N. California Commercial Real Estate: A Bird’s Eye View

The Mercury News reported last week that  Silicon Valley office vacancies are now near 20 percent.

A hedge fund friend, located in the greater San Francisco area, decided to respond to the Merc and Calculated Risk discussions of this issue in greater detail:

Ahh, the real issue in commercial RE: Too many sq ft.

Even in “leased up” buildings. The sub-lease market on the whole West Coast (and East Coast too most likely) is wide open. Deals are getting done at 35-40% of 2005-7 lease rates.

ROI is a beneficiary. We are one of 3 hedge funds in a space formerly occupied by a now defunct VC firm. This is an Equity Office Property building right on the water. My guess is that the total space used – including an EOP management group (8 folks in a space for 40) is about 70% and falling. We got a 50% discount last year for a 5 year deal. Local rates have fallen another 20% since then. There is another 1+mm ft about to hit the market in a building that is in default before in got finished – a real nice one too.

Everybody I talk too here in N.Cal is looking to shrink sq ft taken and hammer lease rates over the next 2 years. Law firms, money managers, etc. – even growing firms are downsizing space.

I should also note we got a great deal from Comcast. High speed internet and unlimited phone service (VOIP) at 70% off what we had been paying. Small fight with landlord about access to cable room aside – better service for 30% of cost. I don’t think the local telcos are going to like this trend.

At some point in the nest few years, the loan amounts and economic value of this space will have to come more into balance. Between now and 2013 it might make sense to purchase RE.

Currently, rates being negotiated at the sub-lease level I have seen don’t cover the wholesale cost of replacing a building – if land were free. I’m guessing prices have a ways to fall.

And, I see no private sector growth here in California that would even remotely start to fill existing space – let alone what is still coming on the market.

None of this analysis takes the public sector into account. State and local governments use alot of space in CA – they are all broke BEFORE taking the pension issue into account. If, over the next 5 years, the public sector disgorges sq. ft. onto the market, things could get even worse.

Of course RE fees and taxes are a large part of the state and local budgets so there is a potential for a death spiral at some point. Full disclosure – I’m not long CA munis.

Could any of this have something to do with Capmark Financial going chapter? Inquiring minds want to know. It seems that, like virginity, sometimes losing is wining.