Commercial Real Estate Blog

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Numbers today came out for the national unemployment rate, and it is no surprise that the numbers continue to rise. The national rate now stands at 6.1%, a five-year high. These numbers don’t tell us much about California and Silicon Valley, so the graph to the right and data below represent the trends for the state and Silicon Valley.

The EDD, doesn’t have a statistic for “Silicon Valley”, but the data they have available on the San Jose-Santa Clara-Sunnyvale Metropolitan Statistical Area (MSA) is sufficiently representative of Silicon Valley, particularly when you are working to contrast the numbers with commercial real estate as these three cities represent three of the larger office markets in Silicon Valley.

In Silicon Valley, the unemployment rate for July 2008 came in at 6.4%, up 30 basis points from June’s 6.1% number, and has been steadily climbing since late last year.

Some historical unemployment numbers for the month of July over the past several years are as follows.

2008 - 6.4%
2007 - 5.1%
2006 - 4.9%
2005 - 5.6%
2004 - 6.7%
2003 - 8.7%
2002 - 8.5%
2001 - 5.4%
2000 - 3.5%
1999 - 3.4%
1998 - 3.7%
1997 - 3.5%
1996 - 4.0%

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.

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.

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:

The CMBA (California Mortgage Bankers Association) released its latest number. The data covered 10,794 properties and found that only 7 were delinquent beyond 30 days. The default rate, .06% is triple what it was last quarter, but still only represents a small number of properties.

In August of 2007, the CMBA Index hit a 5-year low of .03%.

This last quarter’s numbers included $96B worth of mortgages, and the amount of debt which was in default was $54M. You can read this as a tripling of the last quarters numbers, but the fact is that delinquency rate is in fact very low. Consider that during the S&L crisis of the early nineties, some commercial asset classes experienced delinquency rates north of 10%. An the MBA (Mortgage Bankers Association) numbers from late last year showed that 1-4 unit residential delinquency rates were north of 5%, the highest level in over 20 years.

Given the state of the capital markets, it is not surprising to see that the assets which traded hands during the second quarter are far smaller in size than those traded this time last year. A combination of softening rents, dimmer outlook, and a brutal capital markets environment all contributed to the low transaction volume.

That said, a number of assets still traded, including the following properties: