Hans Hansson | January 28, 2015
I have been a commercial real estate broker for over 30 years now. I have witnessed three boom and bust cycles during my career. The first bust was through the 1989 earthquake, followed by the national deep recession that created a perfect storm of disaster for commercial real estate values in San Francisco. The next boom and bust was of the dot.com market from 1997-2001 and finally the Great Recession of 2008 and 2009.
In looking forward into the New Year and the trends that will rise in our current real estate cycle of success, it's frankly hard to imagine that this market is going to be sustainable much longer. Yet, investors are still flocking to our market and conventional wisdom coming from leading researchers claim otherwise. They believe San Francisco and its surrounding areas will continue to grow and flourish.
A recent report from the Urban Land Institute certainly supports that theory. In ranking its annual "Cities to Watch" list and San Francisco is ranked third, only behind Houston and Austin for overall positive growth prospects for 2015. Interestingly enough, investment, development and homebuilding are equally expected to grow at the same rates, suggesting a vibrant overall real estate market for San Francisco in the New Year.
The report states "San Francisco continues to benefit from intuitional investor interest in the market along with a strong private property owner/developer segment. Local market participants see the strength of the local economy driving continued strong investor demand. The availability of capital should keep deal activity high in 2015".
As a street broker, I have a different view of 2015. I do believe that 2015 will be a good year, but a transitional one as well. There are several important factors that a national report such as Urban Land has not focused in on. First is the effect of major rental increases on traditional companies. Firms that are seeing double or even triple rent increases are going to have a tough time growing, let alone keeping existing office space. They will look to scale down either in quality or size of space and look to move from A buildings to B buildings, etc.
Buildings that have recently sold are, in most cases, enjoying vacancy rates fewer than ten percent. Therefore, these new owners are not going to be interested in doing any deals that could negatively impact the value of their new assets. In return, existing tenants looking to make a deal are going to be in for a rude surprise when building owners will not care about making deals just to keep a tenant. Rather, owners will want the spaces to be vacant so that they can re-tenant the building for "tech-tenants".
Secondly, our current growth cycle fueled by new technology companies is entering its third year. This year we should start seeing the first wave of failed tech firms. Given that 90 percent of startups fail, it's only a matter of time for when we start seeing early adapting firms not make it. These firms will start subleasing or abandoning their spaces, which will create vacancy. The focus of the matter will be how much space will become available on the market against the continued need for more space by the continued growth in tech. Venture Capitalist firms will be dictating a lot of this uncertainty as they decide to continue funding these firms or pulling the plug.
The biggest risk is the conversation of traditional office buildings to tech. Currently, new owners are stripping traditional office spaces of private offices and conference rooms in favor of high exposed ceilings and open spaces. If the tech market declines, these office building owners are going to be looking at potentially a major flop, plus major costs to retool there new assets back to traditional office spaces in a declining market.
Lastly, overbuilding is in full swing as new office buildings are moving through planning. These buildings will begin to hit later this year and next. If the national forecasters are correct, these buildings will remain excellent investments as the market continues to grow. If my thoughts based off past experience are correct and the market softens, these new buildings are going to have difficulty leasing without substantial rental rate reductions, which will help them lease but make the asset less successful at least in the short term.
For now, we will just have to continue business as usual and wait to see what 2015 holds for our real estate market in our little city by the bay.
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