By Gavin Curtis
Seattle is currently in the longest stretch of what is considered to be a “landlord’s market” in the City’s history. Rates are at an all-time high, and despite construction cranes being scattered throughout the City delivering new office towers, vacancy rates continue to fall. Much of this is caused by Amazon’s continued growth coupled with the emerging technology firms from the Bay Area seeking larger footprints here in the Northwest. Over the last decade, Seattle has become popular amongst these emerging technology firms that are headquartered outside of Washington State for a number of reasons: the talent pool is similar to what you would find in the Bay Area and real estate costs are less expensive. Not only is real estate less expensive in Seattle, the talent is as well. Emerging technology firms are able to compensate programmers and developers 10-15% less in Seattle than what they would otherwise have to pay those same individuals in San Francisco—that combined with the reduced real estate costs makes opening an office in Seattle a competitive advantage.
Although Seattle is in the longest uptick in its history, we do know this landlord’s cycle can’t go on forever; everything must come to an end. Vacancy began dropping Q2 2010, meaning it’s been 87 months since Seattle’s real estate market has seen any sort of considerable correction. The previous landlord’s cycle lasted only 68 months (Q4 2002 – Q2 2008) and if history is a predictor of the future, Seattle should see a correction in the near future—the only uncertainty is what the cause of that correction will be.
A Brief History of Seattle’s Market Swings
Looking back on Seattle’s commercial real estate market, there are three clear instances where an upswing in the market was abruptly ended. Those three instances were: The CAP Initiative in 1989, the Dot Com Bust in 2000 and the Financial Crisis in 2008.
The CAP Initiative
The CAP (Citizen’s Alternative Plan) Initiative passed in the 1989 polls in response to over-development (primarily the approval by the City for Two Union, 1201 Third, US Bank Centre and Seattle Municipal Tower) and concerns of pollution in the City’s core. The initiative placed a cap on how tall office buildings could be, at 450 feet, and how much new office product could be delivered year over year. At the time the initiative was passed, Two Union, US Bank Centre and Seattle Municipal Tower had Master Use Permits but had not broken ground. Knowing that if the Master Use Permits expired they would not be able to build, these developers built on a speculative basis despite the lack of demand. This caused millions of square feet to be delivered to a market that seemingly had no need for additional space.
The Dot Com Bubble
Fueled by speculative investment, the Dot Com Bubble of 2000 caused many of Seattle’s notable tenants such as MyLackey.com, Network Commerce Inc. and Internap to either go out of business or reduce their headcount substantially. The reintroduction of massive blocks of office space forced property owners to lower rates and caused developers to second guess the decision to introduce new product to the market.
The 2008 Financial Crisis
Similar to the Dot Com Bubble in 2000, the Financial Crisis in 2008 also caused hundreds of thousands of feet to be reintroduced to the market seemingly overnight. The collapse of high credit firms such as Washington Mutual gave property owners considerable concern that the tenants occupying their offices could also go out of business resulting in increased vacancy. To counter this, many landlords reduced tenant’s rates in exchange for additional term on their lease, commonly known in the commercial real estate industry as “blend and extend.”
Nobody knows what the cause of the next market correction will be, but what is certain is that the uptick in growth and rates cannot go on forever. The Wall Street Journal recently published an article speculating that, similar to the housing crisis, easy-to-qualify auto loans could be the next cause for correction. What is certain is that signing a long-term lease in today’s market could hinder a business’ ability to recruit/retain talent from those firms that successfully timed the market.
Protective Measures for Tenants
So what should Seattle tenants do in the meantime, given that a correction is inevitable and signing a long-term extension could place businesses at a competitive disadvantage? One way to remain nimble is by executing a shorter term extension (two to three years). In a landlord’s market like today’s, a short-term extension enables tenants to buy some time and wait for a market correction before signing a longer term lease. Incorporating flexibility into the lease language also enables tenants to remain agile and more effectively time market swings. Options such as a “Termination Clause” provide tenants leverage against landlords by providing an out in the event their rate is above market or the size of the space is longer conducive to the business.
Subleases are also a way in which tenants can find below market options and further alleviate pressure in a hot real estate market. For those companies looking to dispose of their current location before the expiration of their lease (because they’ve outgrown it, need to contract, etc.), the space tends to be a wasting asset. As a result, tenants in that situation tend to offer the space at a below-market rate in order to get it off their books as quickly as possible. Scenarios like this create huge opportunities for tenants looking for space at a discount.
For most businesses, real estate is the second biggest line item on their balance sheet after employee payroll. Signing a long-term lease at the height of the market could significantly impact a firm’s ability to compensate employees and recruit/retain, putting them at a competitive disadvantage to those who more appropriately time the market. The market growth over the last seven years underscores the need to be cautious about extending a lease longer than a few years. Navigating the waters of commercial real estate can be extremely complex. By utilizing a trusted tenant representative, you can ensure that all options will be considered, and that your best interests will be at the forefront at all times.
Gavin Curtis is a vice president at Hughes Marino, an award-winning commercial real estate company with offices in Seattle, San Diego, Orange County, Los Angeles, San Francisco and Silicon Valley. Contact Gavin at 1-844-NO-CONFLICT or firstname.lastname@example.org to learn more.