2006 was a year of uncertainty for landlords and tenants. Commercial rents increased more than 10% while vacancy rates continued to decline. Tenant improvement costs soared, with the average cost to build space from shell condition at $52 per square foot. Residential condo development continued at a fast pace, taking over sites in key downtown locations that could have accommodated office building development. Yet, there are signs of a softening condo market. City hall continued to be a nightmare for anyone seeking permits.
As a commercial real estate broker dealing with this market, I’d like to see landlords and tenants make the following New Years resolutions:
- Landlords: Remember that your rents must equal a tenant’s ability to pay in the long run. That rent should never exceed 6–8% of a company’s gross monthly sales. If it does, you will send that business out of business. Projections are fine, competition is fine, low vacancy is fine—but in the end, rent must be affordable in order for a firm to survive its lease term.
- Tenants: Remember that rents today are the same as 1989 with one big difference: tenant improvement costs have gone up 40% since then. Yes, you have grown accustomed to these low rents and you have long since adjusted your bottom line to incorporate these low rents into your budgets, but the reality is that 1989 rents do not mean a profitable return to building owners. With vacancy rates down, be prepared to pay higher rents in the future.
- Landlords: Remember that condos may bring a better overall return than office development and your friends at city hall enjoy the greater property tax base that condos create. However, residential development must be in line with commercial office development or we will run out of office space to meet the growing demand for a larger workforce that in turn will need homes.
- Tenants: Remember that office inventory is the lowest it has been since the dot-com boom. Be less selective in your search and open to locating office space in different areas of the city in order to meet your budget or adjust your budget to meet market realities. Don’t make the mistake of waiting for the perfect office space at the perfect price: the market is moving too quickly. If a space works but is not perfect, jump on the opportunity, which may be the best alternative you will find.
We at Starboard wish you a successful and profitable 2007. This will be another interesting year full of challenges for the commercial real estate market. The good news is that everyone believes that the economy is doing fine and that business will continue to grow in 2007 in the San Francisco Bay Area. If that holds true, everyone—landlords and tenants alike—will enjoy this year. |
