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Sublease Inventory a Canary in the Coal Mine for Bay Area Commercial Real Estate

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By David Marino and John Jarvis

For the past two decades, clients and business leaders have often referred to the Hughes Marino quarterly report as a “canary in the coal mine.” Hughes Marino has consistently reported trends 12-18 months ahead of an actual market correction, and forecasted recoveries up to a year ahead of past cycles.

These leading edge insights are generated from first-hand market information gained in the field, as at any given moment we are actively representing over 450 active tenant/buyer corporate headquarters, R&D/manufacturing, and distribution center engagements for millions of square feet of commercial space, across industries, company sizes and submarkets. Hughes Marino’s client engagements include expansions, contractions, relocations and lease renewals, which afford us the opportunity to work with corporate tenants 6-18 months in advance of their next occupancy requirement. The lease and purchase transactions we are engaged in today are for companies planning for their 2017 and 2018 real estate strategies and headcount requirements, giving us leading-edge insight into the underlying business dynamics that are driving their anticipated growth or contraction, and related job growth.

After five years of recovery starting after the third quarter of 2010 when the commercial real estate market was at its bottom, 2016 has seen sublease availability rates spike back up over two sustained quarters. A spike in sublease space like this is the best leading indicator of the impending turn in the market. Traditional, full-service commercial real estate brokerage firms, whose job it is to promote landlord listings and who therefore have inherent conflicts of interest, report vacancy rates that conveniently exclude millions of square feet of sublease space, so you won’t see this spike in their published vacancy rate market reports. This truly is the “canary in the coal mine.”

Year to date, total available square footage in the Bay Area actually declined by 346,028 square feet of net office, lab and industrial space. However, as we isolate total available sublease square footage we see a spike of 966,730 square feet! Again, total availability including sublease space is the best leading indicator of a decline in user demand for office, lab and industrial space, as companies look to jettison excess space and reduce their real estate footprints. Contributing to this is the robust merger and acquisition environment, which has led to a shedding of jobs and space.

There is some anxiety with this being an election year, and there is some softening in the life science market, as life science IPOs and the capital markets around them have become a bit volatile. A number of life science companies are beginning to struggle and those potential downsizings will likely bring additional sublease inventory on the market in 2016.

While we are not forecasting a recession or economic calamity like we did back in 1999, and again in 2007, we are seeing businesses respond to new market conditions such that landlords and their full-service listing brokers are going to have a tough time continuing to drive up rental rates, insisting on egregious long-term lease commitments and pushing over-market annual rent increases. Further evidence of these impending changes has recently been reported by the Wall Street Journal here and here, The Registry, and CoStar.

As for why these market changes are occurring, we can point to weakness in financial markets, in particular the US stock market, and hence the IPO window for exits. We can point to a decline in venture capital and new company formation, including down rounds and a few high profile stumbles. We can also point to uncertainty in the global economy, the price of oil, or the upcoming US elections. The truth is we may not be able to tell you exactly why the canary is singing, but we are here to report that she is singing, and we hear her song.

While we don’t expect a return to a tenant’s market immediately, the pendulum that has swung so strongly to create a landlord’s market over the last three years is finally reaching its limit.

Microsoft Word - Bay-Area-Market-Update-Q1-2016.docx

David Marino is executive vice president of Hughes Marino, an award-winning commercial real estate company specializing in tenant representation and building purchases with offices across the nation. Contact David at 1-844-662-6635 or david@hughesmarino.com to learn more.

John Jarvis is a senior vice president of Hughes Marino, an award-winning commercial real estate company specializing in tenant representation and building purchases with offices across the nation. Contact John at 1-844-662-6635 or john@hughesmarino.com to learn more.

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