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

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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.

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.

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.

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.

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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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Commercial Real Estate

Pace of commercial real estate improvement is slowing

(Commercial Real Estate) The commercial real estate sector has improved substantially since the economy crashed, but is now showing signs of slowing, but data does not indicate lost ground.

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commercial real estate

commercial real estate

Commercial real estate outlook is positive

According to the National Association of Realtors’ (NAR) quarterly forecast, commercial real estate is continuing to improve, but the pace is slowing.

Dr. Lawrence Yun, NAR chief economist, said that fundamentals are still on an uptrend. “Growth in commercial real estate sectors continues at a moderate pace from a very slow pace of absorption, despite job additions to the economy. Companies appear hesitant to add new space,” he said.

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“Office demand is expected to see only slow and gradual improvement,” Dr. Yun added. “Demand for retail space is benefiting from improved household wealth, while industrial real estate is stable with increasing international trade, which requires warehouse space. Of course, the apartment market fundamentals are the strongest, as nearly all of the new household formation in the past 10 years has come from renters, and not homeowners.”

Forecasting the future

Overall, national vacancy rates in the coming year are forecast to drop 0.2 percentage point in the office sector (the sector with the worst vacancy rates) to 15.6 percent in the first quarter of 2015.

Vacancy rates are projected to fall 0.1 point in industrial to 8.9 percent, and 0.3 point for retail real estate to 9.9 percent.

With rising apartment construction, the average multifamily vacancy rate will edge up 0.1 percent to 4.1 percent, but this sector continues to experience the tightest availability and strongest rent growth of all the commercial sectors.

Rental rates for various sectors

Office rents are projected to increase 2.3 percent in 2014 and 3.2 percent next year. Net absorption of office space in the U.S., which includes the leasing of new space coming on the market as well as space in existing properties, is likely to total 44.6 million square feet this year and 50.0 million in 2015.

Annual industrial rents should rise 2.4 percent this year and 2.6 percent in 2015. Net absorption of industrial space nationally is seen at 106.1 million square feet in 2014 and 110.6 million next year.

Average retail rents are forecast to rise 2.0 percent in 2014 and 2.3 percent next year. Net absorption of retail space is likely to total 14.6 million square feet this year and 20.9 million in 2015.

Average apartment rents are projected to rise 4.3 percent this year and 3.5 percent in 2015. Multifamily net absorption is expected to total 204,900 units in 2014 and 112,500 next year.

Regional performance varies

The markets with the lowest office vacancy rates in the first quarter are New York City, with a vacancy rate of 9.5 percent; Washington, D.C., at 10.2 percent; Little Rock, Ark., 11.6 percent; Birmingham, Ala., 12.7 percent; and San Francisco and Nashville, Tenn., at 12.8 percent each.

The areas with the lowest industrial vacancy rates currently are Orange County, Calif., with a vacancy rate of 3.7 percent; Los Angeles, 3.8 percent; Miami, 5.8 percent; Seattle at 5.9 percent; and San Riverside/Bernardino, Calif., at 6.1 percent.

Markets with the lowest retail vacancy rates include San Francisco, at 3.1 percent; Fairfield County, Conn., 3.8 percent; Long Island, N.Y., 4.8 percent; San Jose, Calif., 5.2 percent; and Northern New Jersey and Orange County, Calif., at 5.3 percent each.

Areas with the lowest multifamily vacancy rates currently are New Haven, Conn., at 2.1 percent; Minneapolis and New York City, 2.3 percent; and Oakland-East Bay, Calif., and San Diego, at 2.5 percent each.

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Commercial Real Estate

Should you buy or lease office space? 5 questions to consider

When considering whether you should lease your office space or buy, an industry expert outlines the questions you should ask yourself.

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office leadership

office leadership

Should you buy or lease an office space?

Many people set up shop and lease office space, assuming this is their best, and often only option, but there are some instances where buying office space is a better option. Many blindly make this decision based on a gut feeling, and we’re not saying that is a bad thing, we’re saying that in addition to that instinct, these five questions should be asked when considering whether you should lease or buy an office space.

Stan Snipes, senior advisor, Sperry Van Ness Investec Realty of Nashville notes that the two options depend on several variables, as he outlines below:

1. Is your business well-established?

If your business is still in the startup phase, I rarely recommend buying. During the next 5 to 10 years you’ll experience employee count fluctuations, client and customer oscillations and even business direction and strategy adjustments. That is, you’ll need to be flexible, not tied to a certain space. Additionally, any leftover capital should most likely be recycled back into your budding startup. You don’t want to stretch yourself too thin.

The only exception that applies some of the time — not every time — is if your startup is in the technology space. Oftentimes tech employees can work remotely, or the technology is automated and won’t require more employees in the future. Additionally, clients of many tech startups can successfully access the company’s offering without visiting a physical office space.

2. Will you endanger your business with a property purchase?

Yes, buying can be a great investment and add a source of revenue, but even well-established business owners need to think about the stress that buying a property can put on their bottom line. Oftentimes your time and money is best spent on what you do best, running your enterprise. If buying means you won’t be able to focus essential resources to your first priority, your business, then you might want to hold off on buying.

Further, because commercial real estate can be a great investment, business owners are sometimes so eager to get in the game that they sell off portions of their business to finance the purchase. This is a bad idea. You should not let real estate decisions determine how you run your business. You’ve worked long and hard to build a successful company — don’t give it away. Another deal with always come along.

3. Do you have heavy, difficult-to-move equipment?

If you have machinery or specialized equipment that make it difficult for you to move, buying may be a great option for you. Two primary reasons: 1.) Lugging dense equipment from leased space to leased space is annoying, cumbersome and costly.

Plus, you increase the chances of damaging it every time you move. 2.) When a landlord knows it’s difficult for you to relocate, he or she is holding the cards when it’s time to renew your lease. If your lease doesn’t have a stipulation to remediate this, leasing office space will cost you more money than it should. More often than not, buying a custom space for your specialized equipment is the way to go.

4. Does your location affect employees or clients?

If attracting and maintaining top-notch employees means securing office space in your city’s prime business district, finding the perfect space to buy may be difficult. Why? Prime business districts usually have lower vacancy rates, which typically means higher prices plus fewer properties to choose from. Anytime you’re limited to a narrow location, you risk not landing the best deal. This doesn’t mean don’t buy, just understand what you’re up against from the onset.

The other issue you may face in buying location-specific space is when your customers or clients depend on your position for convenience. This is a challenge when and if your city’s submarkets are in transition. The trendy spot of the last five years, may not be in vogue five years from now. A lease allows flexibility to move where your customer and clients need you to be.

5. Are you prepared to be a landlord?

There’s a lot of maintenance that goes along with owning a building. Will you have the ability to hire a maintenance crew or will you tend the bathrooms, burnt out light bulbs and overflowing trash bins yourself?

Furthermore, many landlords have easy access to financing that could benefit you in the form of a tenant improvement package. Even though you may have capital to buy your building, can you afford to build it out the way you want to? The cost of ownership is sometimes underestimated. Make sure you’ve considered all of the possible expenses that go along with buying your office space.

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Commercial Real Estate

Commercial real estate improving modestly, little change to come

As commercial real estate improves across all sectors, the gains have been modest and NAR predicts they will continue to inch forward.

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detroit

Commercial real estate sector is improving

According to the National Association of Realtors’ (NAR) quarterly commercial real estate forecast, commercial real estate is improving modestly, with little change seen for the near future. Dr. Lawrence Yun, NAR’s Chief Economist said in a statement, “Jobs are the key driver for commercial real estate, and the accumulation of 7 million net new jobs from the low point a few years ago is steadily showing up as demand for leasing and purchases of properties,” he said. “But the difficulty of accessing loans remains a hindrance to a faster recovery.”

NAR reports that leasing activity rose 2.0 percent in the third quarter compared to the second, and sales levels are higher than a year ago.

Yun said there have been some shifts in commercial purchases. “Investors have been looking for better yields, and have found good potential in smaller commercial properties, notably in secondary and tertiary markets. Sales of commercial properties costing less than $2.5 million in the third quarter were 11 percent above a year ago, while prices for smaller properties were 4 percent above the third quarter of 2012.”

Commercial investment in properties costing more than $2.5 million rose 26 percent from a year ago, while prices for large properties were 9 percent above the third quarter of 2012.

National vacancy rates over the coming year are forecast to decline 0.2 percentage point in the office market, 0.6 point in industrial, and 0.5 point for retail real estate. The average multifamily vacancy rate will edge up 0.1 percent, but that sector continues to see the tightest availability and biggest rent increases.

Retail vacancy rates should be going down

Retail vacancy rates are forecast to decline from 10.4 percent in the fourth quarter of this year to 9.9 percent in the fourth quarter of 2014. Average retail rents should increase 1.4 percent in 2013 and 2.2 percent next year. Net absorption of retail space is projected at 11.0 million square feet in 2013 and 18.1 million next year.

Multifamily construction will meet demand

Multifamily Markets
The apartment rental market – multifamily housing – is likely to see vacancy rates edge up 0.1 percentage point from 3.9 percent in the fourth quarter to 4.0 percent in the fourth quarter of 2014, with new construction helping to meet higher demand. Average apartment rents are forecast to rise 4.0 percent this year and 4.3 percent in 2014. Multifamily net absorption is projected to total 239,400 units in 2013 and 211,300 next year.

Office rents should be going up

Vacancy rates in the office sector are expected to decline from a projected 15.6 percent in the fourth quarter to 15.4 percent in the fourth quarter of 2014. Office rents should increase 2.4 percent this year and 2.5 percent in 2014. Net absorption of office space in the U.S., which includes the leasing of new space coming on the market as well as space in existing properties, is seen at 32.2 million square feet this year and 46.1 million in 2014.

Industrial vacancies on the decline

Industrial vacancy rates are likely to fall from 9.2 percent in the fourth quarter of this year to 8.6 percent in the fourth quarter of 2014. Annual industrial rents are expected to rise 2.3 percent this year and 2.5 percent in 2014. Net absorption of industrial space nationally is anticipated at 97.0 million square feet in 2013 and 104.9 million next year.

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