• RINA 2017 handout
• I-680 North Office 3Q 2016
• Tri-Valley Office 3Q 2016
• Oakland Office 3Q 2016
• San Francisco Office Q3 2016
• I-680 North Industrial 3Q 2016
• Tri-Valley Industrial 3Q 2016
• Oakland Industrial 3Q 2016
Good morning! Thank you, Pam, Theresa, Tim, and the RINA accounting and Chicago Deferred Exchange for inviting me to speak at your breakfast meeting this morning. We are going to have a lot of fun this morning as there is so much going on in the Bay Area commercial real estate arena. Every morning I check Donald Trump’s tweets to see if any of our major industries have been impacted and which way the wind is blowing. And, as of this morning, we are cleared for take-off.
We will talk about the office market, what is going on in San Francisco, Oakland, and out here along the I-680 corridor. We will discuss the changing nature of retailing, where it is headed, and what is going on with some of the more significant East Bay developments.
We will touch on warehouse development, and the impact of rising interest rates on apartment house prices.
We have a new multi-billion dollar industry coming to California and boy, it will really impact subsectors of our commercial real estate market. Yup, we are talking about marijuana.
I hope to raise a few interesting angles on our housing crisis, and we’ll finish with the potential impact Trump and his policies might have on our local economy and commercial real estate.
I hope there will be time for questions and answers, so let’s get started!
San Francisco is still on fire, with millions of square feet of major class A office buildings under construction. Rental rates for several of those new projects, like the signature, Salesforce Tower, are in the $100-110/square foot range on an annual basis, $8 to 9 a monthly square foot. There is also a growing office sublease inventory in San Francisco, but great sublease space that had the original lease signed 2-3 years ago might be well under market, so the rent can be discounted and the sublease profit shared with the landlord and sublandlord. These spaces have been snatched up, like the Twitter sublease, especially if it comes with state of the art design and almost new furniture.
At some point, San Francisco will hit its office construction building limit of 950,000 square feet per year due to Proposition M. Will this force some San Francisco companies to relocate to Oakland or Contra Costa?
Oakland’s Class A office vacancy is practically non-existent (1.6% as of today), and yet developers are reluctant to pull the trigger on new construction. They remember the numerous times in the past when with a three to five year lead time new construction of major office product commenced only to reach the market during a downfall slump. And that resulted in catastrophic economic effects. Rental rates in Oakland’s Class A buildings are now in the $50 to $60 square foot range.
One thing we won’t be seeing for years to come is new office construction in the Tri-Valley or along the I-680 corridor. One day we may see Concord Metroplex Two, a twin 200,000 square foot ten-story on Willow Pass in Concord, but with office rents still way too low to support new office development plus office land scarce since much of this has been snapped up by apartment, condo and retail development, for office space what you see is what we’ve got.
Vacancies overall are in the 10% range, healthy for both landlord and tenants, not a lot of concessions, maybe, a few months free rent on a five-year lease. And lately I’ve seen landlords counter with no free rent, but there is still too much vacant space to make a tough landlord position stick.
I have associates working on new office build-to-suit projects and they report total new land and construction prices in the $400 to $600 a square foot range. Meanwhile, our existing Class A leased office buildings have been selling in the $300 to $400 square foot range.
Between the Pleasant Hill BART station, which has Walnut Creek address, Walnut Creek Shadelands and Downtown Walnut Creek there is 1 million square feet of available office space right now!
Since 2014, shared office providers have leased more than 3.7 million square feet in leases of 20,000 square feet or more, but it only makes up 0.7 percent of the total U.S. market.
Shared office rents are 181% higher than traditional office space, but the space can be super-cool designed, hosting regular events, workshops, free beer Friday afternoons, encouraging networking and collaboration, and extreme flexibility by the hour, day, week or month. (By the way, WeWork is one of the largest.)
According to The National Association of Industrial and Office Properties (NAIOP), in 2005 there was only one coworking space in the U.S. and by 2013 they had mushroomed to more than 3,000 worldwide.
What is the future of retail shopping? Treat media as the store and the store as media. Retailers are using technology to make every single piece of media – social, online, mobile, Twitter – everything as a direct path to purchase. In 2017 there will be more push-button products and services. Nowadays, Siri or Alexa can order products for home, UberEATS delivers food to your door. Mobile share of global commerce is expected to grow from 40% in 2015 to 70% by 2017, and online shoppers might start a transaction on one device and complete the transaction on a different device.
Every time we have a large retailer go out of business, like Borders Books, Fresh & Easy, or Circuit City giving up stores, those vacancies, for the most part, are quickly snatched up by other retailers. Case in point, The Washington Post on January 11th mentioned that Macy’s is closing 100 stores, The Limited is closing all its 250 stores, and Kmart is shutting dozens of stores as well as Wells Fargo. And mark my words, just about every one of these closures is another retailer’s opportunity!
What is your prediction for what will change in retail in 2017?
Our experts talked about data, convenience, personalization, mobile, and digital. While the answers varied, there was one major recurring theme: Retailers and consumers are getting smarter.
Brick-and-Mortar Stores Will Get Smarter
“The physical store retail format will continue to evolve into smarter environments. Brands will continue to learn how to truly incorporate technology to create a connected store — not just for the ‘concept of it,’ but with the benefit of the consumer at the heart of design.
Big box retail spaces have filled up nicely since the bankruptcy issues have subsided, and large health club fitness center facilities have really been on the rise. Supermarket retailers have also been busy with activity and growth, but there’s also been a continuing downsizing trend among retailers looking to maximize sales per square foot.
“Retailers are going smaller. Existing retailers with long-term leases realize they are not efficiently and effectively using their square footage. They are finding opportunities to lower their overall economics by subleasing out portions of that space.”
A Deliotte survey found that 69% of consumers go “webrooming”—browsing online, either on a desktop or mobile site, and later purchasing in a store. The trend also works the other way: 52% of buyers visit a store to check out the merchandise in person, then go online to find the best price and buy.
A recent Accenture survey found that 47% of shoppers want more retail services through mobile devices, but most retailers aren’t equipped to help them.
In the future, many retail stores will evolve into high-tech showrooms, according to IBM. A customer will examine and purchase merchandise in a store location, but the items will be shipped from a warehouse to a customer’s home address. IBM expects this showroom model to account for at least 50% of retail sales by 2025.
One of the companies paving the way for this showroom model of shopping is Reveal—an innovative startup that has developed a popup clothing boutique that can be assembled in just 22 minutes. The Reveal boutiques’ high-tech arsenal includes free Wi-Fi for guests; touchscreen computers for ordering merchandise; and customer-aware sensors and RFID-tagged clothing, so a retailer knows which items are (or aren’t) popular. All of the resulting data enables retailers to more precisely determine future clothing production, selection, and prices.
Experiential retail provides the ability for brands to further engage customers through authentic experiences—whether they happen online or offline.
This has always been an important part of retail, but we are definitely going to see more of it in 2017 given the success integrating experience has had in retail to-date.
Technologies like interactive fitting rooms, self-checkout technology, and interactive signage and displays that provide customers with product attributes or reviews will be more prevalent across the industry in large and small retail stores.
What’s going on in the East Bay retail arena? – Lots and lots of new retail development all over. Anybody who thinks the internet shopping has killed brick and motor, forget it, they are both here to stay and feeding off each other.
There is so so much going on all over the Greater Bay Area and specifically our East Bay subregion.
Downtown Walnut Creek new residential development is still on a streak. As an example, the Agora Development Group over on Newell at South Main Street has 49 apartments over retail, all 2 bedrooms, and the level flats are rented for $3,800 a month, with the two-story townhomes renting for $4,500 a month. Yes, in Walnut Creek! And they are 98% leased!
At Bonanza and North California Blvd. the Lyric is coming this summer with 119 units over retail.
On the closed-down McDonald’s site they are talking about 70-80 apartments over 11,000 square feet of retail, underground parking and 20 extended-stay hotel rooms.
Talking about hotels, on Lawrence Way the Fair Oaks hotel developer will be building 120 to 130 rooms, and the six-story Marriott Residence Inn across from the Walnut Creek BART station will have 160 hotel rooms.
The old La Virage restaurant site will be 54 luxury units on Main Street, and the Walnut Creek Bart station garage construction should start this summer, with 596 apartments planned after the garage is completed.
The Landing on Ygnacio Valley across from the BART station will have 179 apartments.
The 30,000 square foot Equinox Fitness Club is coming to Broadway Plaza.
The Veranda Shopping Center which will replace the demolished Chevron office complex in Concord next to the Willow’s will have an upscale movie theater where you can wine and dine and watch a movie in luxury. They’ve signed up Whole Foods, and their preliminary merchandising plan shows T.J. Maxx, Sierra Trading Post and dozens more retailers.
New warehouse development – Panattoni is building 200,000 square feet of brand-new warehouse space in North Concord. No tenant as of yet.
Out in Tracy, Prologis, one of the largest industrial developers in the entire world, has a 20-million-square-foot warehouse project. 1.4 million feet is complete and they are about to sign 550,000 square feet and will keep building as the space gets rented. The clear height is 36 to 40 feet and the rental rates are in the $0.40 – $0.45 a square foot range.
On the other end of the spectrum at the Port of Oakland there is another multi-million square foot warehouse development, but with rental rates at $1.20/square foot because it is right at the Port of Oakland and has immediate access to the entire Bay Area.
And what about the huge changes that autonomous self-driving vehicles might cause to the design of residential and commercial buildings? These cars are coming, maybe as soon as five years, and it might take 15 or 20 years of transition, but trucks will be driverless 24/7, and distribution centers will need to be redesigned to accommodate this, 80% of parking spaces might be unneeded and potentially be converted to revenue – generating retail or other uses.
“Lawrence Yun, National Association of Realtors chief economist, and K.C. Conway, senior vice president of credit risk management at SunTrust Bank, expressed confidence that commercial real estate activity should remain on an upward trajectory, but with more uncertainty given the likelihood of a rising interest rate environment in 2017. He predicts that given the slow growth economic environment, instability overseas and the probability of a rate hike by Federal Reserve at the end of the year, investors are expected to take a cautious approach in the months ahead.”
Yun also indicated this would likely lead to a modest decline in commercial property prices, especially in Class A assets in larger markets.
According to the Urban Land Institute, “Investors are increasingly jittery about uncertainties in the market. Although a near-term recession is not being widely forecast, institutions appear to be preparing for eventual cyclical weakness.” Industrial properties are safer, apartments are relatively safe in an economic downturn, the office sector is more risky and could perform poorly during a downturn, hotels might be volatile and may have already hit their peak.
The San Francisco Bay Area is defined as nine counties and about 100 cities and towns. In the Bay Area there are 2.7 people per household, but we are only building one house for every five people we add. We build 20,000 new units a year, but we need 30 to 35,000 units a year, and we are getting further and further behind.
According to the Building Industry Association, which represents home builders, assuming a steady growth path from 2011 to 2040, the Bay Area would have created about 206,000 jobs and 136,000 housing units between January 2011 and now. In reality, the Bay Area created about 531,000 jobs, but permitted only 94,000 housing units.
Let’s spend a few minutes on the commercial real estate investment market and, in particular, apartment house sales. You’ve heard it before, and you’ll hear it again and again, as interest rates go up, real estate values, in general, should come down. When it costs more to borrow against a property, you need either more income to cover the loan or, more realistically, a lower price. All cash buyers will have less competition from leveraged investors, so this will affect all property types.
Also, when interest rates go up, other investment vehicles look more attractive than they did when banks were almost charging you to hold your money, bank savings rates were so low.
Apartment house sales have been at very frothy levels, and this might cool off just a bit, but overall, our job to housing imbalance is going to get worse and worse.
For the big picture, the U.S. property market will have continued strong fundamentals, increased investor flows and high transaction volume.
So, let’s talk about the multi-billion dollar industry coming – marijuana.
The impact of marijuana on industrial real estate already has played out in Colorado, where voters approved recreational use of marijuana in 2012. Sales began in 2014.
The burgeoning real estate market tied to marijuana also has led to companies specializing in listing commercial property that can be used for the cannabis industry. The marijuana industry also now uses one in 11 buildings in central Denver, according to the Denver Post, and uses 3.7 million square feet of space in the Denver area.
“Legal marijuana operations are finding space to grow and store their product by paying premium rents for warehouse space.”
“Because large facilities are needed to grow and store marijuana — and because local laws often limit where such businesses can be located — industrial warehouse owners have seen rental rates spike in areas where medical and recreational marijuana is legal.”
Leasing property to marijuana businesses shows such promise that the first marijuana industry-related business to get listed on the New York Stock Exchange, San Diego-based Innovative Industrial Properties (IIPR), is a real estate investment trust that leases large warehouses to medical marijuana growers.
While most companies can rent warehouse space for about $5 per square foot in Portland, according to Bloomberg, cannabis companies routinely get charged in the $12 to $18 range. Part of the reason is a tight supply of suitable space. Local laws on where cannabis companies can operate limit the options for rental.
If a marijuana tenant does find a landlord, the analysis found it often pays a higher rent, often three to four times more than the average for a mainstream business.
Zanin says buildings zoned as “light industrial” that have been vacant for years are now the most valuable properties in the area thanks to the marijuana industry. Properties go so quickly, Zanin says, that a secondary market has blossomed–well-heeled companies will buy a property, get a license, and sell the whole package to smaller businesses.
Josh Ginsberg, co-founder and CEO of Native Roots, says his company has gotten so large that he has a team tasked solely with looking for property to buy or lease. Native Roots has 450 total employees. Ginsberg says the real estate team has been key to the company’s explosive growth in the past two years, from four to 15 stores. The largest building Native Roots owns is a 180,000-square-foot grow facility with more than a hundred employees and tens of thousands of plants. Shortly, the company will open its 16th location, a third gas station-pot dispensary in Colorado.
The company owns half of its buildings and is working on buying more. Ginsberg says as a marijuana company that is growing as fast it can, he does not want to be at the mercy of anyone, especially a landlord.
Most commercial mortgages prevent tenants from operating illegal businesses, so this can be a challenge as well.
Federal banking laws prevent banks from lending or accepting deposits from illegal businesses. Imagine if you were the landlord of a 50,000 square foot warehouse, housing a growing and distribution pot business and every month had to accept your $50,000 a month rent in shopping bags filled with cash.
So, how do we solve the Bay Area housing crisis?
London, New York, Paris – all have amazingly efficient public transit systems – The Tube, Subway and Metro. But the San Francisco Bay Area has one humongous barrier to creating a smooth efficient public transit system to allow massive affordable housing construction without further exacerbating our increasingly terrible traffic situation – The Bay! The many counties and cities circling the San Francisco Bay are throttled by a handful of bridges and a Bart tube – creating hundreds of thousands of new jobs in San Francisco, and hundreds of thousands of new residential units in Marin, Solano, Alameda or Contra Costa Counties and this will only increase our transit gridlock.
I mean, maybe enough is enough? – We can stop approving new office projects, let Google, Facebook, and Apple take their high-paying jobs to Kansas or Idaho and give us back our freeway lanes and parking lot spaces. Just think, if we lost a couple of hundred thousand jobs? Apartment rents would go down, housing would become more affordable and our commute times would be much shorter.
While we complain about traffic and congestion and moan about how our kids won’t be able to live in Walnut Creek or Danville, for the most part, most people want great jobs to come to the Bay Area, and want lots of new housing to support these new jobs … just not in my immediate neighborhood – down the road over the hill, somewhere else, but right here!
Obstacles to solving our housing crisis.
In some cities, fees alone for new construction can be as high as $100,000 per unit.
Regulations, environmental impact, traffic studies, and neighbors can add 2-3 years or more to a new housing project.
Jobs imbalance – San Jose has 203,576 more jobs than housing units, and San Francisco has 154,594 more jobs than housing units.
So, what do we do? Allow much higher density, higher stories, smaller units, cut the fees from $100,000 a unit to $25,000 a unit, minimize neighborhood opposition, streamline the process, and unleash new residential development, especially near public transportation. And our public transportation is already at capacity, so, unless we want to plan a huge BART, Cal Trans, Amtrak and Ace Train expansion, which can take 20 or more years to carry out, we are basically stuck with our imbalance. A recent study showed that 42% of all kids between the ages of 19 and 34 were living at home. In Cuba it is not uncommon for four generations to be living under the same roof. So, maybe, empty nesting is way over-rated!
The Feds raised the interest rates a quarter of 1 percent, and we may be in for several more rounds of this type of increase in 2017, but hey, our rates are still super low as compared to what we’ve experienced during the last 40 years. I still remember buying my first home back in the late 1970s with a 30-year fixed rate not to exceed 18%!
The largest U.S. demographic group is the millennials, born between 1981 and 2000, now totaling 84 million. The iGeneration (those born after 2000) will surpass millennials by 2030 with a projected 125 million, 35% of the U.S. population. The boomers’ population will decline since every day 10,000 boomers turn 65. By 2030 the oldest boomers will be 84 years old and this group will only represent 17% of the population.
The office sector is expected to finally reach a new peak in 2017, but gains are slowing as tech moderates while the financial sector retrenches.
Across all product types, demand has shifted to cities over suburbs, as millennials demand more accessible and dynamic neighborhoods in which to work, live and play. Even industrial tenants are seeking more central inner-metro locations to better serve online shoppers.
The drop in oil prices hit Houston, Texas and North Dakota among other regions especially hard, but with low gas prices consumers elsewhere have had more money to spend on retail and other things.
Who knows what can happen to our energy sector in California? Will the Federal rebates for solar panels go away, and will the largest coal mine of the 1800’s in California, Black Diamond Mines in Antioch, be reopened, so we can get back into the coal business? Just joking! Or … maybe not?
Trump And the Future of Commercial Real Estate
Interest rates are expected to continue to rise. This may affect property values and cause a decline as cap rates also go up. On the other hand, inflation is expected to increase, and commercial real estate loves inflation as it usually boosts values, replacement costs, and rental rates.
The Trump administration will inherit a strong economy poised for continued, if moderate growth. The planned stimulus package of tax cuts and infrastructure spending should boost growth, but at the expense of greater inflation and interest rates.
Trump’s broader economic platform should benefit key sectors such as energy, finance and pharmaceuticals, but will likely reduce economic growth overall and raise odds of a recession by 2019, according to a number of economists.
With Trump’s election, we should anticipate large tax cuts, deregulation and a likely return of greater risk-taking by financial firms in an attempt to stoke a faster pace of near-term economic growth.
At the heart of Trump’s tax plan is the intention to reduce taxes on pass-through entities to 15 percent, which would decisively favor the middle market which accounts for 40 percent of GDP and employs one-third of the labor force.
Loosening regulations could lead to higher degrees of risk, especially in the banking and investment arena.
Infrastructure projects like roads, bridges, sewer, water, cybersecurity may not affect commercial real estate in 2017, but could be a factor in 2018 and 2019.
The tax reparations of the tech companies that are parking huge wads of cash overseas could have a giant Bay Area impact. Apple, Google, Oracle, Cisco, Facebook, and Intel combined have half a trillion dollars overseas, and if the U.S. takes their 10% tax, this puts $450 billion dollars cash in local companies bank accounts, maybe, to buy more office buildings or other companies.
Ken Rosen, our Bay Area economist guru, says The Day of reckoning is coming and he thought it would have already happened in 2016, but now sees a postponement due to the surprise Trump victory to 2019 or 2020.
The Trump Bump – heavy construction if we get freeway, bridges, highways, sewer – so great for construction and engineering firms.
Temper this with a potential backlash against California and the Bay Area that did not vote for Trump, and sanctuary cities like San Francisco that might see massive cutbacks in Federal funding if they don’t toe the political line.
In conclusion, we have covered a lot. We don’t have to make our Contra Costa and the East Bay great again because we are already great. I see solid years ahead, we haven’t overbuilt office like we did in the past, politics has kept new development in relative moderation, and our future is very, very bright!