Where is the Market? Truth or Fiction

In the Buyer-Beware category, last week the San Francisco Business Times carried the following story (Promontory’s Spear tower lease sheds light on market, January 22, 2010), meant to “enlighten” you about the “real” market for high-end office space in the City. I’ve highlighted in red some of the salient points of the article.

Promontory Financial Group has leased 9,200 square feet on the 41st floor of the Spear tower of One Market Plaza, a deal that helps put a value on what San Francisco’s most desirable office space is worth in the current depressed market.

The financial company, which advises troubled banks “resolve their most pressing issues,” has agreed to pay just over $60 a square foot over 10 years. The space, last occupied by Accenture, would have leased for $100 a square foot in 2007 at the height of the last boom. In September of 2007, Artis Capital Management leased 18,000 square feet on the 26th floor of the Stuart Tower at One Market for $100 a square foot.

Promontory opened its San Francisco office at Embarcadero Center One in 2004 with two employees. The firm has since grown to nine, and the new space will allow it to expand to 20 people.

“We were delighted to get a long-term lease at what we think is a very competitive rate,” said spokeswoman Debra Cope. “We think it positions us well for future growth plans in San Francisco.”

Riccardo Gale of Cornish & Carey Commercial, who represented the tenant with Donette Clarens, said the Promontory space, which is being designed by Gensler/SmithGroup and built by GCI, has mind-blowing views of “Farallon Islands to San Jose.” Wes Powell and Chris Roeder of Jones Lang LaSalle represented the owner.

People like to say that the A ++ space has not fallen very much — I think in this deal we’ve demonstrated that it has,” said Gale.

I offer you this rebuttal:

  • Agreed, the 41st floor of One Market Plaza should be the most expensive space in San Francisco. Also agreed, that “market” is where folks sign deals. All told, however, $60+ per square foot per year is a ludicrous rate for any tenant to agree to in this economy, no matter the building in San Francisco.
  • The tenant’s spokesperson said, “…we think this is a very competitive rate…and positions us well for future growth plans in San Francisco.” However, 27 years of experience tells me that tenants paying $60/sf/year will likely be troubled tenants. These are Dot-Com rates, which were far from sustainable for the mass market. To say that these rates are “competitive” suggests that there is active competition amongst tenants to pay such rates—a gross exaggeration at this point.
  • Don’t miss the forest: The tenant cited is in the business of advising troubled banks. Why would they (a) seek such high profile space to assist failing banks; and (b) sign a 10-year lease, unless they foresee a long-term continuation of the decline in the economy and, therefore, growth in their clientele?
  • Average occupancy for most tenants is ~200 square feet per person, yet the tenant, here, suggests that the 9,200 square foot space will accommodate only 20 people (460 sf/person). Perhaps these people, like Artis and Accenture, have money to burn. At capacity of 20, if the firm spends 8% of its gross revenue on ($60) rent, each of those 20 employees must generate $345,000/year in revenue just to pay for their space. Does that make sense to you?
  • Last but not least, the article quotes the tenant’s gloating broker, touting how $60 is so much cheaper than at the height of the market. Would it help make my point to divulge that at the same time the Promontory deal went down, I concluded a similar sized lease for a law firm client in Bay view space just across the street, in another Class A building…at less than $35/sf/year?

The SFBT article continued with a bit about the market for building sales, featuring quotes from Dan Cressman.

The sale of 49 Stevenson St. could be the last of the sub-$200-a-square-foot deals for downtown Class A office buildings.

That’s the take of Grubb & Ellis broker Daniel Cressman, who represented investor Steven Pan in his acquisition of the building for $24.2 million, or $190 a square foot. Cressman said that Pan beat out more than 20 other bidders, and given the number of opportunistic investors out there and the dearth of buildings coming on the market, competition is likely to drive bidding for subsequent properties over $200 a square foot.

“It’s been dry in terms of new product on the market, and there is a phenomenal amount of interest for good-quality, well-located real estate,” said Cressman.

Lest you forget, this is the same Cressman who three years ago spoke alongside our Mayor at the SFBT annual breakfast, assuring tenants and his investor clients that $100/sf/year rental rates would be commonplace as the new basis for average rents in the City. Cressman and Grubb & Ellis were among a crowd of brokers and advisors who were as complicit as any on Wall Street for the run-up in building prices.

  • Now Mr. Cressman has picked the proverbial “bottom” of the investment market. Is he any better now than three years ago at underwriting deals and predicting the economy?
  • Is there a “dearth of buildings coming on the market” because prospective sellers don’t like today’s pricing…or is it due to the dramatic decline in available financing and inability to underwrite deals in this failing economy? The lack of volume of sales also has everything to do with current owners and their lenders frozen in place—neither able or willing to handle the harsh reality of lost equity and pissed off investors.
  • The market will seek whatever levels are necessary to make ends meet. There could be plenty of downside from $200/sf. After the Dot-Bomb, for example, when tenants folded their tents at Market Center (555-575 Market), Tishman Speyer defaulted on the loan and the 80%+ vacant complex sold for ~$110/sf…

What do you think of my analysis? Leave your comments below or give me a call and let’s get together to discuss.

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