Real Estate Reporter- Silicon Valley Business Journal
So is this a bubble, or what?
That was one overarching question as CBRE convened top dealmakers and analysts this week to talk shop about the state of the economy and what’s ahead for commercial real estate.
The real estate services firm held its 2015 Market Forecast on Wednesday at downtown San Jose’s Fairmont Hotel, days after releasing third-quarter market analysis that showed the Bay Area notched yet another healthy three months of leasing and sales across all asset classes.
Wednesday’s presentation was a largely optimistic assessment — though observers noted that market volatility is significant and regional pressures such as housing are definite tension points.
Here are a couple of key observations.
A volatile, but largely positive national economic outlook
Despite recent market ups and downs, the U.S. economy likely has a few years of expansion left before the next contraction, said CBRE Global Chief Economist Richard Barkham.
There are three main reasons why he’s optimistic, all having to do with major economic drivers loosening purse strings: The government is spending again, consumers are also becoming less tightfisted, and the construction sector is getting stronger.
That last item is key, because construction spins off so much economic activity.
“Construction of single-family homes has been weak,” Barkham said. “The financial crisis of 2007, 2008 and 2009 was as much a real estate crisis as it was a banking crisis. But pent up demand should boost construction.”
This doesn’t mean developers don’t have to worry about timing.
“If you have long term projects, you probably want to make sure they’re squared away by the end of 2017,” he said.
Tech still has runway
According to Barkham, the national economy will continue to expand until at least 2018 — and that means the tech sector will remain strong at least that long as well.
“It moves with the broader economy,” he said. “I don’t think that’s a bad message.”
One result: Rents still have room to grow. “Rents peak when unemployment troughs,” he said. “I think you have two-and-a-half to three years before you get to that point where the labor market begins to ease, and unemployment trends up. After that, you begin to see rents dropping.”
This boom is still growing
Now, about that bubble question. Colin Yasukochi, CBRE’s director of research and analysis, showed an eye-opening chart that revealed rents are not yet at their bubblicious 2000 highs. Office rents in Palo Alto would have to rise 56 percent to reach their peak; Mountain View, 28 percent; Redwood City, 55 percent and San Francisco, 18 percent.
“Are booms always followed by busts?” Yasukochi asked. “The last two were. Based on what’s happening in real estate today, the current boom is still getting bigger.”
In a wide-ranging discussion, most panelists agreed. George Fox, an executive vice president with CBRE in Palo Alto who focuses on tenants, said the current economic climate feels a lot different than the late-1990s.
“It’s been sustainable growth, Bay Area-wide and involves a lot of different industries, unlike back in the late 1990s,” he said, singling out new sectors such as automotive, social, and solar, among others. “All that feeds everything else: the retail, the housing, the construction. In my world, it’s not a bubble… (Companies’) biggest issues are, who are we going to get hire and how are we going to get them?”
Raul Campos, a CBRE managing director in San Francisco, said many of today’s tech tenants driving demand can afford to spend more money on space because they’re generating more money. It’s not as much an issue of affordability as it is availability, he said.
“The underlying technology is so profitable that they’re ramping up as fast as they can,” he said.
Investment sales pricey, but deals still below replacement cost
As for sales? Some recent trades have tested high-water marks ( 303 Bryant St., anyone?), and value-add deals with significant upside are becoming harder to find. But Brad Zampa, CBRE’s executive vice president in its debt and equity finance group, said in most cases buying is still cheaper than building. Land, construction and labor prices are all rising, meaning that building buys are still smart investments.
“Recently our building in San Jose traded for just inside of $400 a foot,” he said, referring to the sale of 225 W. Santa Clara St. “It would cost $600 a foot or higher to rebuild that all day long. If you look at discount to replacement cost, we have some runway. “
SV vs. SF? Try SV and SF
There’s increasing chatter that San Francisco is the place to be for tech companies, and to a certain extent that’s true. CBRE research shows that since 2010, Silicon Valley-based tech companies have leased 2.5 million square feet of office space.
“What we’re hearing from tech tenants is they have to be in San Francisco for recruiting and retention,” said Daphne Spieker, a CBRE vice president in San Francisco.
But Yasukochi noted that the Valley is still creating more tech jobs in absolute terms than San Francisco.
“The facts tell us San Francisco is becoming a new front and the two markets are interconnected in a new and more powerful way,” he said. “Most firms moving into San Francisco haven’t moved (out of Silicon Valley) outright.
“It’s not about Silicon Valley vs. San Francisco. We really have two very strong and vibrant fronts in the Bay Area,” he said.
So what’s the bad news?
Actually, there is some. Inadequate transit, the increasingly unaffordable housing market and talent shortages are real and growing problems for the region’s economy.
CBRE is anticipating about 10 million square feet of growth over years ahead, which is at least enough space for 50,000 new employees, most of them tech jobs. Yet only 25,000 new multifamily units are under construction.
“That’s not going to solve the current problem, let alone take care of the demand in the future,” Yasukochi said.
Nathan Donato-Weinstein covers commercial real estate and transportation for the Silicon Valley Business Journal.