Commercial Real Estate Blog

Wachovia issued a report earlier this month on the state of commercial real estate. Generally speaking, they are bearish on almost all asset classes. Citing a tight lending market, oil prices, slowing demand, and other factors, the anticipation is that the run up in asset prices will continue the reverse which was initiated over the past few quarters.

The report contains a lot of useful data and charts, and rather than paraphrase the details, I’ve outlined the key points below. If you’d like to read the whole report, it is available here for download.

• Traditional Commercial Mortgage Financiers Pick-up Market Share
• CMBS Issuance Halts and About Face
• Nonresidential Construction Set to Weaken
• Property Fundamentals Correction Underway
• Domestic Banks Tighten Lending Standards
• Slowing Economy Puts Pressure on Office Fundamentals
• Industrial Demand Cooling Off
• Apartments Expected to Benefit from Housing Slump?
• Retail Slowing with Consumer Spending

There isn’t much that wasn’t generally known in the report, but the numbers and charts quantify what is going on. The prices are national averages so cap rates, costs per square foot, etc. in the report vary significantly from what assets trade for in Silicon Valley and bay area. Nevertheless, money chases opportunity so any fundamental change in other markets will have an impact on our local market as opportunity costs become to great to ignore.

According to the Allen Matkins/UCLA Commercial Real Estate Survey, San Francisco rents and occupancy will both fall over the next two to three years. This comes on the heels of several years of rental rate increases and a strong office market.

It should be noted that the economic models UCLA has prepared have a difference of opinion from the panel’s analysis. Citing continuing employment numbers, the model forecasts that office space supply in the city could in fact be in short demand within four years.

On June 18, UCLA will release its full findings at its 2008 Economic Outlook and Real Estate Conference.

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. 

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According to research put out by CBRE’s research team, overall vacancy rates in the Bay Area increased from 8.6% to 9.7% in the fourth quarter. The peninsula and San Francisco have remained strong while the East Bay has suffered some.

In the south bay the lowest vacancy rates were in Mountain View, Palo Alto, and Cupertino, and Sunnyvale had the highest at 17%. Sunnyvale’s number is somewhat skewed however by the large deliveries of new office space which are occurring.

In Sunnyvale, there is roughly 3M square feet of Class A office being planned or currently under construction. The largest project is Moffett Towers, with other projects at Almanor, Sunnyvale Town Center, and on Java Drive.

While the overall economy remains healthy in Silicon Valley, factors influencing residential real estate, commercial and residential lending, and the general psychological affect a looming recession might have will likely continue into the near future may cause some companies to possibly temper their future growth forecasts.

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.