Commercial Real Estate Blog

Cushman & Wakefield released its mid-year report on the Manhattan market. Vacancy now sits at 7.1%, up about 180 basis points from this time last year. Rents continued to edge up slightly, but concessions and tenant improvement allowances also crept up, effectively keeping rents flat to slightly down over last quarter.

Investment sales fell to $13.8B for the first half of 2008 versus the $34B that occurred in the first half of last year. Nearly half of all the investment sales occurred to foreign buyers.

Why is this important? Two reasons, with the first being that the Manhattan market in many regards is a “leading indicator” for overall commercial real estate trends. The second is that statistics generally are a “lagging index” when it comes to what is happening on the ground. For instance, in San Francisco the Business Journal wrote an article the other day about 500K SF of space coming onto the market.

We didn’t report on this because the extent of availability is likely much greater than 500K. There is “shadow space” which is sitting vacant and unused by firms while they reorg and figure out what they need and don’t need. In a downturn it takes several months at least to figure this out for most large firms. That said, we anticipate that not only will companies such as PayByTouch and RedEnvelope vacate space, but that financial firms and law firms will also start making cutbacks in headcount. Once that happens, the amount of space to actually hit the market will grow significantly higher than the 500K SF that was reported in the Business Journal. So you might read that it’s 500K SF, but in fact in a period of contraction, the actual figure is higher.

Also, keep in mind what is happening in venture capital. That could be another wild card when it comes to forecasting how the office market fairs.

The National Venture Capital Association (NVCA) just released some numbers for Q2, 2008 and they don’t look good. While venture capital might have seen a bit of a slowdown in the past quarter in Silicon Valley, the number of liquidity events for venture-backed companies has come to a screeching halt.

For the first time since 1978, there was not even a single IPO of a venture-backed company. This compares to five in the first quarter and 43 that happened in the first two quarters of 2007. The situation is being termed as a “crisis” by the NVCA.

In addition to a slowdown in the IPO market, there has been a fairly significant slowdown in the volume of Merger and Acquisition (M&A) deals as well. The release by Thomson/Reuters is below for your viewing, but what is important to consider is the significance of venture capital in Silicon Valley. Without exits and liquidity events, investment in venture capital will dwindle. That is in essence the life-blood of the valley in many ways. Much of the big run-up in San Francisco office rents, particularly in SoMA, Potrero, and in Silicon Valley (think Palo Alto, Mountain View) can be attributable to a great extent to venture financing. Venture financing not only is responsible for the creation of jobs at the start-ups, but generates an increase in demand for office space from accountants, law firms, and other professional service providers.

The majority of VC’s surveyed as part of this report indicate they don’t see the IPO window returning until at least 2009. This will undoubtedly translate to a continued weakening in office space rents and demand.

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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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.