing market

A mid-year market analysis? Already? Time flies when you’re having fun, and I guess also when things are slow and steady. The first half of the year seemed to putter along. The pulse of the market has been steady this year, as we shrug along into the second half of 2010. I am still trying to grasp that two quarters have passed in 2010 with basically little to show as far as occupancy or rent growth. Depending on whose numbers you use for vacancy rates year to date, there are either very minimal improvements according to Cushman & Wakefield, or very minor setbacks according to Reis.

That being said, absorption is negative no matter what source you use, meaning companies are still shrinking on the whole, and less space is being occupied than marketed. “The year-to-date absorption rate, a measure which indicates the net change in occupied space, was negative 441,498 square feet at midyear 2010, a 98 percent increase in absorption from the negative 24.9 million square feet at midyear 2009.” – a Cushman & Wakefield report.

A recession breeds new competitors and different market dynamics. Some fundamentals remain the same: landlord concessions, tenant demand and the quintessential battle for leverage. However, markets across the US are seeing new tenants, new industries and new economic forces emerge.

The Wall Street Journal noted the leasing market has boasted some atypical tenants around the country: Non-profits and boutique financial services firms born from the aftermath of the Great Recession buoy the New York market.

Governmental agencies’ role

Additionally, the governmental agencies continue to expand, despite President Obama’s promise to reduce the Federal Government’s CRE footprint, “In Washington, the Securities and Exchange Commission recently leased 200,000 square feet and is considering taking more.” WSJ. Office Vacancy Rate Keeps Climbing.

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San Francisco has facilitated strong emergences in biotechnology, solar energy, cloud computing and social gaming. Harsh market conditions have created fierce competition for venture capital, government funding via bailouts and creative strategies from brokers and CRE professionals. On the other hand, traditional companies have been hit hard, and the bankers, lawyers, consultants, etc have consolidated and shrunk.

Some of the prodigious deals in San Francisco come at a negative net to the overall absorption. Law firm giant Morrison & Foerster inked the biggest deal of the year in San Francisco, totaling 220,000 square feet for 17 years, but took on 50,000 square feet less than previously occupied, similar to Deloitte (negotiating deal for 100,000 square feet less than their previous deal), Wells Fargo (vacated 350,000 square feet in San Francisco), along with many other larger institutional users.

Pockets of tenant competition

While there are pockets of tenant competition around the country in which Landlords can be competitive on pricing and concessions, the good credit tenants of significant sizes are still king.

The unemployment still teeters on recessionary levels on many local markets and 9.3% nationally, and the vacancy and rental rates will remain suppressed or stagnant, some experts say, until 2012.

“Businesses have to feel very confident that they will ultimately not only replace the 8.2 million jobs lost in this recession, but that they will grow payrolls even further,” says Sam Chandan, global chief economist and executive vice president at researcher Real Capital Analytics. “That’s when you begin to see very strong positive absorption.” National Real Esttate Investor Online. Office Tenants and Landlords Battle for Upper Hand.

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What will decide growth?

Employment will be the deciding factor for growth nationwide. Expect to see more of the same in the second half of 2010: leveling out of vacancy rates, more consolidations and possibly a bottoming of rental rates. The green shoots will continue to be technology companies, solar energy and biotech. Large tenants will continue to blend and extend leases and take advantage of the favorable market conditions by inking longer term deals.

The market will not return to 2005-2007 levels for quite some time, but the recession has created a new reality that the market is finally adjusting to.

Written By

Justin Bedecarré is a broker at Cushman & Wakefield in downtown San Francisco representing local and multi-market tenants including Wells Fargo, Marsh & McLennan, Gensler and Broadcom. He is also a blogger and co-founder of the Bay Area Commercial Real Estate Blog (www.bayareacomre.wordpress.com), UC Berkeley alum, avid Cal football fan and fifth generation San Franciscan.

13 Comments

13 Comments

  1. Nadina Cole-Potter

    July 12, 2010 at 4:20 pm

    Thanks for the big-picture, macro update, Justin.

    Here in the Phoenix area, there is also a shadow inventory of vacant onesie office condos, a few vacant office condos in individual developments owned by a single investor, and “broken” office condo developments and conversions where the developer owns the bulk of the inventory.

    Along with the vacancies, we are seeing entire office buildings taken back by the lender, new-built space being taken by companies whose leases in marginally older spaces are not being renewed (now there’s an absorption nightmare!), and, among other elements of the proverbial “perfect storm”, balloon payments coming due on partially vacant properties where the owners overpaid and the lenders permitted them to over-leverage.

    Don’t let anyone convince you any time soon that commercial real estate has “hit bottom”. The bottom fishers are still circling and waiting.

  2. Duke Long

    July 12, 2010 at 8:02 pm

    Justin,
    Clean,clear…we need job growth.

  3. Justin Bedecarre

    July 13, 2010 at 3:08 pm

    Nadina,

    Thanks for your comment! That shows you every market is different, and the need for market and submarket expertise is crucial. I believe your market has not reached the bottom, but other markets like D.C. have begun growing. San Francisco has seen some growth in our creative, tech spaces, but the traditional office space is still teetering on the bottom. I look forward to hearing from you on AG again!

  4. Justin Bedecarre

    July 13, 2010 at 3:11 pm

    Duke, thx for the comment. As people begin to pick up jobs, there should be a drive to assess workplace strategies and use space more efficiently as jobs get redefined and new jobs are created. I think this will be an exciting time for our business in the next few years, once most of the markets are propelled by innovation and job growth ensues.

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