Market Insight Editorial & Advice to Tenants: 2Q1999

The Space Crunch Continues, With a Vengeance

Leasing activity in San Francisco, shall we say, has been impressive. By now none of us are surprised to learn of relatively young or new companies taking down large blocks of space. Based upon their credit, it was not long ago that these tenants would have been shown the door. Currently, however, landlords are all too eager to open their doors to the new dot-com community. These deals are being secured with letters of credit, huge security deposits and pledges of shares. While shareholders may be left holding the bag down the road, the crunch continues and we see no end in sight to this incredible new wave of users. Big shoppers included:

LookSmart              134,000 sf
Northpoint Comm.        98,000 sf
US Web/CKS              75,000 sf
Netcentives             70,000 sf
Sapient                 66,000 sf
Advent Software         60,000 sf
E-Greetings             56,000 sf
Quokka Sports           46,000 sf
AOL                     35,000 sf
BabyCenter              24,000 sf             20,000 sf

The “Spot” Market is the Focus

As you can see from the chart below, the amount of space “Currently Vacant, Ready for Occupancy” has declined substantially in all but the East Bay counties. In San Francisco and San Mateo counties, where many of the multimedia and technology companies are concentrated, “spot” availabilities declined dramatically versus last quarter. Basically, tenants are telling us: We want space NOW, and don’t worry about the economics. Many of the “spot” users are actually leasing currently vacant space while their new long term homes are being renovated. There are some telltales of the future market: Landlords do NOT want to do short term deals in these tight markets; and numerous large blocks of space are being aggressively marketed for future occupancy, at today’s rental rates. If the markets are so secure, or potentially rising (according to some) then why would landlords bother seeking commitments for space for late 2000, 2001 space?

Leveraged Deals. Landlords Get Their Way

Old rule of thumb (emphasis on “old”): Do your best to keep your rent down to ~8% (or less) of your company’s gross revenue. If you do the math for a 20,000 square foot requirement, with space allocations at 200 square feet per employee, if rent is $30/sf/year you’ll need to produce $7.5 million/year in gross revenues. How times have changed, now that rent in the City is in the mid-$40s. These same tenants will have to produce 50% more revenue or (a) start a new business; (b) leverage the company with investor’s and shareholder’s money; (c) add “dot com” to the company’s name so that outside objective parties and landlords expect to see a lopsided balance sheet.

Bet the family jewels that tenants are and will continue to post huge letters of credit and other enhancements for the landlord. Typically landlords are demanding letters of credit for all out-of-pocket expenses, such as tenant improvements and broker fees. In addition, however, demands are also made for some number of months of rent in the form of an L/C as well.

Could we leverage these new lease deals any further if we wanted to? We don’t think so. As long as business is booming, terrific. But be prepared, if possible, with an exit strategy. Make no mistake: we are leveraging our tenant base to extremes never before achievable.

Look at the Fundamentals: 25 Million Square Feet Coming

Keep your eye on the ball. 1998 total net absorption for Bay Area counties was dismal, at -9,046 square feet. Obviously activity has accelerated, yet absorption to date is still negative in San Francisco—and totals only 180,000 square feet for all the Bay counties. Bear in mind that the 12-months-out supply hanging over the market is a whopping 25 million square feet. Once again, the focus of surging activity has been in the “spot” market. Watch out down the road. If the Bay Area can absorb anywhere near a small fraction of that 25 million, you’ll wish you’d have bet the farm on the Nasdaq.

Please note: We provide Bay Area market data and analyses for the current year only. To request commercial real estate market data for previous quarters, please contact us.

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