• Despite Looming Clouds, Bright Forecast for U.S. Real Estate
• San Francisco Office Construction Deliveries Expect to Boost New Absorption
• California Remains No. 1 For Business and Job Growth
• Bay Area Market Remains Optimistic Despite Anecdotes of Sublets, Moves and Tech Struggles
• Market Research 2015 Mid-Year & Forecast Report San Francisco
• Move Over, Millennials, Here Comes Generation Z
• Emerging Trends in Real Estate by PwC
• United States Housing Bubble
• A New Real Estate Crash Is Unlikely Soon
• I-680 North Office 3Q 2015
• Tri-Valley Office 3Q 2015
• Tri-Valley Industrial 3Q 2015
• I-880 Office 3Q 2015
• I-880 Industrial 3Q 2015
This was a speech forecast about the 2016/2017 commercial real estate market, given on January 13, 2016 at Walnut Creek Scott’s restaurant.
In a moment I’ll get into what’s happening around the Bay Area and California in commercial real estate, but many of you know and read my Corporate Office Perspectives I have written and published every other month without fail for 213 issues and 35 straight years, and I’d like to start out by reading several quotes from a few past newsletters.
June 1 1980
1990 N. Cal $1.30/sf full-service, 10% load
$25 parking space Top of the market
New space Growers Square and Walnut Creek Center
$1.60 $50 parking late 1981 completion
1990 N. Cal August 1977 .80/sf full-service
August 1980 $1.40 75% rent increase
“Tenant improvement costs are getting extremely expensive. On a recent lease I did the cost to paint the walls, install new carpeting and remove 300 square feet of paneling was $3.00/sf ft. Current estimates on tenant improvements from shell space is $12 to $14/sf ft.
October 1, 1980
Projected downtown San Francisco rents for new office projects scheduled for 1982 availability is $26 to 30 per foot per year.
June 1, 1981
I attended a recent luncheon with the San Francisco Chamber president as a principal speaker. On a current survey of major San Francisco users the following four reasons, in order of importance, were given as primary reasons to relocate out of San Francisco. #1 No office space available in San Francisco for the next two years (if you gotta grow, you gotta go). #2 Sheer cost difference of 200 to 300% in rent. #3 Difficulty in locating entry-level people with enough education, motivation who want to work in San Francisco. #4 Housing availability and cost. San Francisco is still the place to be if you can get around these four factors. (An estimated 7,000 employees left San Francisco last year, primarily relocating to Contra Costa).
February 1, 1983
Last year Contra Costa absorbed over 900,000 square feet of new office space. Oakland absorbed over 500,000 square feet. Rents stabilized after a four year consistent escalation in mid-1982 when the market turned soft. Areas like Pleasant Hill, San Ramon and Pleasanton are very soft with owners offering 3 to 6 months free rent. This softness will continue onto mid-late 1983.
January 1, 1984
Full-service office rents in San Francisco at $40 a square foot are the 4th highest in the world and in London the rent was $76 a square foot. The bargain was Belgium where prime space was going for only $8 a spare foot!
April 1, 1984
PIE sold their 80,000 sf Shadelands office building to Kaiser Permanente for $7.4 million – Last December 2015, 575 Lennon, a 100,000 square foot Shadelands office building was sold for 7 million. 31 years later and even less per square foot!
August 1, 1984
San Francisco vacancy rate ranges from 4% from Grubb & Ellis, 5 to 7% from Coldwell Banker, with Jones Lang Wooten estimating 5%. The other side of the coin and the Bay is that there is currently a 21% vacancy factor in completed projects in Central contra Costa/Pleasanton with over 2,000,000 square feet up and available and an additional 3,500,000 expected to be completed by late next year. A few projects currently offer one year free rent on a 5-year lease with the norm being 3 to 6 months free rent.
Back in 2014 Bloomberg had predicted oil at $96 a barrel for 2015 and were they ever off! Just this morning Morgan Stanley is predicting that oil will drop to $20 a barrel!
The stock market has just fallen over 1,000 points just during the first week of the new year, the price of oil at unbelievable low prices, interest rates are up, unemployment is down, China’s economy is scaring many, Americans fear another Paris or San Bernardino type attack, California is finally getting lots of rain and skiers and boarders are in heaven. Most Americans feel just “okay” about their personal economic situation but overall are still nervous and uncertain about the future, tech in the San Francisco Bay Area continues to be over the top, the big boys like Google and Facebook are still taking down hundreds of thousands of square feet of new facility space, San Francisco has over 5 million square feet of new office space under construction, most of it already committed. The East Bay has over 3 million feet of vacant Class A office space just waiting for San Francisco and Oakland tenants looking for comparatively cheap office rent.
I’m going to spend a few minutes discussing the major population centers in California in regards to commercial real estate, including warehouses, offices, retail, investment sales and the apartment house market.
Starting with San Diego, some of the hot things going on include creative office development, where industrial buildings are being repurposed into multi-tenant, multi-media, tech, start-ups. Go Pro just took on 44,000 sf and I believe another 177,000 sf. San Diego has 300,000 sf of speculative life science space and their apartment rents are skyrocketing, with 2-bedroom units downtown going for $3,200 a month!
Los Angeles has many different submarkets with downtown now flat lined, Santa Monica has had a number of large out relocations, retail reports huge demand for restaurant locations, everyone is eating out more from Ruth Chris to Chipotle.
Industrial all over is tight, the Inland Empire has a sub-3% vacancy, Orange County lots of Industrial conversions into creative space, Netflix leased hundreds of thousands of feet in Hollywood.
Up in Sacramento, the overall office vacancy is 15%, there are no specific industries expanding.
Sacramento retail has improved with an overall vacancy of 10 ½ percent. Class A vacancy has come down, but Class C rental rate have brought the overall rental rate average to a monthly rental figure of only $1.34/sf. The Sacramento MSA unemployment rate is 5.7%, down from 7.4% a year ago.
The apartment market in Sacramento is strong, with market occupancy at over 97%. Average monthly rent is $1,082 and very little new apartment houses being built – multi-family permits for the last quarter was only 186 issued. The average cap rate on sales is 5.4%.
Fresno, which our folks there say can reach 98% of California overnight which makes it an excellent central distribution hub, has a lot of new warehouse space being developed. A few deals, Joanne Fabrics took 700,000 sf, BTS took down a million square feet. New projects are 36 foot clear height.
What has hit Fresno hard, with the year after year after year drought, is the impact this has had not just on the farming economy, but on all the businesses and industries that feed on farming. Big tractor sales are way down, and so is a lot of other related businesses – a farmer worried about hanging onto his farm might put off buying a new truck or big screen TV.
The California high-speed rail project is already impacting Fresno, with buildings being knocked down and lots of traffic disruption.
Oakland – wow, that region is on fire! The industrial market along the I-880 corridor has been tight for years, sub-5% vacancy, available land is almost non-existent and too expensive for industrial. A lot of industrial product is obsolete, with 12 foot or 16 foot clear instead of the 30 and 36 foot clear clients are looking for.
Apartment rents in non-rent controlled buildings have shot up, and with Oakland office rents two-thirds of what San Francisco is, there have been a number of recent announcements of office relocations out of San Francisco to Oakland. The biggest was Uber’s announcement to move their 330,000 sf headquarters in 2017, and the Sierra Club just signed a 38,000 sf lease to move their head office to Oakland.
Oakland is almost out of decent office space, so the landlords in Pleasanton, Concord, and Walnut Creek expect to see the next wave reach them.
Apple is taking a 760,000 sf planned office development from Wolfe and Central, super cool architecture, on top of their 2 million foot spaceship headquarters which will be done by 2017. Google has a 2.5 million foot Shoreline development and another 2 million feet at Moffett Field. LinkedIn at Mountain View took 400,000 sf and will build 1.6 million feet. Facebook bought a third huge campus and will have employee housing as a component to attract and retain its workers. Palo Alto Networks is building one million square foot data storage facility. Who says California is too expensive?
San Francisco is the epicenter in the entire world right now, with many of the top tech firm headquarters – Salesforce, Twitter, Instagram, on and on, currently over 5.2 million square feet of new office buildings being built; most of this is preleased, and almost 18 million square feet of additional office development pending. However, San Francisco has a Prop M growth moratorium which starts next year and will limit new development to 850,000 sf per year, and there are political forces trying to shut down development, increase rent control and otherwise stifle growth.
Traffic is ridiculous, and the commute now begins at 4 AM. Bart is packed, San Francisco downtown parking is $35 a day or more and even the sidewalks can be filled to capacity with pedestrians.
Apartments are renting, two bedrooms for $6,000 a month, more expensive than even New York, and people are doubling up, renting out closets for bedrooms – they have 280 square foot micro-condos for $400,000, but it comes furnished with a Murphy bed that converts to a dining room table.
Many millennials in San Francisco are attracted by six-figure starting salaries, don’t own cars, use Uber and local bus and Bart, eat out a lot, and don’t have home ownership on their wish list – and they are having the times of their lives, working hard and playing twice as hard.
An article by Michael Storper published on October 23 of last year titled “Why San Francisco’s way of doing business beat Los Angeles”.
From 1910 to 1970 greater LA multiplied its population 21 times, and was the center for movies and aerospace. Since 1970, when San Francisco was ranked #1 and Los Angeles #4, today the five-county Los Angeles region is ranked 25th on the income scale while the 10-county Bay Area region remains No 1. Per capita, workers in the Bay Area make 30% more than those in greater Los Angeles.
Biotech, Amgen was established in Thousand Oaks while Genentech started in South San Francisco. By 2010 there were 214 biotech start-ups in the Bay Area compared with 55 in greater LA. $8 billion in VC financing vs. $551 million in greater LA.
The overall vacancy rate for retail in the Los Angeles Basin has dropped to 6%. Unemployment for LA is 6.9% as compared to Orange County of 4.5% and the Inland Empire, at 6.8%. For product types, single tenant buildings had vacancy rates of 2.6%, super regional malls of 4.3%, and neighborhood shopping centers at 8.6%. Industrial space within the Los Angeles County region is down to a miniscule 1.6%.
It is interesting that in our global economy, where many millions of jobs have gone offshore to India, the Philippines and elsewhere, where you can get programmers in foreign countries at a fraction of the cost of US workers, and even in the US, where cities in the Midwest and South will almost pay your company to move, they will train your employees, give amazing tax breaks and incentives to entice California companies to leave California – heck the average price of a house in the US, according to the Huffington Post, is $189,000, and there are dozens of states where the average price is under $150,000, and yet Californian big tech companies for the most part are buying and leasing huge office campuses, right now, to house new employees. As I mentioned, Apple is building a 2.1 million foot headquarters and Apple, Google, Facebook, Salesforce, LinkedIn and many others have purchased or leased tens of millions of square foot office campuses, or, in the case of Salesforce, Class A high-rises.
Our California infrastructure is so far behind our current job and housing growth, it is ridiculous! We have roads and bridges literally falling apart, we are adding thousands of new housing units and millions of feet of new office space in a number of subregions, yet no new mass transit, freeway, parking lot infrastructure plans are in play to keep up. Yes, the Bullet train may be coming, Bart trains are at capacity, and in some cities, like suburban Walnut Creek, public parking is five years behind development.
Cities, counties and the State are collecting billions of dollars in windfall property tax due to the crazy sale prices we are experiencing, and this won’t last, but this is when government should be investing big-time in major infrastructure upgrades for the long-term and not wait for the economy to slow down and these bonus revenues to dry up.
For VC funding nationwide California totally dominates. The San Francisco Bay Area alone accounts for 48% of all funding, followed by New York City with 12%, New England with 8%, and Los Angeles/Orange County with 5%.
Let me touch on the Contra Costa and Tri-Valley commercial real estate markets. In the Pleasanton / Dublin / San Ramon region there are several million feet of vacant Class A office buildings, with Class A rents in the $2.35 to 2.85/rsf range, full-serviced. A few projects offer as much as 200 to 800,000 square feet of Class A office space. The overall Class A vacancy rate is 11.8%. Other than huge expansions by Workday, we have seen large downsizing by SAP, Safeway, and Chevron and no influx, as of yet, from Silicon Valley or Peninsula Tech companies.
Retail is strong, and out in Livermore, get this name the San Francisco Premium Outlets just expanded to 134 Factory outlet stores, TripAdvisor recommends you plan on spending at least 2 to 3 hours, and the huge parking lots fill up and it can take you a half an hour just to find a parking spot while next door the 150,000 square foot Asian center anchored by Marina Foods is getting started. Next to that is Shops at Livermore, 100,000 square feet of off-price retail. Up in Concord, Chevron sold their 30 acres and the 565,000 square foot office complex will be torn down to make way for a new retail center.
Apartment rents in this area are now hitting $3,900 for two-bedroom units in the new complexes, there are seven apartment over retail projects currently under construction, and apartment house cap rates can be as low as 3 ½ percent!
What else is happening with multi-family? Rumblings of rent control, still in Richmond, Alameda and Lafayette. An investor bought an apartment house in Lafayette where the rents were way, way below market and she gave all the tenants 50 to 90% rent increases. Hello, what do you think would happen other than an outpouring of protest and pressure on City Hall?
It is getting more and more expensive to build multi-family. Land costs are crazy, construction costs are very high and headed higher, increased interest rates add more cost to this equation, and cities and counties think adding more fees and regulations will somehow help our housing supply.
Downton Walnut Creek Class A office rents are in the $3.50 to 4.00 a square foot range, while five miles north in Concord they go for $2 to 2.35 a square foot.
Santa Clara and Silicon Valley expect to lease combined warehouse, flex and office in 2015 of over 25 million square feet of deals, which is huge. Tech is still the major driver, but Tesla Motors just by themselves leased one million square feet of research and development, office, and industrial space.
Let’s spend just a few minutes on tech and commercial real estate.
Warehouses are being built 30 to 36 foot clear height, some even as high as 60 foot clear, with a heavy emphasis on robotics and automation. At some point, there may be design changes to have rooftop landing strips for all the drones Amazon will be sending out for same-day deliveries.
In retail, they are combining internet, cell phone and in-store, so you can walk down a store aisle and your phone will tell you of special sale prices that might not even be on the display and keyed to you personally.
There are used car websites where you buy online, get your financing online and the car is delivered right to your home, you have a ten-day window to drive the car and return it if you aren’t happy. The car comes with a 150 point inspection, check out beepi.com or carvana.com.
Office buildings – a ton of tech stuff is happening, from sensors that connect the HVAC to your lighting to tell whether you are there or not. Micro-wind turbines on the roof, Intel just installed 58 of these on their Santa Clara headquarters, window glass that collects sunlight for energy, electrical vehicle charging stations are coming on strong. It won’t be long before net-zero energy office buildings are the standard.
The January 1, 2016 San Francisco Business Times “Job growth surges forward, showing no signs of stopping. The Bay Area as a whole added more than 112,000 jobs in the year through November, State figures show unemployment has dipped to below 4 percent in both San Francisco and Santa Clara metropolitan areas. Job creation continues to be very good. It’s off the charts strong, economist Ken Rosen said. “Job openings are at the highest level in two decades. This is a very strong labor market.”
Even Bank of America’s latest survey in September of Bay Area small businesses found that they were overwhelmingly optimistic about the future of their businesses “with 64 percent of respondents planning to hire in the next 12 months, nearly triple what it was two years ago.”
There are several segments of our Bay Area economy who are not very happy now and will get even unhappier over the coming months and next few years.
Folks renting apartments and houses all over the Bay Area have seen their monthly rent shoot up, sometimes as much as 20% per year or more and instead of spending maybe 20 or 30 % of their take home salary on rent now they are spending 40% on rent. Some are being forced to make large commutes in search of more affordable housing and with today’s cheap gas prices this may be barely tolerable but when gas prices go back up this might make it intolerable.
Office tenants for years during the Great Recession took advantage of the glut of office space and resulting low rents.
Concord Class A office rents just a few years ago were as low as $1.65 a square foot, full service and that same space today rents for $2.25 a square foot meaning a 10,000 square foot office tenant over a five year period will be paying $350,000 more in office rent. Downtown Walnut Creek Class A buildings have seen rents go up just in the past two to three years from $2.45 a square foot to $3.65 a square foot, as an example and the impact over five years on a 10,000 square foot office tenant is $720,000 more in rent payments.
These are bargains as compared to the poor 10,000 square foot office tenant in San Francisco who on an annual basis has seen their annual rent go up from $35 a square foot to $65 a square foot today, a $1.5 million rent hike for a five year lease term.
The Los Angeles Times on January 4, 2016 addressed California’s reputation as having a challenging business climate, overregulated, and very expensive. However, evidence proved that California was actually one of the largest, richest and most diverse economies in the United States, as well as one of the nation’s fastest growing economies and a national leader in job creation.
And to debunk the myth that tons of companies are fleeing California for other less expensive, more hospitable states, “Less than 1% of all businesses that disappeared in California in 2013 are due to out of state relocations, according to data from Youreconomy.org which tracks business dynamics across the country. That’s in line with the average for all states.”
“And in an earlier Beacon analysis of census migration data showed that, despite California’s comparatively high income tax rates, more people making in excess of $100,000 moved to California from other states from 2007 to 2013 than those who left.”
The Urban Land Institute in their article published October 2, 2015 titled “Despite Looming Clouds Bright Forecast for US Real Estate”. The latest ULI Real Estate consensus forecast calls for relatively smooth sailing ahead as it relates to both continued economic growth and a favorable outlook for commercial real estate investment. Yet, the forecast is not as bullish as it was six months ago, and there are headwinds that are expected to temper growth heading into 2017. Cap rates were expected to rise from 5.2 percent in 2015 to 5.3 percent in 2016 and 5.7 percent in 2017, in part due to rising treasury and interest rates.
Vacancy rates will decrease modestly for office and retail. Commercial property rent, for office, retail, industrial and apartments as well as hotel revenue are all expected to rise over the next two years.
What Could Cause Our Economy To Go Sideways or Tank?
China’s economy actually does have a meltdown. Remember what happened to Japan 20 years ago?
Google, Facebook, Apple and Sales Force all start major layoff campaigns
20 groups of terrorists drive large trucks filled with explosive over the 20 most critical bridges in America at the same time, and blow themselves, the bridges, and everyone driving on them to smithereens.
Or amusements parks, or major shopping malls or subway systems.
Ross Perot’s aliens actually turn out to be real and they invade Earth in force and they are huge and treat us like appetizers.
But I don’t think any of this will happen.
What will surely go up in 2016 and 2017?
- Land prices
- The cost of construction, both for new projects as well as tenant improvements and retrofits.
- Interest rates
- Rental rates – across the board
- Cap rates
- Electrical vehicle charging stations
- Suburban solar panels on buildings and over parking areas
What will go down in 2016 and 2017?
- East Bay Office sublease space which has almost disappeared during the past 60 days!
- Selection of available vacant office space
- Energy usage as more and more Title 24 retrofits kick in with all new overhead lighting, sensors, and switches that turn off lights when not needed.
In conclusion, 2016 and 2017 will be terrific years to be in business here in the East Bay. Rents will go up, and for office space since we aren’t building any more for a while in the East Bay, vacancies will continue to go down. Keep your eyes on the major tech sublease space as an early indicator that hiring is slowing down or going backwards, and the unicorns that go public – will their stock zoom up or down?
Hang on for the ride into the future, but hey, we are living in one the if not, the most beautiful places in the world, Tahoe 3 hours away, the Ocean, a thousand wineries an hour drive away, some of the best universities in the world, so what better place to work, play and raise our families while we see what actually happens during the next year.