Hype in Commercial Real Estate Values in San Francisco Could be the Next Shoe to Drop
Nov 29, 2011
Kilroy, a major new player in commercial real estate acquisitions in the San
Francisco Bay Area, recently paid $400.00 a foot for a near vacant office
building in South of Market that has had trouble leasing in good times as well
Buildings are selling at prices up 40% in one year while rental rates are
skyrocketing in areas that are attractive to tech firms.
San Francisco is considered one of the top four commercial real estate
markets to invest in the United States.
Vacancy rates in core tech areas have dropped to less than 5% with overall
vacancy rates dropping to the low teens for the first time since the dot-com
All sounds like a real estate boom!!!!
Yet it makes no economic sense…
In 1985, I did a deal for $34.00 a foot at 33 new Montgomery Street for shell
space. The term was for five years and there was a dollar increase per year. The
tenant received $35.00 a foot to build out the space. The broker received a
$1.00 a foot per year in fees; attorneys and architects added another $4.00 a
foot. The operating expenses to run the building was $12.00 a foot and the net
income to the landlord on that deal was $10.00 a foot.
Today in 2011, a deal could be done for $43.00 a foot at the same building
with the same dollar increase per year. The tenant in shell would receive $70.00
a foot to build out the space. The broker would receive $2.00 a foot per year
with attorney and architects fees running $5.00 and operating expenses now
running $19.00. This leaves the landlord with a net income in a hot market of
$4.00 a foot for the same type of deal 26 years later.
Yet the building just sold for 20% more 26 years later.
Today, new commercial buyers are thinking about replacement cost.
To build that same building today at 33 New Montgomery Street includes:
buying the land, hold time to get the necessary approvals, adding in finished
construction and leasing would total somewhere around $1,200-$1,400 dollars a
foot. As a result, REIT buyers do not look at net incomes they look at safety
and replacement costs; at $400 a foot that looks like a steal in comparison to
building a new product.
The problem with looking at buildings as you would fine art is that net
income still has not kept up with the value of buildings. In fact, over the
years the spread between net income and building value has increased rather than
decreased. San Francisco may be enjoying higher rental rates but those rental
rate increases are coming because of a tech boom that is based upon speculative
firms that may or may succeed. The real issue is whether mainstay businesses are
able to pay higher rental rates or not. Like the rest of the country, most
mainstay businesses have stabilized their business at best and are not booming.
The shoe is about to drop.
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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 26 years in the San Francisco Bay Area and specializes in office leasing and investments. If you have any questions or comments please email email@example.com or call him at (415) 765-6897. You may also check out his website, http://www.commercialspacefinder.com/.