Op-Ed, Commercial Real Estate, Bay Area
greg fogg
TenantSee Weekly: Knowing Your When

We see a lot of confusion in the market around when to begin negotiations.  It’s not an insignificant consideration.  In fact, when you begin can make a huge difference in the outcome.  It’s understandable that tenants would not know when to start.  Brokers are not always keen to start at the right time, since compensation is derived by transacting and the closer the tenant is to lease expiration, the faster it will need to transact (and the fewer options it will have).  Good for the broker, bad for the tenant.  This creates a misalignment of interests that discourages thoughtful consultation on the front end – the more time a broker spends on a project, the lower the compensation. 

TenantSee Weekly: Knowing Your When
Op-Ed, Commercial Real Estate, Bay Area
greg fogg
TenantSee Weeky: A Big Decline in Rents, Four ...

Throughout 2020, the prevailing sentiment among investors in the San Francisco office market was one of relative optimism.  After all, despite the fact tenants were prohibited from occupying their buildings, they continued to collect full rent.  The buildings were full, with vacancy hovering around 4%.  Sure, companies weren’t happy about paying for space they couldn’t use, but business was good.  In many cases the tech sector (which makes up most of San Francisco’s office occupancy) was booming due to an even greater reliance on and usage of tech caused by pandemic driven changes in how people were living.  Throughout the course of 2020 there was no reason for San Francisco investors to panic, as few (if any) office occupiers were showing signs of developing long-term hybrid or remote-first strategies.  Most were simply focused on solving for ongoing operations as a temporary reaction to the pandemic.  Yet early indicators did point to a future in which companies would be shedding office space, as some expiring leases were not replaced.  This, coupled with the addition of new supply, caused a big increase in vacancy to nearly 12% by year end.  Despite this large uptick, the brunt of the sluggish demand dynamic was being felt in the sublease markets, where rental economics more accurately reflected the true state of the market.  Despite a total closing of the office market in 2020, average asking rents ended the year off just 6% from the pre-pandemic high.

TenantSee Weeky: A Big Decline in Rents, Four Years in the Making
Bay Area, Commercial Real Estate, Op-Ed
greg fogg
TenantSee Weekly: Modern Workplace Planning: ...

In the years leading up to the pandemic, most medium and small companies defined their office space need based on headcount (current and projected), space programming, and industry/sector norms.  The exercise was mostly formulaic.  The primary differences in the offices of a small, regional law firm compared to those of an AM Law 100 firm would be scale, the cost of finishes, and the quality of the building and views.  It was planning for the same outcome, just at different levels on the cost spectrum.  Companies having a larger portfolio of offices would typically create a “workplace strategy” that included guidelines around programming (e.g., space layout, office size, critical adjacencies, growth factor, finishes, FF&E, etc.).  These guidelines could then be used to inform the real estate process across geography.

TenantSee Weekly: Modern Workplace Planning: Solving for Experience Part I: The Purpose
Bay Area, Commercial Real Estate, Op-Ed
greg fogg
TenantSee Weekly: This, or That?

Negotiations are always about (or should always be about) this or that.  There’s always something else, maybe that something else is nothing (as in sometimes the best thing to do is nothing at all).  Decisions made without proper consideration of all relevant alternative scenarios are decisions made poorly.  As important, in the context of office lease negotiations, the best negotiated outcomes are directly correlated to the extent to which we understand the alternatives of the landlord counterparty.  This is a bit counter intuitive, allow us to explain. 

TenantSee Weekly: This, or That?
Bay Area, Commercial Real Estate, Op-Ed
greg fogg
TenantSee Weekly: I Digress...

A little AI distraction to cheer your day (and relieve us of yet another discussion about workplace). Ever wandered through the streets and felt like you've stepped into the future? With their undeniable presence here in San Francisco, the driverless car is quickly becoming the most prominent representation of AI in our daily lives. If you spend any time in San Francisco neighborhoods, you can’t miss them. The other day, as I chatted with a neighbor, I counted 6 autonomous vehicles casually cruise by our front door within a span of 10 minutes. Intriguing, right? And today, in a twist of irony, I was held up by one. Blocked by a double-parked UPS truck, the driverless car hesitated, unsure about navigating into the lane of oncoming traffic. Of course, all the drivers in the opposing lane weren’t too keen to make space for the driverless car, as one normally would (or at least the more decent among us would) for a human-driven vehicle. Hence, we waited.

TenantSee Weekly: I Digress...

#CRE

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TenantSee Weekly: Encumbrances

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TenantSee Weekly: Encumbrances

An encumbrance is a burden or impediment.  Office leases often contain rights which are exclusive to a specific tenant and which place constraints on the landlord’s ability to lease space to other, 3rd party tenants.  These rights are referred to as encumbrances.  When tenants consider leasing space in a building, one of the first things they should qualify is the extent to which the landlord’s ability to lease the subject space is subject to any encumbrances.  If so, the specific terms of these encumbrances must be understood before proceeding.

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TenantSee Weekly: I Was Told We'd Be Discussing the Office...

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TenantSee Weekly: I Was Told We'd Be Discussing the Office...

AI has summarized capitalism for me as follows:

“…an economic system where private individuals and corporations own and control the means of production, such as property, businesses, and industries. In capitalism, the core principles are profit motive, private property, and market competition. The government's role is limited to taxation and standard regulatory laws, and individuals are given the freedom to operate their businesses and manage their income as they choose.” 

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TenantSee Weekly: Connecting Your Advisor’s Fee to Value Creation

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TenantSee Weekly: Connecting Your Advisor’s Fee to Value Creation

In cities like San Francisco, tenant broker fees have increased significantly since the pandemic.  These fees are typically fronted by the landlord and recouped over the term of the lease through the rent paid by the tenant.  You may be wondering why landlords would offer more fee when rental economics are on the decline.  It’s because landlords think of the fee as an incentive to brokers to bring deals to their building.  As soon as one landlord increases the fee, others marketing comparable buildings follow suit because they want to ensure their building gets equal consideration (and they think brokers select which buildings to show the client based on fee – they (mostly) don’t).  When the markets are tight, as they were in the decade preceding the pandemic, landlords hold fees flat.  They don’t need to pay more to attract demand – the simple fact they have available supply is sufficient. 

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TenantSee Weekly: It's What's Inside That Counts

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TenantSee Weekly: It's What's Inside That Counts

If you’re like me, growing up your mother told you no less than twice a day “…it’s what’s inside that counts” or “…don’t judge a book by its cover”.  I’m grateful for that advice, as it helps me be more mindful of bias, more open minded.  Did you know the same is true for office buildings?  That it’s not just about how the building looks, or where it’s located.  The nuanced details of the ownership, debt, and occupancy also matter…a lot.

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TenantSee Weekly: Knowing Your When

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TenantSee Weekly: Knowing Your When

We see a lot of confusion in the market around when to begin negotiations.  It’s not an insignificant consideration.  In fact, when you begin can make a huge difference in the outcome.  It’s understandable that tenants would not know when to start.  Brokers are not always keen to start at the right time, since compensation is derived by transacting and the closer the tenant is to lease expiration, the faster it will need to transact (and the fewer options it will have).  Good for the broker, bad for the tenant.  This creates a misalignment of interests that discourages thoughtful consultation on the front end – the more time a broker spends on a project, the lower the compensation. 

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TenantSee Weekly: Sweet Spot

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TenantSee Weekly: Sweet Spot

How do you know when you’ve fully accessed market leverage in negotiating a lease extension?  It’s when you find the sweet spot, a place in which the economics of the potential relocation lease match the lowest value the existing landlord is willing to offer.  This is not a simple exercise of identifying the asking rents for alternative sites and asking the landlord to match.  No, instead, it’s a byproduct of a carefully orchestrated negotiation that involves 2 main elements: 

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TenantSee Weekly: Bottom?

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TenantSee Weekly: Bottom?

Have we hit bottom in the pricing of San Francisco office assets?  Maybe. 
 
The historical measures by which office buildings were valued, a function of capitalized net operating income, doesn’t apply to assets having large vacancy and limited weighted average lease term (“WALT”).  These assets are trading at a simple cost/sf metric.  Investors take a long-term view of the investment, betting the value for San Francisco office will, ultimately, recover.  They may or may not use debt to finance the acquisition – where there is limited occupancy, they may not be able to secure debt.

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TenantSee Weekly: Modern Workplace Planning: Solving for Experience Part VI: Negotiating the Lease

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TenantSee Weekly: Modern Workplace Planning: Solving for Experience Part VI: Negotiating the Lease

Leases vary by building, by market, and by market circumstances.  In most major metros, when dealing with larger buildings, the lease document is sophisticated and complex, addressing a broad range of variables that will have a material impact on the occupier’s experience at the building, as well as its cost of occupancy.  If you’ve done a good job negotiating the letter of intent, you should begin the lease negotiation phase from a position of relative strength.  However, even when the letter of intent is fully maximized, there’s still a lot to negotiate in the lease.

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TenantSee Weekly: This, or That?

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TenantSee Weekly: This, or That?

Negotiations are always about (or should always be about) this or that.  There’s always something else, maybe that something else is nothing (as in sometimes the best thing to do is nothing at all).  Decisions made without proper consideration of all relevant alternative scenarios are decisions made poorly.  As important, in the context of office lease negotiations, the best negotiated outcomes are directly correlated to the extent to which we understand the alternatives of the landlord counterparty.  This is a bit counter intuitive, allow us to explain. 

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TenantSee Weekly: New Year, More Leverage

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TenantSee Weekly: New Year, More Leverage

n March, we’ll hit the 4-year anniversary of the date when offices all over the city first shut down due to the pandemic, a time when just 5% of the city’s office inventory was available.  Today, despite having more office workers now than we had then, just under 30m sf of our total supply sits vacant, and even more than that is available.  Citywide average asking rental rates declined 17.5% during this period.  We expect this trend to continue, possibly to accelerate in 2024.  Sublease supply is pulling rates down as companies increasingly view any recovery as a net positive.  There’s little on the near-term horizon to suggest we’ve begun (or will even begin in 2024) the long march toward recovery.  The market dynamic is considerably worse than that which we experienced in the dot-com recession when it took 63 quarters to get from bottom to peak.  We’ve not yet reached the bottom. 

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TenantSee Weekly: TenantSee Team San Francisco Market Predictions: 2024

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TenantSee Weekly: TenantSee Team San Francisco Market Predictions: 2024

Let us lend our TenantSee perspective to the coming year.  Despite green shoots from 2 large AI sector leases (Open AI and Anthropic), demand for San Francisco office space remained low throughout 2023, yielding 4 more quarters of negative net absorption.  We finished the year with vacancy at >35% - an historical record.  The market is under significant stress, creating sizable opportunities for occupiers.
 

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TenantSee Weekly: Timing the Downturn

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TenantSee Weekly: Timing the Downturn

Since the pandemic, the cost to lease San Francisco office space, but for the most premium segment of the market, has steadily declined.  The pace of decline is beginning to accelerate as more landlords capitulate to unprecedented vacancy and reduced demand, just as more companies are (finally) taking a longer-range approach to workplace. For occupiers, this provides a welcome respite from the relentless effects of a decades-long dynamic in which the office market was both too tight and too expensive.   
 

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TenantSee Weekly: The Lingering Fog of a Bull Market

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TenantSee Weekly: The Lingering Fog of a Bull Market

The Lingering Fog of a Bull Market.
 
Advisors on the right side of a bull market end up looking good, no matter what they do.  This was certainly the case for landlord advisors in the San Francisco office market for the ~10 years leading up to the pandemic, a time when you could win for losing, as the deal you failed to make was often (quickly) replaced by a new deal at better rental economics due to rapidly appreciating rents.  Today, both landlord advisors and the investors they advise are, in some cases, suffering from the lingering effects of the bull market.

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TenantSee Weekly: The Artificial Floor

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TenantSee Weekly: The Artificial Floor

Currently, there’s a lot of downward pressure on rental rates in the San Francisco office market.  This is caused by a massive uptick in available space  (4% to over 30+%), the proliferation of subleases in which the sublandlord is motivated to mitigate cost, not achieve target NOI, and the presence of owners having a materially lower cost basis, either through a long-term hold strategy, or a recent acquisition at steeply discounted pricing, both of whom can compete at much lower rental economics.  Indeed, the economics being offered by these parties stands in stark contrast to those offered by landlords who bought or refinanced in the years running up to the pandemic.  This latter category, by the way, encompasses a large swath of the market.  These investors are struggling against a confluence of factors, including rising interest rates, maturing debt, rising insurance costs, decreased demand, lack of capital, and valuation outcomes that put equity and debt underwater. 

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TenantSee Weekly: Meet WALT

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TenantSee Weekly: Meet WALT

WALT, or weighted average lease term, is an essential metric in the valuation of office buildings as it forecasts the stability of future cash flow.  WALT was less important back when office markets like San Francisco were seeing aggressive year over year rent growth.  Back then vacancy was worth more than leased space, the theory being a buyer could take advantage of vacant space to capture higher rent (necessary to justify inflated pricing which baked in aggressive rent growth assumptions).  However, in the broader historical context of valuation, the idea that vacancy is worth more than occupancy is antithetical to defining value.  Indeed, the more prevalent (and logical) approach to value hinges on the quality and duration of the net operating income.  Of course, this approach is less sexy as it disables a seller’s capacity to “sell the dream”.  The buyer is buying stability and yield, both of which are measurable going in.   

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TenantSee Weekly: What Could Go Right?

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TenantSee Weekly: What Could Go Right?

Mass psychology is literally contagious (that’s how it becomes “mass”).  This is especially true in times of change, when a significant event has precipitated such change (e.g., the pandemic).  These events can be positive or negative.  In our current state, the catalyst was negative, and, in many ways, has resulted in a decidedly negative outlook.  When things turn negative, there will always be market casualties (just as a rising tide lifts all boats in the positive context).  For example, the impact to investors in the domestic office sector has been mostly negative.  As change unfolds, it can have knock-on impacts that weren’t necessarily anticipated.  For example, the demise of urban downtowns due to shifts in daily worker population.  Collective sentiment tends to aggregate around a view and stay there until some brave souls dare to take the contrarian view.  As these contrarians see success, it spurs others to jump on board and the collective sentiment begins to shift, once again, in the other direction.

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TenantSee Weekly: How to Protect From Landlord Default?

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TenantSee Weekly: How to Protect From Landlord Default?

Office building owners are facing the most challenging environment of the past 50 years due to substantial reductions in demand for space.  The shift in demand is not cyclical; it’s a systemic shift caused by changes in how work is done in the information economy.  In other words, investors can’t count on a swift reversion to the norm.  This dynamic is playing out globally.  There are geographic differences, but the fundamental trend is the same.  The impact on office investors has been swift and brutal, leaving many in a precarious financial position.

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TenantSee Weekly: The Disconnected Worker

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TenantSee Weekly: The Disconnected Worker

I read an article recently about layoffs in the tech sector.  In it, one worker shared her story of being laid off by 3 companies in less than a year.  The first was a startup where she had worked for several years.  She questioned why she had been selected – it clearly felt personal.  The next 2 employments were each of short duration, the last being merely a month long.  In the end, she was left questioning whether she wanted to continue working in tech.  The tech sector, especially the startup segment of the tech sector, has never been a great place to seek job security because of its inherent volatility.  Yet it has long been a place in which employers seek to espouse winning and attractive cultures that are all about “the people”.  This got me thinking about job security in the post-pandemic workplace.  Has employment in the information economy become more unstable because there is less connection between employer and employee?  Is the relationship between employer and employee becoming more transactional? 

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TenantSee Weekly: Sublease, Terminate, or Restructure

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TenantSee Weekly: Sublease, Terminate, or Restructure

Subleasing is the most common approach occupiers take in mitigating the cost of underutilized space.  Yet in San Francisco, it has become increasingly difficult to sublease office space.  With recoveries ranging from 0 to 25%, companies must consider the full spectrum of options.  Remember, too, sublease recoveries can be expensive to execute (fees and concessions); and, in subleasing, the occupier takes on a variety of risks that can prove costly (e.g., subtenant default). 

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TenantSee Weekly: Knowledge, Leverage, and Opaque Markets

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TenantSee Weekly: Knowledge, Leverage, and Opaque Markets

An office lease is a unique financial transaction.  While supply data is widely available, the values associated with completed leases are not so readily available, nor is the financial position of the landlord and its partners.  In effect, despite the preponderance of available data in residential markets (e.g., Zillow, etc.), office markets remain opaque.  The educated occupier can certainly access more information today than in decades past. But it’s not enough to merely know available spaces. Achieving a complete understanding of the markets can only be accomplished by partnering with a firm which is engaged in the market in a variety of very specific contexts.  You need an intimate understanding of landlord motivations, capital structures, and even the intricate dynamics of tenants within a building. Yet many real estate service firms don’t have this information because they lack the practice groups.