; Just Like They Told Us In Econ
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Just Like They Told Us In Econ


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									                                                 QUARTER 1 | 2008                                                                                          A COMMERCIAL REAL ESTATE NEWSLETTER
                                                                                                                                                           PUBLISHED BY WAYNE MASCIA ASSOCIATES
                                                                                                                                                          SERVING THE INTERESTS OF SILICON VALLEY

 01     JUST LIKE THEY TOLD                                      02      WHILE MOOD IS CAUTIOUS,                                      03         BUILDING A FOUNDATION
        US IN ECON 1A                                                    SILICON VALLEY IS PERFORMING                                            FOR FUNDING REQUESTS
                                                                         SOMEWHAT BETTER THAN
        Article By Mark Regoli                                           NATION AS A WHOLE                                                       Article By Lois Steiner
        Partner                                                                                                                                  Principal/CEO
        South Bay Development Company                                    Article By Andres Claure                                                Facilities First
                                                                         Executive VP & Director of Sales
                                                                         Wayne Mascia Associates

                                                                                              Mark Regoli brings over 20 years of commercial real

Just Like They Told Us In Econ 1A                                                             estate investment and portfolio management expertise
                                                                                              to South Bay Development Company. Mr. Regoli is
                                                                                              responsible for originating and negotiating real estate
                                                                                              and development investments, including structuring
ARTICLE BY MARK REGOLI | PARTNER | SOUTH BAY DEVELOPMENT COMPANY                              complex transactions and arranging capital to meet
                                                                                              the unique requirements of South Bay clients, partners
                                                                                              and investors. Since assuming this role in 1995 he has
It has been a while since I sat through an economics course. At the time it all seemed        completed in excess of nine million square feet of real
so abstract and irrelevant. Business cycles, money supply, and fundamental analysis           estate investments with a value of over $2 billion. Mr.
                                                                                              Regoli has also completed several million square feet
were committed to memory, but without a lot of thought of how it would all be                 of ground-up and build-to-suit office, industrial and
applied. As the commercial real estate market is moving rapidly again, I am reminded          R&D development projects. Mr. Regoli began his career
                                                                                              working with various pension fund advisors where he
of these economic principles and how the fundamentals rarely change.                          was responsible for sizable equity acquisitions, real
                                                                                              estate purchases and dispositions, and asset management.
                                                                                              Mr. Regoli holds a bachelor’s degree in Business
It turns out, just like they told us in Econ 1A, real estate is a cyclical business. We are   Administration and a master’s degree in Business
not immune from business cycles, a downturn in the general economy or problems                Administration with a concentration in Finance, both
                                                                                              from San Jose State University. He is currently on the
in the commodity markets. It always seems to happen more quickly and dramatically             Silicon Valley Chapter of NAIOP Board of Directors
than we thought it would, so fast that we often miss the signs the market is turning.         and served as a Chapter President.

Not the signs reported on CNBC or by Wall Street’s “Top Analysts”, but the everyday           About South Bay Development Company
                                                                                              South Bay Development Company acquires, develops and owns commercial property for its own account and
signs that there might be trouble on the horizon. Before the market started to turn
                                                                                              in partnership with a variety of institutional investors. The firm focuses its efforts entirely in Northern California
down last summer, a former construction worker, who had never done a real estate              and is considered one of the leading managers and developers of office, industrial and retail properties.
development, had tied up a 40 lot subdivision in Hawaii and stopped by our office
                                                                                              South Bay is vertically integrated with in-house expertise in all phases of development, acquisition, construction and
seeking financing; my barber was evaluating commercial investments, and law firms             property management. South Bay Development Company was incorporated in 1978 and remains privately held.
were losing lawyers to housing developers – clearly signs Rockefeller would not have
missed while getting his shoes shined.

When his shoeshine boy started giving him stock tips, Rockefeller knew that investors         The memory of the dot-com bust and how the high cost of real estate contributed
had been shoved aside by speculators, and sold out before the market crashed.                 to their problems is still very fresh. They are extremely cautious in regards to
He was reading these everyday signs that trouble was on the horizon. We should                expansion and thoroughly negotiate every lease clause. This all contributes to
all keep this in mind.                                                                        making leasing perhaps harder than it has ever been.

When it all seems so fun and easy another economic principle is often forgotten:              The tenants are able to get away with this because they are acutely aware of the
The value of an asset is directly related to the income it produces. Income is related        fundamental economic principle that supply and demand directly affect price.
to value. Speculators do not do this type of analysis. It is typically done for them by       This is the building block of economics. When touring new buildings, it does not
real estate auction houses that put this analysis into shiny investment prospectuses.         take the tenant long to figure out that there is still a lot of commercial space in
The auctioneers take an already inflated market rent and grow it by 15% per year,             the valley. Business parks still have vast vacancy. Milpitas, Fremont, and South San
which makes the investment look spectacular to the speculator.                                Jose have such little occupancy they look like modern day ghosts towns.

The speculator, like a gambler, is taking tremendous risk. And as is turns out risk is        It is hard to push rents when there is still plenty of unoccupied space. There is a big
risky. You can lose money. If you overpay, you will be punished.                              difference between $1.50 and $2.00 per foot when you are leasing 50,000 square feet
                                                                                              of space. There is always another landlord who has a better building and is willing to
At some point, the interest reserve in the loan runs out, the tenant improvement              lease it for less money. Despite optimism and wishful thinking, tenants do not care
requirement is higher than the anticipated, and the project needs more capital.               about the cost of the landlord’s debt service.
Getting a building leased is hard – much harder than it seems in the spreadsheet
                                                                                              As this market downturn creates economic chaos, it will provide opportunity for
or Argus analysis. Tenants and their brokers are tough negotiators.
                                                                                              investors that can still remember their basic economics. When the speculators
In leasing a building, tenants follow another economic principle: price sensitivity.          are gone prices will correct and provide plenty of opportunity for investors who
They are very sensitive to rent, net charges, and improvement costs.                          remember the lessons from their economic courses.

www.waynemascia.com | page 01
                                                                                                 The overall vacancy rate increased slightly over one percentage point to 11.82%, with
 While mood is cautious, Silicon Valley                                                          new buildings coming on line, helping to contribute to the increase. Palo Alto and

 is performing somewhat better than
                                                                                                 Cupertino continued to maintain the lowest vacancy rates at 7.02% and 3.64% re-
                                                                                                 spectively, so it’s no surprise that these two cities command the highest asking rates -

 nation as a whole                                                                               $5.23 for Palo Alto and $3.75 for Cupertino. Of the nine Silicon Valley cities we track,
                                                                                                 3 cities - Palo Alto, Cupertino, and Fremont - still possess single digit vacancy rates.
                                                                                                 We saw a decrease in the asking office rates in San Jose as Equity Office Properties
Andres Claure is an Executive Vice President                                                     lowered their asking rates on the San Jose Airport buildings due to very light activ-
and Director of Sales at Wayne Mascia                                                            ity and a fleeing of tenants whose leases expired and who were unwilling to pay the
Associates, a Santa Clara based commercial                                                       newer asking rates after the Blackstone acquisition. The vacancy rates in downtown
real estate services firm. In addition, Andres                                                   San Jose are also tentative, with Oracle’s acquisition of BEA. The BEA building at 488
serves on the Board of Directors of TCN                                                          Almaden Avenue still remains unoccupied as Oracle’s occupancy plans remain in ques-
Worldwide, a consortium of independent                                                           tion. This building - along with Legacy’s 319,000 sf tower currently under construction
commercial real estate firms, providing                                                          and scheduled for delivery the 2nd quarter of 2009 - could increase the vacancy rates
complete integrated real estate solutions                                                        in downtown San Jose dramatically.
locally and internationally, with approximately
$13.9 billion in annual transactions. Andres                                                     Overall leasing activity for the first quarter was mostly flat. Gross absorption totaled
also serves as President of the Board of                                                         1.35M sf., the lowest quarterly absorption experienced in the last 5 years. Note-
Directors of the Association of Silicon Valley
                                                                                                 worthy transactions of the first quarter were Netflix’s expansion of 80,000 sf in Los
Brokers, (ASVB).
                                                                                                 Gatos, Anchor leasing 40,000 sf in Mountain View, and Emulex leasing 31, 388 sf in
                                                                                                 San Jose.

The first quarter of 2008 was full of negative headlines; we read about the consumer             Although the office sector posted slight negative absorption and sublease space
confidence index dropping to 64.5 in March, down from 76.4 in February, a flat                   increased slightly, lease rates continued to climb, albeit at a very slight level. Silicon
reading for the CPI, and the near collapse of Bear Stearns. The words “subprime                  Valley continues to post strong fundamentals and operate in a bubble compared
mess” are still heard in most conversations regarding the economy. In March, the                 to the rest of the country. We expect the office market to continue at its current
10-year Treasury yields rose on statements from Standard & Poor’s, suggesting that               level throughout the second quarter, with flat absorption numbers and a leveling off
an end to the sub-prime mortgage write-downs may be in sight. The fed continued                  of rental rates.
to cut the Fed Funds rate which currently stands at 2.25% and another quarter point
cut is expected at the April 30 meeting. The national unemployment rate for March                R&D
increased 40 basis points to 5.2%, while the California unemployment rate ended
the first quarter with an increase to 6.4%, and Santa Clara county fared better at               “Cautious optimism” seems to be the term used by most brokers to describe the
5.3% at the end of the first quarter. Silicon Valley netted 6,900 more jobs in March             mood of companies involved in leasing R&D space during the first quarter of 2008.
than the same period a year ago. VC funding for the first quarter slowed to $5.6B                The R&D market posted commendable numbers to start off the year with over 3M
in 626 deals. Silicon Valley received $2.56B in 213 deals, roughly 33.7% of all VC               sf of gross absorption and 135,968 sf of positive net absorption, keeping the
funding and a 10% increase over the previous quarter. Investments were spread                    overall vacancy rate at 16.76%, while rental rates increased slightly.
through different sectors - 37% of the money going to the BioTech, Medical Devices
and Software companies; of this, 75% of the money is going into later stage funding              Several markets performed better than others. As expected, the Palo Alto and
and expansions.                                                                                  Cupertino markets were the tightest, with Cupertino posting a 9% vacancy rate
                                                                                                 and Palo Alto 7%. Mountain View, soon to be “Googleville”, also posted a single
The economic uncertainty has placed commercial real estate in Silicon Valley in
                                                                                                 digit vacancy rate at 9.7%. The average rental rates saw a very slight increase to
a holding pattern. Local executives are re-analyzing real estate decisions and
                                                                                                 $1.30, with Palo Alto and Cupertino posting the highest average asking rate of
proceeding with extreme caution on expansion plans and preferring shorter term
                                                                                                 $2.50 and $2.25 respectively.
leases. There are some companies, however, which bucked the trend and have
proceeded with acquisitions to expand - as Nvidia did with their 10 building,                    There were numerous significant transactions occurring in the first quarter, with
475,000 square foot campus and adjacent 25 acre land purchase in Santa Clara.
                                                                                                 at least five over 100,000 sf. The most notable was Xenoport’s renewal/expansion
Absorption numbers for Silicon Valley remained positive , but when broken down by
                                                                                                 in Santa Clara of 161,503 sf, followed by deals by Nvidia, Phillips, and Data Domain.
sector, the office and warehouse sectors came in slightly negative, while lease rates
                                                                                                 There were also several sale transactions occurring in the first quarter that were
increased across the board for all categories. Our analysis by product group follows:
                                                                                                 very close to 500,000 sf each. Nvidia’s acquisition of the San Tomas business park
                                                                                                 (directly following its leasing of 122,432 sf in the same complex), consisting of 476,000
                                                                                                 sf, topped the charts, followed closely by La Salle Partners’ 417,000 sf acquisition in
                                                                                                 San Jose and TMG Partners, 410,473 sf acquisition in Fremont.

                                                                                                 It is our feeling that the R&D segment will continue moving in a positive direction
                                                                                                 as Silicon Valley bucks the national trend with its tech-based economy. With venture
                                                                                                 capital spending continuing to fuel research related companies, there will continue
                                                                                                 to be a need for quality R&D space.

                                                               JIM MAGGI AND DAVE VANONCINI      Industrial
                                                               REPRESENTED ACCURAY IN THIS
                                                               72,500 SF LEASE EXTENSION AT      The industrial sector in Silicon Valley maintained stability as the overall vacancy rate
                                                               1310 CHESAPEAKE, SUNNYVALE.       dropped almost a full point to 7.91% with 8 of the 9 tracked markets posting single
                                                                                                 digit vacancy rates. Gross absorption totaled slightly over 800,000 sf for the quarter
                                                                                                 - one of the highest absorption figures since 2005. Net absorption came in at a posi-
                                                                                                 tive 392,854 sf, despite the current economic situation. Several significant transactions
Office                                                                                           contributed to the positive absorption numbers; one of them was the 152,675 sf lease
                                                                                                 completed by Asus Computer International in Fremont. Rental rates continue their
The sluggish activity levels experienced during the 4th quarter of 2007 seemed to have
                                                                                                 upward trend as some tenants are now considering industrial space as a lower cost al-
transferred over to the first quarter of 2008, producing negative net absorption and a
                                                                                                 ternative to R&D space and most companies with expiring leases are opting to renew
slight increase in available space, but also a slight increase in average asking rental rates.
                                                                                                 current leases instead of relocating. There are no projects under construction due to
Despite serious economic concerns on a national level, we feel the Silicon Valley fared
                                                                                                 a lack of developable land and high construction costs making development unproduc-
well: net absorption was negative 1,384 sf, total available office space increased to
7.5M sf, and average asking rental rates increased to $2.85/sf.                                  tive. We expect the activity level to maintain its current pace, pushing the vacancy
                                                                                                 rates lower and helping rents continue upward at very slight levels.

                                                                                                                                                               www.waynemascia.com | page 02
                                                                                              except for their immediate needs and assumptions based on rough estimations
                                                                                              that are made on the fly.
                                                                                              Interestingly, this often leads to architects interpreting someone’s dreams,
Another sector that remains healthy is the warehouse sector. Despite a negative net           inadequate schedule issues, cost overruns, and results that create even less
absorption number of 165,583 sf for the quarter, the gross activity levels managed to         confidence in real estate and facilities professionals by executive teams so that
post a 738,456 sf number for the quarter. These numbers would be skewed in the                the next time funding is requested the pendulum swings in the opposite
positive direction if Newark’s activity were included in the calculations, as several large   direction for implementation and the request is for “plain vanilla” buildings etc.
leases in Newark totaling near 500,000 sf took place in the first quarter. Average ask-       So… what we suggest is to observe and record current practices and negotiate
ing lease rates increased several pennies to $.55/sf for the first quarter of ’08. Several    best practices based on each individual company’s goals and recommend them
significant transactions, including Super Micro’s 246,450 sf lease in Fremont, contrib-       to be the standards for approval of all company executives – even Boards,
uted to the absorption for the quarter. Many companies have opted to renew leases,            if appropriate.
rather than relocating their business due to the limited amount of available space
and the lack of new space coming online. We expect the vacancy rates to continue              When the strategic planning, standards and processes have been documented
downward as companies continue leasing more warehouse space, pushing rental rates             and approved then the list of projects can easily be scoped and budgeted based
upwards as well.                                                                              on approved standards. Projects can be prioritized for funding and timing and
                                                                                              the case for funding is then based on previously agreed upon productivity,

Building a Foundation for Funding Requests                                                    retention and overall business enterprise goals. What gets funded is what
                                                                                              is made visible and defensible as uncontested “value” based on common goals
                                                                                              and understanding.

                                                                                              Support Staff Funding
Lois Steiner is Principal/CEO of Facilities
First of Mountain View ,California, a full                                                    In addition to project funding, support staffing will need to grow as the company
service facilities firm founded in 1992.                                                      grows. Some organizations believe that outsourcing is the answer. When Facili-
Facilities First partners with companies to                                                   ties First develops staffing plans for facilities organizations we benchmark against
create solutions for integrated technology                                                    other organizations and provide suggested options for out-sourcing, out-tasking,
to manage the workplace, strategic planning                                                   technology improvements and the kinds of skills that will be necessary for
preparation and metrics for executives,                                                       in-house staff and supporting vendors as an organization grows. Although there
staffing for facilities positions, space
                                                                                              are general assumptions that can be made, we recommend establishing staffing
planning and interior design, programs for
                                                                                              metrics related to each of the special kinds of spaces rather than blanket
sustainable practices, construction and
                                                                                              assumptions per employee or per square feet. In this way, as projects are
move management and surplus equipment
disposition. “Because workplace matters to
                                                                                              completed, the staffing plan, regardless of how achieved, can be implemented
your people and your bottom line!”.                                                           seamlessly along with any resultant growth or change in portfolio size and
info@facilitiesfirst.com                                                                      complexity. This helps maintain the quality and viability of the workplace in
                                                                                              a consistent manner over time.

Busy corporate real estate executives and facilities directors are often plagued              With this method of adding portfolio support staff, the issue is no longer how
with “too many projects - not enough money.” Given such challenges, how can                   to get funding for appropriate staffing levels, but who to hire, when and how.
you make the case with the executive team to finance the project at the                       Wise facilities leaders integrate this kind of planning into their funding scenarios
appropriate time, at an appropriate level?                                                    when they make presentations to their senior executives. This helps satisfy the
                                                                                              requirements of all of the decision makers - the CFO who is tasked primarily
Building Corporate Backing                                                                    with financial goals, the VP of HR who is tasked primarily with worker/head-
                                                                                              count/retention goals, and the VP of Engineering who is tasked with development
Successful corporate real estate executives need to take a step back from their
                                                                                              of product goals - because you have related the funding needs and timing to the
need for money to view the financial portrait of their objectives and relate their
                                                                                              direction of the whole organization.
projects to a return on investment and appropriate timing for their projects.
They have pursued diverse paths to build relationships with their organization’s
                                                                                              Setting the Pattern for Real Estate & Facilities Funding
top leaders and understand the goals and vision of those top executives.
Acquiring money for facilities is rarely a goal unto itself. The requests must relate         What this planning approach also does is help focus the organization on how the
to overall goals of the organization such as - increased worker productivity,                 real estate and facilities operations costs relate to the driving forces of the whole
enhanced corporate image, sustainability goals and long-term reduction                        organization. If facilities leaders are able to project this image then it is also
in costs of operations and maintenance. We have watched several Silicon Valley                easier to obtain funding for various opportunities for savings that may involve
corporations build exquisite facilities at exorbitant first costs only to be faced with       up front funding, and thereby free up funding for other future projects.
retreat or even folding due in part to excessive and unwarranted occupancy costs.
                                                                                              Consider initiating server room utility projects to reduce carbon footprint
Successful leaders prepare strategic plans based on historical data and previously            and electrical use and space saving servers to save real estate portfolio dollars.
agreed-upon standards from their organizations, benchmarks in the industry,                   For every dollar of savings in reduction of actual server utility costs there is an
productivity and retention of employees in their company, growth projections                  opportunity to save about twice that in ongoing building systems utility costs
of various groups in their organization, geographical targets and potential income            and often significant corresponding reductions in real estate footprint required
projections.                                                                                  by data centers. But, implementation requires cooperation company-wide.
                                                                                              If these cooperative cost savings projects are achieved, long term payback
Project Funding                                                                               periods may amount to significant dollar returns to the bottom line.
                                                                                              This translates into possible funding availability for other projects and
In conjunction with gathering the important background information, successful
                                                                                              rewards real estate professionals with status and corporate credibility.
real estate and facilities leaders also develop strategic planning scenarios, standards
and processes documents and have them accepted by the organization – before
                                                                                              In summary, get the metrics, get in alignment with overall goals, build
they request the funding. As Facilities First has found when we develop strategic
                                                                                              relationships, get your presentation graphs right and “getting the money”
plans, standards and processes documentation for companies, it is often a challenge
                                                                                              will become more effective and satisfying work!
to develop this documentation because no one has either recorded history or
noted the processes currently being used, nor the standards and benchmarks that
are the “givens” in the company. If a company has been growing exponentially,
many times the staff involved has had little or no time to focus on planning

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