WESTERN SNAPSHOT, APRIL 2009

San Jose, California, Office Market

During the last 20 years, the San Jose/Silicon Valley has been one of the most active office markets in the country. Through the 1980s and ‘90s (with a dip for a few years in the early 90s) and through the dot com explosion and implosion (1998 to 2003), the Silicon Valley market has grown dramatically. Silicon Valley companies have continued to grow, but the mood at many of these companies is changing.

The high-tech firms that make up the majority of large tenants in the valley have been affected significantly by the global economic downturn, and that includes their real estate holdings. Silicon Valley is still one of the largest owner/user office markets in the country, but even that is beginning to diminish. Contraction, disposition and sales are becoming more commonplace among valley corporations, and the words “exit strategy” can be heard in every “C” suite.

How has this affected the Silicon Valley office market? Well, the vacancy rate is up in the mid-teens. Net absorption was negative 2 million square feet for 2008, and more than 2 million square feet of new construction is about to come on the market in 2009. Sublease space is beginning to increase in the market and will increase during the coming year. There were some significant leases done by Apple Computer and Citrix Systems, and a large sublease by Trend Micro, but not the volume of leasing activity seen in past years.

Renewals in 2009 will become more commonplace in the market. In order to save the cost of moving offices, labs and personnel, companies will stop relocating to new quarters. Landlords under the gun from lenders to hold close to pro forma will be more difficult to negotiate with because the lenders are driving deals. Letters of credit to cover tenant improvements will become more commonplace, especially as the creditworthiness of some tenants comes into question. While rents will drop perhaps as much as 15 to 20 percent in 2009, deals will not be easier to complete for both the tenant and landlord. Brokers, tenants and landlords are going to have to get creative to make deals work for everyone.

The situation now is in some ways unprecedented. Tenants are putting expansions on hold because of problems with diminished sales throughout their global markets. As a result, vacant space is not leasing particularly in new projects. Tenants are also putting space back on the market to sublease. To add to this already stressful situation for landlords, they are trying to find cash from very limited resources to finance deals.

We have been told there are many high-tech companies that have been hoarding cash and don’t have to do anything. That may be true, but at some point you have to either renew or terminate and relocate. There could be some “quiet spells” as the market waits for tenants to act. With the economy so unpredictable lately, it could be a slower year for office leasing in Silicon Valley.

Brian Gleason is a senior vice president in UGL Equis’ San Francisco office.

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