January 12, 2009
Pro Forma Problems: Find Commercial, Replace With Residential?
From J.K. Dineen at the San Francisco Business Times:
Downtown San Francisco’s weakest year for commercial real estate since 2001 ended with a whimper, with the central business district losing another 1.3 million square feet of occupied space in the fourth quarter of 2008.
For the year, San Francisco’s “negative absorption” — the sum of both space vacated and empty new square footage coming on line — topped 2 million square feet, according to end of the year reports from CB Richard Ellis.
The deluge of newly available office space drove taking rents — the amount that tenants actually pay for space they agree to occupy — down by almost 25 percent, according to an analysis Colliers International did of 93 leases completed in the fourth quarter. The gap between what office landlords are asking and what tenants are willing to pay is widening, according to James Bennett of GVA Kidder Mathews.
“You have a lot of newcomers to the market who bought buildings at astronomical prices who are now having to stomach the fact that their pro forma rents are not going to materialize,” said Bennett. “It will be interesting to see how those owners respond to the down market.”
We're still talking commercial, right?
∙ S.F. tenants pour more space onto market [San Francisco Business Times]
First Published: January 12, 2009 4:00 AM
Comments from "Plugged In" Readers
unfortunately, the downturn in Commercial Real Estate will be another un-needed stress to our economy.
many banks spared by the residential mess will be slaughtered by a commercial real estate downturn.
specifically, it's the smaller sized banks and regional banks that really focused on Commercial RE. So this bears watching.
Posted by: ex SF-er at January 12, 2009 8:51 AM
Some pretty logical allusion here.
Residential rents are much stickier than commmercial rents: a company with 10,000 square feet of office space downsizes, and can sublease 2,500 square feet. But someone who gets laid off can't rent out 150 square feet of their 600 square foot 1-bedroom, or a corner of their studio. So you won't see the impact on apartment rents until the lease rolls.
I don't have a link to support this, but I've heard that a vast majority of SF leases renew May through July. So if we do see a material drop in rents (ala 25%), it may not occur for a few months.
Posted by: Dude at January 12, 2009 10:30 AM
This adjustment is very much needed. One feature of this bubble has been home equity used to conjure businesses of questionable value which helped to keep not only office rents high, but also fill the surplus of space coming along with recent developments. With the equity game gone space that had been taken up by weakly developed businesses will now be available for companies with more robust revenues.
If things get really crazy then we might even see live-work lofts ending up in the hands of actual practicing artists.
Posted by: Mole Man at January 12, 2009 10:32 AM
the reduction in the value of commercial office properties will be GREATER than the reduction in value of residential properties.
1) rents down 20% from peak -- but that means 40% from proforma from any 2006-2007 acquisition.
2) cap rates increase, say, 150 bps
3) no debt , so transactions down by say 75% thru 2010.
4) all equity deals will then require even more price drop to make investor yield requirments on 2006-2007 funds.
Posted by: louis at January 12, 2009 3:20 PM
3) Are you suggesting cap rates will decrease in a falling interest rate environement?
Posted by: Paul Hwang at January 12, 2009 5:40 PM
3) Are you suggesting cap rates will increase (sorry meant increase) in a falling interest rate environement?
Posted by: Paul Hwang at January 12, 2009 5:41 PM
louis & Paul;
Your point about cap rate increases of 150 bps - is this a projection for 2009? Shouldn't they go even higher, say +300 bps or more?
What is your outlook for commercial rates?
Posted by: FSBO at January 12, 2009 7:39 PM
Hurray for falling commercial rents. Perhaps more "Silicon Valley" businesses will set up shop in SF. We get to keep more of our commuting neighbors- software engineers, venture capitalists and tipping point geeksters and gene splicers in townn and not zooming down 280 at 85 miles per hour.
Posted by: Kathleen at January 12, 2009 8:56 PM
As far as cap rates increasing while interest rates decrease, that is already happening. In theory, you would expect that as interest rates move down cap rates would follow (cap rate = risk free rate + risk premium). The problem is that as treasuries (risk free rate) have moved down, risk premiums (credit spreads) have widened tremendously and more than offset any tightening in the risk free rate component of the cap rate. This trend is only going to reverse itself, in my opinion, when you have property level income growth and cheaper debt -- and I don't think you are going to see either of those for awhile (definitely not in 2009).
Posted by: DB73 at January 13, 2009 9:31 AM
"Hurray for falling commercial rents. Perhaps more "Silicon Valley" businesses will set up shop in SF."
Huh ? Silicon valley commercial lease rates have also cratered. Vacancy is quite high right now.
Posted by: The Milkshake of Despair at January 13, 2009 9:58 AM
Wouldn't it be nice if a variety of businesses considered having their companies located in the city San Francisco prestigious?
I am old fashioned. Make that jsut plain old.
Posted by: Kathleen at January 13, 2009 12:32 PM