Square Feet

Tenant-Landlord relationships in San Francisco can often be “delicate”, particularly in rent-controlled buildings, but I just read a story in the SF Chronicle which is astounding, to say the least.

The story is that a pair of 33-year old landlords purchased a building, began the eviction process, and when things didn’t go entirely their way, a chemical imbalance caused them to completely lose it. They allegedly cut the electricity, cut phone lines, sawed a hole in the apartment floor, and even went so far as to remove beams supporting the apartments floor. The story doesn’t end there, the landlords were also accused of breaking into the tenant’s apartments to steal possessions and using ammonia to damage the tenant’s clothing and electronics.

You can read the entire story here. Simply amazing. If there is one thing Landlords and potential landlords in San Francisco need to understand, it is rent controls and the power tenants wield in that city. The city offers free legal aid to tenants, a legal system (jury) full of renters, and a very tenant-friendly rent control board.

The San Francisco Building Inspections Commission voted in favor on enacting new green building requirements. The requirements would require almost all commercial buildings (those bigger than 5,000 square feet) to comply with LEED standards. In addition, residential structures exceeding 75 feet in height and other buildings in excess of 25,000 square feet must also comply with LEED standards.

The new guidelines will need to be signed into law by the Mayor, but he has indicated that if they are passed by the Board he would do so. It should be noted that the new building requirements would not be fully implemented until 2012.

These requirements will likely become codified in more and more cities over the next several years.

Faced with a possible downturn in the economy, tenants seeking space in San Francisco returned to the sidelines in the fourth quarter. 2007 saw a number of large deals take place including 200K for Google and 170K for O’Melveny & Myers. Rents also saw an uptick in 2007 overall, but that trend seemed to have stalled in the fourth quarter as tenants seemed to begin questioning whether the economy had the legs to support the demands of landlords.

As new landlords have moved into the San Francisco office market over the past few years, there has been a rapid push to raise rents and lower tenant improvements and concessions as the economy recovered and financial district vacancy dipped below 10%. Now that there is some doubt about the economy, tenants have pulled back until there is more visibility in the market while landlords are also seemingly on the sidelines about making concessions.

Uncertainty coupled with troubles facing the financial market has caused a significant slow down in demand for space in the financial district. There is approximately 1M square feet of new office development coming online in the city this year which has not been pre-leased. The additional supply, possible uptick in sublease space available could finally put the pressure on landlords in the second half of 2008.

I attended a CoreNet Global dinner event at the Four Seasons in San Francisco on thursday honoring the Corporate Real Estate Service Provider of the Year as well as the Corporate Real Estate Professional of the Year for the Northern California Chapter.

This year’s winners were Joan Price of Gensler for the CRE Service Provider of the Year award, and Frank Jesse of BEA Systems for the CRE Professional of the Year.

This year’s dinner honoring the winners brought out about 450 corporate and industry professionals. It was a great event and a good opportunity to connect face-to-face with individuals I have interfaced with over email and phone. Another pleasant surprise was running into a few clients!

For seven years, vacancy and rental rates in San Francisco made it economically infeasible for developers to build new office buildings. With rents up, vacancy rates down, and large blocks of space hard to find, speculative building has returned to San Francisco.

There is currently approximately 2M square feet of office space under construction in San Francisco. Bay Area wide, that number is close to 10M.

Some of the projects in San Francisco under development include:

500,000 SF @ 555 Mission Street (Tishman Speyer)
300,000 SF @ 500 Terry Francois Blvd (Lowes Corp)
160,000 SF @ Owens Street (Alexandria)

We anticipate that top floors of view buildings will see strong tenant demand while lower floors will have more difficulty leasing as the price differentials between new construction and existing buildings are difficult to justify. Regardless, initial buildings coming online will likely benefit with the level of risk escalating for developers building subsequent buildings.

The New York Times today published an article outlining not only the dramatic turnover of San Francisco office buildings but the disconnect between current rental rates and prices recently paid for office buildings.

According to the article, it is estimated that 75% of San Francisco’s higher end office space has changed hands since the beginning of 2006. During this time prices have seen a dramatic rise from virtually all previous prices. An example is 650 California Street which was recently sold for $610 per square feet. In 2004 this building was sold for $350 per square foot.

While rents have moved up markedly they are still generally a ways off from the price points needed to justify many of the sales prices which were recently recorded. In fact, many purchasers have recently been assigning a higher value to vacant space than occupied space under the belief that rents will continue their rapid rate of increase.

Our belief is that many landlord’s have gotten ahead of themselves and we urge tenant’s to proceed with some caution in some markets. While San Francisco and Silicon Valley are fundamentally strong markets, resurging commercial construction coupled with a potential slowdown in consumer spending might once again exert downard pressure on rents.