Square Feet

I attended a broker luncheon of NAIOP’s (National Association of Industrial and Office Properties) Silicon Valley chapter today. The panel was comprised of three brokers, two brokers who spend a majority of their time representing landlords, and one who is a predominately tenant representative.

There seemed to be some concern in the air about the overall economy, but at the same time there was a fairly positive outlook on the current economic situation. The two brokers who provided insight into the market from a landlord’s perspective indicated that rents remained fairly unchanged from a decade ago and that the general expectation was that there would be sufficient demand to drive absorption of the nearly 4M square feet of new product coming online over the course of the next 12-18 months.

I tend to hear investors and brokers discuss construction costs quite a bit and how there is a disparity between face rents today and the rental rate required to support new construction. Right on cue today was an audience member who raised that very same point.

While I agree there is a disparity, I disagree with the philosophy that construction costs are a significant factor which will drive future rent increases. Rent is a function of demand, pure and simple. The only time when there is a divergence from this is when the supplier has pricing power so great that they are able to shift the supply curve.

We have seen rents increase most in the markets such as Palo Alto, Menlo Park, and Cupertino. In those markets, rents have increased because the demand has materialized.

In and around San Jose, rents have increased as well, but the rate of increase has been fairly consistent with the growth rate of of demand. In markets such as Redwood Shores where a single landlord (Equity Office) controls a large portion of the supply, they have been able to move rents upwards at a rate which can be classified as a bit artifical. By large, this pricing power does not extend much beyond niche submarkets and it is therefore very important for investors and tenants to discern between what is simply hype and reality.

The economy is really teetering on recession. The next few weeks and months will be vital in determining if the steps the government is taking will be enough to keep us out of a recession. While there are some large requirements likely floating around right now (Facebook, etc.), it is difficult to see how nearly 4M square feet of new product will lease at rates representing a 30-40% premium to existing space in a matter of 12-24 months.

In Singapore, the Nanyang School of Art has taken the definition of green building to another level. The building features a verdant turfed roof which doubles as a functional space people can use and access via sidesteps along the roof edge.

The roof helps lower roof temperature as well making this design both functional as well as environmentally friendly.

I see a lot of trade publications that feature architecture from cosmopolitan cities in Europe and Asia. Then there are the projects coming out of the ground in Dubai which are amazing to say the least. But I came across a project today in Louisville, Kentucky which peaked my interest. It’s called Museum Plaza and it is being developed by the Poe Companies.

Despire the turmoil in credit markets, construction has begun on this project which is slated for completion in 2010. When finished it will encompass 1.5 Million Square Feet and soar 62-stories. The architecture firm behind the project is REX (Ramus Ella Architects). The project will include a 1-acre “island” located 22-stories up which will be open to the public. Additionally the project will encompass 1,100 stall car park, 300-room hotel, and 160 luxury units and lofts, and an office tower.

Amazing! To learn more about the project you can visit the official project site at www.museumplaza.net. I’ve also embedded a project video from youtube below that is interesting.

In the past few years there has been a surge of TIC investments, particularly in the NNN leased investment market. There has been a lot of uncertainty in the area of TIC investments with regard to what commercial real estate brokers can and cannot broker.

On November 13, the SEC published a proposed rule governing the sale of TIC interests that will hopefully end the battle between brokers and securities broker-dealers. The rule, if finalized, would allow commercial real estate brokers to sell TIC interests under a certain set of rules. The rule is currently undergoing comments and review, and will likely be finalized during the middle of 2008.

The current set of rules are that commercial real estate brokers will be exempt from securities regulations if the following rules are followed:

• An agreement must be signed by the investor agreeing to have the broker provide advise on the TIC investment
• Securities broker-dealers will still need to decide if TICs are right for investors
• The investor would pay brokers a consulting fee, but the fee could be picked up by the securities broker-dealer or sponsor if the investor purchases the TIC investment
• Real estate brokers would not be allowed to advertise TIC investments

Most of Silicon Valley has been unscathed by the sub-prime mess with bank-owned homes being a fairly uncommon site (with the exception of East San Jose). Lately however we have been finding more and more bank owned properties in more exclusive neighborhoods. For the past several years finding a bank-owned property in Los Gatos, Saratoga, Palo Alto, or San Francisco would have been very rare. While the number of properties coming on the market that are REO in these markets still remains low, we have noticed a few cracks begin to show in these high end markets.

What we have also noticed is that there is a fair number of NoD (notice of defaults) occurring in some of these higher end markets as well. The numbers are still insignificant in these particular markets to have any material impact as the market remains hot enough to allow people in trouble to get out safely, it is something to keep a close eye on as some good opportunities might be arising very soon.

Some of the sites for the lenders which they list their REO properties on include:

Bank of America REO

Countrywide REO

Wells Fargo REO

According to research put out by CBRE’s research team, overall vacancy rates in the Bay Area increased from 8.6% to 9.7% in the fourth quarter. The peninsula and San Francisco have remained strong while the East Bay has suffered some.

In the south bay the lowest vacancy rates were in Mountain View, Palo Alto, and Cupertino, and Sunnyvale had the highest at 17%. Sunnyvale’s number is somewhat skewed however by the large deliveries of new office space which are occurring.

In Sunnyvale, there is roughly 3M square feet of Class A office being planned or currently under construction. The largest project is Moffett Towers, with other projects at Almanor, Sunnyvale Town Center, and on Java Drive.

While the overall economy remains healthy in Silicon Valley, factors influencing residential real estate, commercial and residential lending, and the general psychological affect a looming recession might have will likely continue into the near future may cause some companies to possibly temper their future growth forecasts.

A 112,000 square foot office building currently leased to WSGR (Wilson, Sonsini, Goodrich & Rosati) has been picked up by Shorenstein. The purchase price comes in at a whopping $85M representing a price tag of $750+ per square foot! The building was built in 1998 and is a single-tenant leased investment.

$85M is a monster number and is predicated amongst other things on the strength of the rental market within Stanford Research Park and it’s A+ location. Nonetheless, that is a big number.