Will 2010 Be Any Better Than 2009 For Commercial Real Estate?

Monday, February 22, 2010

2009 was the most unpredictable year we’ve seen in the commercial real estate in some time, with a major slowdown in leasing/buying and a historic high in space availability. What will 2010 bring? A continued downturn, or is there a recovery in sight?

We interviewed David Marino, a principal with Irving Hughes in San Diego, to get his perspective.

Q: Let’s get right to the point—how bad was 2009?

A: 2009 was really worse than anybody could have expected. The leasing market lost 25-30% of its value in 2009—a very abrupt adjustment.

Q: So how did the commercial real estate market get that bad?

A: I saw the early signs of this recession back in 2007, with too many new buildings being built paired with the destabilizing base of hundreds of commercial real estate tenants in the mortgage, title, escrow, construction and home building industries. The signs of softness in both office and industrial space were building, but economic conditions didn’t bleed over from residential real estate to the broader economy until 2008. By 2009, the full effects of the recession had gone through every sector resulting in huge negative absorption—much more space given back by tenants than leased by tenants. Sectors like Biotech were particularly hard-hit, and availability rates went up into the 25-30% range, which was previously unimagined by landlords and lenders.

Also in 2009, the amount of available sublease space skyrocketed to over 7 million square feet, which is an historic high. Not only were there fewer companies to lease space due to business failures, but those left were smaller on average due to layoffs.  Demand really eroded, causing that huge availability spike, resulting in downward price pressure and increased concessions from landlords.

Q: Can we count on 2010 to bring a little hope back into the market?

A: First we need hit bottom—and I think we will do that by the end of 2010. Many landlords wrote down their assets last year, and more are doing it this year.  With lowered expectations, Landlords have made radical cuts in rents, and offered significant free rent and tenant improvement concessions.

They have also been willing to do shorter 1-2 year leases just to keep tenants in place, rather than the traditions 5 year leases which were the norm 2-3 years ago in a stronger landlord market.

The amount of sublease space and rental inventory seems to be leveling off, and availability rates seem to be capping out as a result. Within our own client base, there’s no real growth, but no real decline either—we’re finally seeing an environment of stability. The worst is behind us, but we are going to be in extended equilibrium.

Q: How long until prices start rising again?

A: I think the market will be flat for at least three years in most office submarkets—and as many as 7 years in areas like Carlsbad and I-15 corridor where things were really overbuilt, and for wet lab biotech space in Torrey Pines, which companies won’t need more of for the foreseeable future.

Since businesses aren’t really hiring and new companies are not sprouting up due to the lack of funding, net demand will probably remain thin for several years because you only get demand for more office and R&D space when people begin to hire en masse.  Pretty much across the board, we’re in for an extended period of equilibrium—no big net losses, no big net gains.

Q: Who will be big winners in 2010, and who will not?

A: Small and medium sized businesses will be the big winners in this environment—both from leasing and purchase standpoints. If you are a 3000-5000 square foot tenant (15-25 employees) you have a huge number of alternatives in any submarket you might consider, from Downtown San Diego through, Mission Valley, UTC, Del Mar Heights and Carlsbad--literally anywhere in San Diego County. This recession has been particularly cruel to small businesses—and they left in their wake hundreds of open suites throughout the county. There are also great opportunities for larger businesses needing 20,000-100,000sf—our market surveys for clients are unprecedented in the sheer number of leasing options anywhere in the County.

Q: What information should tenants have in their back pocket this year?

A: Landlords are going to work hard to keep their tenants.  When pushed, which is what I do, they will get creative in how they structure deals, and will take more credit risk on tenants.  2010 should present small to medium sized businesses with an opportunity to buy—particularly buildings with 40,000 square feet or less.  There seems to be decent financing out there for companies with reasonable credit to make those purchases. Three to four years ago the market was driven by speculators and loose lending and little supply—now we are in different climate where there are some good options for owner-user buyers.

Q: If people choose to stay put, do you have advice for renewing and renegotiating leases or anything to improve their existing situations?

A:  Definitely. First, don’t forget, the landlord is still the driver of the transaction in a renewal. He is in the business of commercial real estate—so in any situation where the tenant lacks information or leverage, the tenant is going to lose. The biggest classic mistake tenants make is telling the landlord they are willing or wanting to renew, and THEN trying to negotiate. If you practice good due diligence—get an advisor, go see what’s in the market and get real proposals, and do real negotiating to create viable alternatives—you’ll end up in a good lease renewal position. 

Truthfully, I’ve seen some people agonize more over a $5,000 copier lease than their $500,000 facility lease. Here are some tips to make sure your next lease negotiation—whether a new lease or a renewal, ends up in your favor:

1. Whether you move or stay, go through the same rigor, analysis, and test of the market to make sure you’re making the right choice.
2. Hire capable representation to test the market, no matter the size of your business, because as every management team knows, rent is a significant chunk of your monthly expenses, and deserves real attention.

As the “watch dog” for the tenant community, we help our clients take advantage of the best opportunities in the market—it’s not just our job to stay on top of what’s going on out there but to add value to the tenant’s bottom line.

About Irving Hughes
Irving Hughes is a San Diego-based brokerage firm specializing in tenant-only real estate representation and advocacy. The firm does not represent landlords in the leasing or management of properties.  The firm provides its clients with advocacy, objectivity, accountability and confidentiality during their search for or renegotiation of a lease or purchase of a new facility. To learn more, visit www.irvinghughes.com.