Bay Area Real Estate Update Q1 2006
By Garrett Krueger

Bay Area Commercial Real Estate Update Quarter 1 2006

• Market Overview
  The last few years have been a time of renewal for the Bay Area office market. There has been a slow moving shift from a strong tenant’s market to one with the tenant and landlord being on equal footing. Vacancy has generally dropped across the market while rates and new building construction are beginning to rise.
   
  • The Downtown San Francisco market has gone from an 18.5% vacancy in 2003 to a 12% vacancy at the conclusion of 2005 with rates increasing to an average of $32.00 Full Service* ($2.66 per month). The best deals in the market can be found in SOMA (South of Market).
  • The Peninsula market is at its lowest vacancy level in five years and rents have continued to rise. The vacancy level averages to 16.4%, while the average rental rate is $26.50 Full Service ($2.20 per month). The best deals can be found in Menlo Park.
  • The Silicon Valley market was hardest hit during the Dot com implosion and is now said to be in recovery. The average vacancy level is 14% with an average asking rent of $27.00 Full Service ($2.25 per month). The best deals in the market can be found in North San Jose.
  • The East Bay market (880 corridor) has a vacancy rate of 14.2% with an average asking rent of $22.00 Full Service ($1.83 per month). The best deals in the market can be found in Emeryville or Alameda.
    
    *The definition of Full Service is provided below in this article.
     
• Useful Planning Tips & Definitions
  Leases for a startup or growing firm can at times slow a company’s growth. Below are a few things to look for when negotiating a deal and reviewing a potential lease:

• Tenant Improvements
  The current market has Landlords moving away from providing turnkey (all-inclusive) tenant improvements and more towards partial tenant improvement allowances. For startups, some spec suites are still available that can be a very attractive option. General TI budgets range from paint and carpet ($7 per square foot) to building office improvements from shell condition ($45 per square foot). Most tenant improvements for a short term deal will not exceed $10 per square foot.
   
• Expense Pass Throughs
  Landlord will pass on to the tenant any cost that is feasible. At the conclusion of the year, remember to analyze the costs provided by your Landlord. In some leases you have only two weeks to clarify any discrepancies. Some typical pass throughs include taxes, insurance, security, building maintenance, elevator repair, new heating and cooling units (amortized over the life of the improvement), and spikes in utility costs.
   
• Average Square Footage per Person
  The Average square footage per person depends on the type of firm. The  number we use is one person per every 200 square feet, but in the most extreme case I have seen the average fall to 83 square feet per person. Read your lease carefully because many leases will limit the density of employees per square foot.
   
• Parking
  Most office buildings offer the right to parking based on a ratio related to square footage occupied. For example, a typical downtown building will offer one space per thousand square feet occupied and charge the prevailing market rate. In suburban office markets, parking allocations can range as high as four per thousand square feet occupied and are typically free of charge.
   
• Security Deposits
  Security deposits currently range from one month to three months depending on credit and tenant improvements needed. It is rare to have a personal guarantee included in a lease document.
   
• Option to Expand
  The best way to receive this clause is to begin your negotiation with your Landlord with a one to two year deal that cannot go longer due to foreseeable growth. The Landlord might allow for this growth through an option to expand to nearby space, or by allowing a buyout clause should the landlord not be able to accommodate the growth.
   
• First Right of Refusal & First Right of Offer
  These clauses are used frequently if you sign a lease and have vacant or soon to be vacant space in close proximity to your suite. The first right of refusal is typically more difficult to get a landlord to agree to because it slows down their leasing process. If expansion is foreseeable, these are very good clauses to bring up early in the negotiation.
  
  Definitions:

NNN, Industrial Gross and Full Service rent payments
 

NNN: the Landlord passes on all elements of costs for the building to the Tenant.

Industrial Gross: The Landlord is responsible for the taxes, insurance and Common Area Maintenance (CAM) for the project. Tenant pays its own utilities and janitorial.

Full Service: The Landlord is responsible for the taxes, insurance, CAM, utilities, and janitorial for the project. The tenant is responsible for paying their share of increases of these expenses based on their Base Year agreed upon in the original lease.

Note: Some Landlords will have different variations of these rent structures. Read your lease carefully to be sure you are comfortable with the charges.
 

Base Year
 

The Base Year is the year that you typically move into your space. The expenses for your building for that year are set as your Base Year. Throughout the subsequent years, you will pay your percentage share of the expense increases from the Base Year (ie. Base Year expenses $200,000 in 2004, Expenses in 2005 are $210,000, you pay on your percentage share based on your occupancy of the project of that $10,000 increase.)
 

• Space options available to start-ups and young companies

• Incubator
  These are hard to find, but the environment and price can be very attractive to start-ups. They are hard to find because they are not profitable to the Landlord and typically have to be subsidized through government agents or universities.
   
• Shared/Friendly subleases
  These can be found by way of referrals through real estate professionals or venture capitalists. The subleases occur when you exist in part of another firms’ space.
   
• Subleases
  These are typically furnished, wired, and 50-75% of the costs of space being marketing directly by the Landlord.
   
• Direct space
  In this case, Landlords have more flexibility in allowing growth and providing for tenant improvement needs.
   
• Spaces marked for conversion
  With the recent residential boom, many older office buildings and converted warehouses have been targeted for conversion. Once the new owner buys the property, they typically have a two to three year timeframe before construction starts and they can offer cheap rents.