May 30, 2018
By Dennis Kaiser
Connect Bay Area pointed a spotlight on one of the nation’s most complex and active markets. Our annual conference, held on May 17th, 2018 at Galvanize in San Francisco, drew an audience of more than 250 commercial real estate professionals to hear an investment overview, a presentation from BART, and three deep-dive panels.
A panel titled “Buy, Build, Lease, Sell, Hold?” was moderated by JLL’s Andy Poppink and included CIM Group’s John Bruno, Newmark Cornish & Carey’s Michael Taquino and The Swig Company’s Tomas Schoenberg.
The discussion started by delivering the punchline of panel topic of where the market is today. CIM’s Bruno notes he did roughly $1.4 billion of dispositions last year, and they are leasing to vacancy, which he says probably illustrates where things are headed and why they remain in a sell mode.
NCC’s Taquino believes it is too expensive to buy, so advises selling in what’s a “pretty frothy market.” That should continue to generate record pricing that is “primed” to continue doing so, he notes.
Swig’s Schoenberg agreed that selling was the company’s approach last year, and will likely continue to be its strategy this year. Swig tends to be long-term holders of real estate, and acquisitions are challenging now unless it is an off market deal, so they are investing in their portfolio in a “heavy way.”
JLL’s Poppink pointed out the imbalance between supply and demand has created a bit of a frothy market. From a broad macro perspective, that seems to have the current market in a “good place to continue on a bit further,” he notes, especially given the strong labor demand, which could push companies to look at alternative Bay Area markets such as Oakland or Walnut Creek.
Bruno says a savvy strategy is to pick your spots on where to buy – typically were there’s great talent, quality of life and lower all-in employee costs. Now, they seek markets where there tends to be less duration risk and that’s resulted in them doing less development than they’ve done previously.
Swig has honed down its core market focus to just a few where they have an in-depth knowledge of and are familiar with. That’s meant keen attention on San Francisco, Oakland, Mountain View, Los Angeles’s Westside, and NY’s Manhattan. Instead of looking at new markets, they are exploring a little further out on the risk curve such as heavy value-add deals in their existing markets.
Poppink notes that on the occupier side, they are hearing more frequently from tech companies that want to know what the “next labor markets” are going to be, rather than asking the real estate question first. Companies are also considering the construction cost equation early since it influences new development, value-add deals and a company’s total cost of tenancy.
Taquino notes it is tough to build a ground-up development today, but since rents have gone up too, its construction costs haven’t halted commercial development. What has stopped, as a result of the regulatory environment, is residential construction. Now that San Francisco has so many headquarters’ locations, the housing supply isn’t there to support them. It has become a major consideration in every new project in San Francisco.
The trend to how office space is used has shifted, too. The emergence of workspace providers and flexible space has created a trend of “office as a service,” notes Schoenberg. From landlords creating their own version of the shared workspaces, to partnering on short term licensing deals with companies like LiquidSpace, he says, “we’re witnessing a profound revolution in how we use space.”
Bruno agreed that the shared space trend has been in the works for some time, though he points out not quite to the “blunt” extent it is today with the emergence of enterprise uses. Often, shared space companies are taking the space before they’ve even signed users, he says. Eventually, he believes the growth of this sector could cause a hiccup for landlords if the market turns and they seek to renegotiate rents.
Taquino also notes that banks aren’t quite sure how to look at the credit of assets with co-working spaces, either. Even though they are now doing corporate guarantees, there isn’t certainty about what that means.
As to the big question of where the San Francisco market is in the cycle, panelists noted it isn’t early, though solid fundamentals will likely provide sufficient steam. What gives Bruno most pause is where interest rates are going, and the lack of structure in deals (i.e. lending on construction without completion guarantees). “The fundamentals are strong, but that doesn’t mean there’s not risk out there,” he says. He pointed out cycles don’t extend forever, though believes it should be a soft landing with a slight pricing reset, rather than a catastrophic one.
Taquino says “it feels rosy out there.” He notes some Bay Area CRE brokers believe the massive transition underway in how business operates will be viewed 30 years from now like the industrial revolution is. He points out the market today is filled with unrelated tech companies that are still growing. He notes, “San Francisco has become a headquarters city, populated by big companies with established profiles.”
Schoenberg observes the market is clearly in its late cycle, which calls for a more cautious approach. He says they are hyper selective, seeking deals with no downside and more upside, as well as striving to keep space occupied, rather than keeping space off the market in hopes of future rent bumps. He thinks any correction will be a soft landing with rents and values flattening, though not by big drops.
Poppink notes that on the occupier side, with plenty of funding still available for tech companies in the Bay Area, the indicators JLL tracks aren’t revealing any “blinking red lights on the horizon” warning of an imminent downturn.
For comments, questions or concerns, please contact Dennis Kaiser