Square Feet

The Fed’s recent actions to help stabilize economic conditions are not impressing foreigner’s holding US debt instruments. The inflationary actions of the Fed have resulted in foreign buyers of US debt to essentially boycott government auctions for treasuries.

Over the past eight weeks, the share of foreign buyers participating in these auctions was somewhere around 25%. In last week’s auction, they represented only 5.8%.

Additional steps the Fed has taken or will take this week include bailing out Bear Stearns by essentially financing a JPMorgan takeover of Bear Stearns. The emergency overnight rate for bank’s was cut by 25 basis points, and in the Fed’s next meeting, they might cut interest rates by as much as seventy five basis points.

Unfortunately though, the Fed can only control short term rates. What the Fed cannot do is control long term rates and that is what will affect commercial real estate going forward. The current economic conditions, compounded by inflationary pressures and increasing long term rates does not bode well for holders of such real estate. What we see is people continuing to be bullish in certain market sectors, but it is hard to see how they envision that some sectors, such as Silicon Valley, will escape unscathed.

Time will tell who is right, but with a weakening dollar and thereby increasing commodity prices (for those priced in US Dollars), the effect will be felt in Silicon Valley. We are seeing some Venture Capitalists increasingly wary of their ability to raise any more money in this market and have become increasingly conservative in placing investments.

This has already and will continue to have an impact on the Silicon Valley Market.

Cornish and Carey held its annual forecast in Santa Clara this week. Along the lines of what I’ve been writing about, they are predicting rental rates to be static for 2008 for office and R&D, and vacancy rates to remain in a similar state.

The fact is that there is a large amount of new space coming online in 2008. In addition, there remains a fair amount of space available outside of Palo Alto, Menlo Park, Shoreline, and Cupertino submarkets. All of these submarkets will see new buildings come online this year, though no tremendously large projects are slated to dramatically change the landscape. In Sunnyvale however, Menlo Equities, Jay Paul, Sand Hill Property/RREEF JV, and a few smaller projects are bringing online more than 1.5M square feet of space this year alone. That is enough for 7500 employees in a time when most people now see that job growth will also be static if not recessionary this year.

As a result, we believe a portion of the price increases in the past 12-30 months we’ve seen in some of the softer markets outside those indicated above have been in large part a combination of broker hype and new owners paying dear prices for commercial property and being essentially forced to raise rents to make their deals pencil.

I think that while we may not see landlords drop asking rents immediately, smart landlords see the writing on the walls and we’ll see some get more aggressive in making deals.

NVIDIA is rumored to be buying San Tomas Business Park from Harvest Properties. The 10-Building project on San Tomas Expressway right across from NVIDIA’s campus was picked up by Harvest and BlackRock Realty in late 2005 for roughly $205 per square foot.

The project encompasses 10 buildings of roughly 47K SF each spread across 24 acres. There is no confirmation of the deal or whether additional land or buildings have been rolled into the deal or when the deal is slated to close.

This deal comes about a year after NVIDIA killed negotiations to acquire a Class A highrise in downtown San Jose from Sobrato that ultimately ended up getting acquired by BEA Systems.

NREI is reporting that in January, not a single CMBS was priced in a one-month period. This is the first time in the 20-years since CMBS product was introduced that this has happened.

Also telling is that despite this lack of activity, some $37B in securitizations remain in the pipeline. In the face of this prices have seemed to remain resilient. Longer term though, it is difficult to see how prices will be able to withstand the financing conditions if they continue. Goldman Sachs analyst James Fotheringham doesn’t see it happening and has forecasted that commercial real estate prices might be susceptible to a drop of up to 26% in value through 2009.

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

If the performance of the S&P Index during the first week of January is right again this year, the markets and the economy may be facing a bumpy ride ahead.

Below is the performance of the S&P 500 index over the last ten years; and 2008 has had the worst showing in a decade. We’ve been advising our clients to take a cautious approach and we believe that while the fundamentals in Silicon Valley remain strong, the pockets of weakness will expand and both tenants and investors should apporach any investment or lease with that in mind.

MIT’s Center for Commercial Real Estate publishes a quarterly report tracking the performance of commercial property investments. The data is derived from sales information provided by the National Council of Real Estate Investment Fiduciaries (NCREIF).

The third quarter of 2007 saw a 2.5% negative capital return for the properties sold in the NCREIF database. This was the first negative price change since the third quarter of 2003. The graph below is from the MIT Center for Real Estate.