Commercial Real Estate Lending Likely to Feel Spillover from Subprime Crisis
By Wayne Mascia
The commercial real estate sales market and the residential real estate market may or may not at any given point in time experience the same difficulties. The reason, of course, is that the forces that drive each sector are different. The commercial sales market is driven by returns and available funding through institutional lenders, and home sales area driven by available product and low interest rates through banks and mortgages companies. As only a cursory reading of the media, in August 2007, not only was residential real estate lending sent reeling by the credit crunch brought on by subprime lending, but because of that crisis, commercial real estate lending was also affected, albeit differently for the different categories of commercial buyers.
We all have come to understand the problems caused by the credit crunch in the residential market - defaults on loans, depressed housing prices, lending companies going out of business and huge losses at established companies - both here and abroad.
As a result, the commercial industry has had problems created for both buyers, developers, owners/users and investors. Each category, of course, has different goals, horizons and borrowing parameters, and these are beginning to become more apparent as we progress through 2008.
Developers, for example, purchase property to improve and either dispose of or lease it, ideally for a profit. They use short-term financing, typically from one to two years and priced on a variable rate tied to short-term indexes. Their perspective focuses on market indicators and property fundamentals, rather than on the cost of capital. While the recent Fed rate cuts are likely to make their cost of money more attractive, on the other hand, a slowing economy associated with those decisions is likely to have a more negative impact on the feasibility of any project in the year ahead. According to Mark Regoli of South Bay Development Company, the crunch and its aftermath will have an effect on project feasibilities: "We expect that buildings will be tougher to sell. There will be fewer buyers in the market," he speculated, "but at the same time, it will create opportunities for some."
For established, well-qualified developers, capital will be both available and attractively priced. Lenders, of course, will scrutinize projects to assure that they can perform in today's market. Owners/users, on the other hand, are buyers who intend to occupy the property to use in their businesses. They generally seek long-term financing with fixed rates since their horizon can be a decade or longer. Many make use of U.S. Small Business Administration financing that is both attractively priced and can be highly leveraged. They repay the loan out of the cash flow of the business.
Investors bring yet a different perspective to property purchasing and financing. Interest rates to this category of buyer are particularly important since their return is basically the difference between their cost of funds and the net operating income generated by the lease or leases on the property. Due to the inability of banks to place their securitized residential loans and the myriad of other costs associated with the credit crunch, inves- tors are likely to find capitalization hard to find and more expensive and, in turn, are likely to be the hardest hit of all the commercial real estate buyers, at least for the next several years.
As South Bay Development's Mark Regoli notes, "Investment buyers are going to have to accept lower yields and this, in turn, will lead to repricing of commercial real estate as an asset class."
Finally, we in the commercial brokerage community are likely to find the next year particularly challenging as we adjust and advise our clients to adjust to the new financial realities. In the perspective of history, Regoli put today's credit crunch in context: "We have seen how a lack of liquidity has impacted on markets in the late '80s and '90s and it seems to be repeating itself. Just like they told us in business school, real estate is a very cyclical business."
September 2008 Commercial Edition Issue
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Know Details to Capture Sublease Opportunities
Looking for new offices or other facilities for your business? Whether your need is for expansion or you are looking for your first space, sublease facilities are and always have been a viable option. Sublease space represents facilities offered by other businesses that, for a variety of reasons, find such space in excess of their current needs.
Typically, technology companies find they have overestimated their space needs because anticipated expansion did not occur, or any of a hundred possible economic or business calculations simply did not materialize. They find themselves locked into excess leased space they don't need that represents an often expensive drain on resources.
For both overall space available and for the subcategory of sublease space, Silicon Valley is no different than any other market - perhaps just more so. Availability is a constantly changing picture, subject to economic shifts and the realities and perceptions of those businesses needing and supplying commercial real estate space.
Our data indicates that for the last five years, the amount of sublease space on the market has varied from a high of 44% of total space - the situation in 2002 during a time of corporate downsizing, buyouts and general consolidation - to a current low of 21%, reflecting economic expansion and buoyant expectations.
Because of the obvious pressure on businesses needing to sublease excess space, such facilities generally provide very competitive rates and sometimes unusual opportunities and therefore should not be overlooked. At the same time, subleases do require careful attention to the details and documents used, to be sure you get what you expected.
Unlike direct-lease transactions of a lessor and lessee, a sublease involves three parties: the master landlord, the lessor and the sublessor. All parties have their own competitive interests in the sublease negotiations. As brokers representing the tenant, we always recommend that our client engage the services of an attorney to review the master lease and sublease documents to assure their own interests and needs are met.
As brokers having negotiated numerous subleases, we have found that several issues consistently surface during discussions that should be reviewed carefully by the tenant. First is to thoroughly review and understand the master lease, which will continue to rule your occupancy. It may be, for example, you who were verbally assured the lease expiration date was fi ve years hence, when in fact the lease says three years. There may be restrictions on use of the building, which would impact your intended business use. If you later find out about these potential limitations, which are locked into the master lease and cannot easily be changed, any bargain may be problematic.
In reviewing the master lease, you should be alert to several other typical issues. For example, in case of default, make sure the lessor cannot terminate the lease so long as you continue to pay the rent to the lessor. You will want to be sure that as a sublessee you have the right to sublease your space should your own situation change. Finally, you will want to be sure that when you surrender the premises at the end of your sublease, you are clear about your responsibility of returning the space to its original condition.
These cautionary notes notwithstanding, as you begin exploring the market with your broker, the inclusion of subleased space could present some intriguing opportunities.
June 2008 Commercial Edition Issue
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Tour Provides Perspective on Looming Silicon Valley Dynamic
By Wayne Mascia
On a drizzly day in mid-October, all the brokers in the office bundled onto a bus for a tour of all the new commercial projects under construction and sites planned to be initiated in 2008 and beyond. Intended as more than a simple inventory update, the tour was to give us the collective opportunity to gauge and analyze the trends looming on the near-term horizon and their impact on the landscape and economies of the region.
As confirmed by a view from just about any upper-floor window in the Valley and certainly from our tour bus windows, numerous high-end office projects of three, four and five stories are now under construction and will add 2.1 million square feet of new space in 2008 alone. Spearheaded by developers Jay Paul, Menlo Equities, California Bavarian Construction and others, such projects signal the new building boom is more than a rumor. Among the trends in a market already mature is the fact that much of the new construction is taking place where previous facilities built in the late 1970s and early '80s must be demolished to make way for campuses of two- and three-story buildings. Led by veteran Sobrato Development Companies with 516,000 square feet in Santa Clara and Sunnyvale Town Center, such new facilities are supplementing the previous tilt-ups that characterized these markets in the past.
Even more dramatic, Tishman-Speyer, Hunter-Storm and others are eyeing eight office towers totaling 400,000 to 800,000 square feet in Santa Clara's North First Street area. Such projects not only contain the of- fice towers that are the symbols of the new development dynamic, but also major hotels (in this case featuring 230 rooms) and retail space on the same site.
When it comes to such mixed-use development, few signal the new dynamic more than the area for the city of San Jose's "Vision 2030" in the city's North First Street corridor. A truly bold project on approximately 230 acres, loosely bounded by North First Street, and highways 237 and 101, it envisions 32,000 homes and apartments, retail, schools, entertainment and services within a short distance of the facilities in which the inhabitants work. Like comparable visionary urban projects across the country, Vision 2030 will be characterized by higher density construction, new lifestyle patterns and more intensive utilization of the available area. Realization of the Vision 2030 project will require the demolition of 4 million square feet of existing buildings, but in the larger context of the Silicon Valley, more than 5.5 million square feet has already been razed to make way for residential and supporting development of the new urban infill. While issues of balancing public and private responsibility for costs and other details remain, developers and city officials do seem both committed and enthusiastic.
Certainly, we were all stunned to realize that many of the new projects planned necessitated the destruction of existing facilities, many of which were less than 30 years old. In light of today's environmental sensitivity where recycling is viewed as a virtue, it can be difficult to comprehend that the life of many Silicon Valley buildings is but 30 years. On the other hand, changing space configurations have rendered them obsolete by design and shifting function. Further, the value of the land itself, which has increased from $2 a square foot in 1977 to $60 today, obviously places a monumental premium on obtaining higher use to maximize return on investment.
Our tour disclosed that many of the new projects are staggering in scope and ambition, yet again promising to change the landscape of Silicone Valley commercial real estate. Look at the numbers: 15 new high-rise office buildings totaling 5 million square feet; two hotels with a total of 340 rooms; 15 retail projects totaling another
1.3 million square feet; and countless infill residential units covering the gamut of lifestyle options. While the last building boom in the mid-1980s consisted almost exclusively of single-story buildings suitable for manufacturing, this building boom is characterized primarily by high-rise office buildings designed to attract engineering and business users in close proximity to supporting amenities. Commercial designs in addition to green features are likely to be architecturally imposing, giving the Valley a new face and vibrancy.
As exemplified by products of the new building boom, Silicon Valley promises to become taller and denser, yet ironically more human and environmentally friendly. The new commercial facilities address shifting technology industry demands for working environments that stress creativity while addressing employee needs like never before. Further, these commercial properties are very consciously being developed in an overall community context that, unlike the previous often myopic attention to economic function alone, will see a greener, more livable, more productive Silicon Valley.
January 2008 Commercial Edition Issue
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Know Details to Capture Sublease Opportunities
By Wayne Mascia
The biggest story in Silicon Valley commercial real estate in 2006 was the record dollar amount paid for large building portfolios. Continuing in early 2007, the trend is shifting ownership from many of our local developers to large national and institutional owners. The trend within the trend is that the majority of buyers are paying more than the asset's economic value as based on inplace rents.
The buyers support their decisions by pointing to an expected upturn in the market and saying they will be able to raise rents 25% for new tenants and lease renewals for existing tenants. As a result, tenants who want to remain in buildings recently included in a portfolio sale can not only expect increased rents, but also increased taxes as a result of the inflated sales price.
In 2006, from a tenant's perspective, we sat on the sidelines watching the transfer of properties across the valley, secure in the thought that the complex in which our offices reside would not be sold and that we would not suffer the same fate as tenants of buildings that had sold. We were forced into the game in March, after discovering our complex was indeed coming to market and that in all likelihood we would be dealing with a new owner before summer.
Our company offices are housed in the McCandless Towers complex, a pair of 13-story, 211,000-square-foot buildings visible from Highway 101 as you approach Great America Blvd. The first tower was completed in 1984 and is a multi-tenant building. The second tower was completed in 1998 as a built to suit for Informix, which was later purchased by Network Associates. The project was developed by the late BirkMcCandless, who created a design and quality that was ahead of its time. We have been in the complex for 13 years.
When we discovered the buildings would be for sale, we approached our current landlord and exercised our option to renew. We felt it easier and to our advantage to negotiate our option with owners that we have known for many years rather than with new owners who we might not know - and worse - might not be totally familiar with this market. We recommend this same course of action to our clients in such situations. If you have an option to renew your lease, make every attempt to do this before the sale. In the absence of an option, approach your landlord and ask to renew your lease now and extend the term for several more years.
We feel we have dodged a bullet with regard to future rent but are reminded that we must still pay our pro rata share of the increased taxes on a building that has increased in value by 75% - a situation all tenants will have to deal with if the building in which they reside is purchased. We also are concerned about additional changes we might encounter if the new owners need to increase income. After all, the building was built by the Birk McCandless, who had his offices in the complex and therefore made sure it met his high standards. What standard will new owners want to maintain?
Will they institute a fee to use the lap pool, work out facility and exercise room? Will they replace with video screen and phone the affable security guard who opens your office door for you when you forget your key? Will they charge for the underground parking? Will they put on as fabulous a holiday party as McCandless Company has done in the lobby of the building every year?
Pot luck, anyone?
September 2007 Commercial Edition Issue