With Office Market Softening, Some Landlords Mull Reducing Asking Rents

June 2nd, 2008

After seeing rents continuously rise over the past 24 to 36 months, Tenants are finally beginning to see an easing in rental rates. During the past two quarters, net absorption in the South Bay and Peninsula markets have either been flat or mildly negative. In the Silicon Valley, depending on whose numbers you use, net absorption in the first quarter was in the range of minus 50-100k. At the same time rents remained fairly static.

Landlords, experiencing a marked slowdown in leasing activity have now begun to question the strength of the market. In some instances, Landlords are keeping asking rents up but getting more aggressive in providing concessions. Equity Office, which first used this approach with some of its projects, has now begun to actually lower their asking rents in some of their projects.

It helps to understand how the debt markets had an impact on the rapid rise in rents, and what could be the beginning of a period of weakness in the markets. During the past several years, cheap financing coupled with lax lending standards allowed investors to buy and sell buildings and projects at an unprecendented rate.

Part of what fueled transactions was the belief that rents would continue to increase. The availability of cheap financing in the market kept competition high for assets and buyers were using projected rental rates to value the assets they were acquiring, and lenders were lending based on these numbers.

Investors who bought into the market in 2004 to early 2005 have for the most part done well as demand did in fact increase and with it rents were raised. Investors who purchased during late 2006 to 2007 however are likely concerned as many picked up assets assuming rents would continue to rise and what we’re seeing now is that might not be the case.

Second quarter numbers will be out shortly. We’re working on adding a market data section to the blog and hopefully will have all those numbers incorporated within the next few weeks. Those numbers will help provide some insight as to what Silicon Valley landlords do next, but for now, what we’re seeing on the ground is that tenant demand has slowed and many deals have been put on hold.

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