Commercial Real Estate Blog

USBanker Magazine is featuring an article in its September issue discussing the impact of the current financial turmoil on office space vacancy rates. According to the article, New York’s Independent Budget Office is forecasting roughly 60,000 total job losses stemming from the credit crunch. The CEO of New York’s GVA office has estimated that as much as 3.7 million square feet of space can come back on the market in the next quarter alone as companies such as JP Morgan (Bear Stearns) dump or attempt to sublease space.

Of all the markets with the largest financial exposure (New York, Boston, Chicago, San Francisco), Orange County has been the hardest hit with 3-4 million square feet of space combing back online on top of the 8 million square feet of new construction. The vacancy rate there according to the article has risen a thousand basis points in one year alone.

It certainly didn’t take long for San Jose councilmemebers to take notice of the Los Angeles city council decision to ban fast food restaurants. Now Nora Campos, Forrest Williams, and Kansen Chu, councilmembers in the City of San Jose are proposing a one-year moratorium on new fast-food restaurants.

I’ll try and keep this post from turning into a tirade, but I am disguested with this trend, and sorely disappointed with San Jose city leaders. The last time I checked, liberty and free will were a fundamental part of this country. What we have now are city leaders and legislators working to limit what we can and cannot eat; this is something which needs to be stopped. In the San Jose Mercury News today, the article quoted councilmember Kansen Chu (which I have a lot of respect for) as saying, “When you talk about fast-food restaurants, you’re thinking burgers and fries and chips and pizza.”

First of all, it sounds like they don’t even have a way to classify what “fast-food” is. Second of all, they are working to ban this city-wide. This is unfair to the restaurants, entrepreneurs, and citizens. There is indeed a problem with obesity in this country, but the solution is not to ban a certain type of restaurant; the solution is better education and better opportunities. That is the job of our leaders.

Instead, our leaders feel compelled to effect change by going after supply. That is their fundamental mistake - what they need to do is to lead in ways which will reduce demand. Imagine banning MP3’s because people pirate music, or banning credit cards because of identity theft, or banning large SUV’s because they burn too much gas. That is not the solution. The solution to the problem is creating an environment where people choose not to pirate music, or to buy a Hummer, or better safeguard against identity fraud.

What our leaders are doing by proposing such legislation is sending a signal that says they have given up. That is not the type of leadership I would want running my city and I encourage those that agree to write Chu, Williams, and Campos and let them know now and give them an opportunity to reverse their decision. Or you can wait and do it on election day.

The governor of the Bank of England stated yesterday that “It’s bound to be the case that there is the possibility of a quarter or two of negative growth”. That would qualify as a recession, though that word is not used. Following on Japan’s release of numbers which showed contraction in their economy, it is clear that commodity and energy prices are taking effect worldwide. In the UK, headline inflation is expected to come in more than twice as high as the 2% target rate, and the latest unemployment numbers reveal six successive months of rising unemployment.

Compounding economic declines with the credit crunch, it is clear that banks are unlikely in a position to relax the strict underwriting practices which have replaced the easy money environment of two years ago. The less visibility that banks and lenders have, the more pressure it puts on commercial real estate since during these times loans will come due and will need to be refinanced. The tough lending environment may result in the need for owners needing to kick in additional equity, which if unavailable, could lead finally lead to the distress sales in commercial real estate so many are eagerly waiting for.

In a sign that the slowdown being felt here in the US is evolving into a global phenomenon, Japan reported that its GDP contracted by 2.4% (annualized) in the quarter ending June 30th.

Japan is the world’s second largest economy and relies heavily on imported natural resources. Japan is facing a situation similar to that in the United States; increasing inflation and stagnant economic growth. What’s more is that Japan’s central bank has interest rates at 0.5%.

For the first time since the dot-com era of 1999-2001, inflation rates in the San Francisco Bay Area have increased at more than a 4.5% annualized rate. Many tenants over the past several years have accepted CPI as the determining factor for annual rent escalations. For several years, the CPI method paid off (assuming a 3% floor was not agreed to) since the CPI rose by around 2% annually.

But now, increasing energy and fuel costs have had a dramatic effect on inflation. As a result, the most recent 12-month increase in the Consumer Price Index came in at 4.7%. The CPI index is based on San Francisco Urban Wage Earners and Clerical Workers. Savvy landlords generally utilize this index instead of the All Urban Consumers because it rises faster.

As a tenant, it is always best to fix escalations, particularly when macroeconomic trends point to inflation. If inflation-indexed escalations must be utilized, then it is important to cap the increases under the lease (5% is typical in today’s market, but if inflation continues to rise, then that could go out the window).

The chart below provides a 10-year history of the CPI index for the San Francisco Bay Area.

There is an interesting article in Bloomberg about how the credit crunch and litigation slow down has affected law firms and their partners. Some of the side effects cited in the article include some law firms requiring partners to take out bank loans for any amount above the minimum amounts provided for in their partnership agreements.

According to Bloomberg research, deal flow is down 34% this year, resulting in an estimated 15% drop in the income partners at the top 100 firms can expect. Such dramatic slow down has caused many firms to delay hirings, fire associates, and in some cases terminate partners.

Most of the slow down has been felt in finance, private equity, and real estate practices. Some of the law firms cited shed nearly 10% of their staff. This is an area to keep an eye on since some of the strongest Silicon Valley markets (Menlo Park, Palo Alto) greatly benefit from the presence of law firms. That said though, several firms have recently bucked the trend by taking on additional space in the past two quarters.

The latest unemployment numbers for the state of California indicate that the rate has jumped significantly from last year. Last June, the seasonally adjusted unemployment rate in the state was 5.3%, June’s preliminary numbers are 6.9%, up a further 10 basis points from May’s 6.8%.

To put in perspective the unemployment rate cycle in California, below is a chart of California’s unemployment rate since 1990: