Silicon Valley Chapter of NAIOP Broker Luncheon

January 31st, 2008

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.

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