Musical Chairs with Office Space?
Mar 17, 2008
Between 2008 and 2011, San Francisco will see more than 3 million square feet of new office space come onto the market. This will be the largest increase in new office space in San Francisco since 1985. In addition, if all the residential units that are at the permit stage or that have applied for permits are built, San Francisco will see 45,000 new condo units available for purchase during a similar period.
Wall Street certainly believes in San Francisco. Real estate investment trusts (REITs) have pegged San Francisco to sustain rents as much as $100 per square foot by 2009. Although this is high by San Francisco standards, it is half the rate projected for New York. Yes, tenants should be nervous. But so should landlords.
I started in this business in 1984 in a similar market. Rents were $52 per square foot at 44 Montgomery Street and climbing while new office space was coming on the market. What happened next? The market collapsed.
Build it and they will come? They didn’t come in the 80s. What Wall Street fails to understand is that San Francisco is not New York; it is not Chicago; it is not even Atlanta. San Francisco is a solid mature office market that relies not on headquarters-type businesses but on startups, independent firms, and branch offices of major companies. There is a ceiling to what these firms can afford to pay in rent. If they cannot afford the rent but need a San Francisco address, they will simply reduce their space requirements and move most of their operations to a cheaper market.
Here is what I believe will happen in the next several years. New buildings will fail to land tenants prior to occupancy. They will look outside the San Francisco market for tenants willing to move or expand into the city. But these tenants will not materialize; doing business in San Francisco will become prohibitively expensive. Landlords of new buildings will have to raid current Class A buildings for tenants. At that point, “musical offices” will begin.
New Class A buildings will raid tenants from old Class A buildings by offering competing rates for a new product. Faced with losing their tenants, older Class A buildings will look to tenants in Class B buildings, offering upgrades to Class A buildings for Class B rents. Class B buildings will look to Class C buildings to fill their new vacancies; in the process, the rental market will collapse.
Building owners must focus not on Wall Street predictions but what tenants can pay in rent. As a general rule, tenants can afford to pay 6–8% of gross receipts toward rent. Companies that pay more than that will find themselves in trouble. When building owners push rents too high, they too will be in trouble.
My prediction of musical offices is based not on theory but on history: This is exactly what happened in the 1980s. We should consider ourselves warned.
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Written by: Hans Hansson
Hans Hansson is President of Starboard TCN Worldwide Real Estate Services as well as a member of the Board of Directors for TCN Worldwide Real Estate. Hans has been an active broker for over 23 years in the San Francisco Bay Area and specializes in office leasing and investments. If you have any questions or comments please email firstname.lastname@example.org or call him at (415) 765-6897. You may also check out his website, http://www.commercialspacefinder.com/.