State of the Market: Given that 2003 was a year of difficulty and confusion for the state, the nation, and the world, San Francisco necessarily grappled with those pressures even as it struggled with its own unique circumstances. The commercial real estate market reflected these conditions and turned in year-end statistics best characterized as generally positive but specifically conflicted. Certain benchmarks were positive, but required stating in a negative sense, i.e. " sublease space declined substantially but inventory remains high " and " direct vacancy rates and total availability rates inched down slightly." By the end of 2003, however, tenants had finally acknowledged the folly of waiting for the market to sink substantially lower, stepping up to seize the value San Francisco delivers, often in spite of itself.

No one agrees on the same year-end numbers because each source counts differently. By almost all accounts, however, year 2003 ended with two quarters of positive absorption, an over-all citywide vacancy rate hovering at 20%, and space available to lease in the amount of approximately 16,000,000 square feet. Leasing activity itself certainly had a strong finish, at least 6,000,000 square feet and very likely over 8,000,000, wildly disparate numbers, again because of different methodologies. (Specifically, tracking all lease renewals, especially those by smaller firms which are a significant presence in the City's tenant population, is problematic for brokerage firms no matter how good the research department is.) Certainly either is an acceptable number, but not yet cause for excessive celebration.

The most important measure, year-end net absorption, reveals an even wider spread. By the way, I read as many industry quarterly and year-end reports as possible before making comments and statements about the market, although I am especially leery of quoting statistics as hard and fast absolutes. That's why this newsletter is not primarily geared toward market statistics and why you will consistently find modifiers in these reports, the "for all intents and purposes" and "approximately" and "around" or "not quite" and even "by almost all accounts"-there is no single source which I completely rely on or agree with. Let's go back to 2003 absorption figures. Take a look at the (extremely wide) range from six company's year-end reports for San Francisco: +138,149 sf; +190,896 sf; +358,203 sf; +900,000 sf; -155,149 sf; -311,769 sf. Without knowing the parameters of the research, it is difficult to dispute individual results but it is also impossible to draw identical conclusions. Based on mixed signals, what nonetheless seems to be the pulse of the market right now? Thready, rather faint, but reviving.

Vision 2004 and Beyond: Ken Rosen, real estate analyst and consultant from Berkeley who had been quoted here, spoke recently at a joint NAIOP, BOMA, and CREW luncheon. A few salient remarks to chew on:

• 5.6% national unemployment rate quoted is really a 9.9% underemployment rate, which includes those not only looking for work, but those working part-time or not at all.
  
• Less job demand overall due to fewer people doing more plus increased outsourcing overseas.
  
• Moderate economic growth is projected next year, estimated @ 3%, with a boom possible but unlikely. There is also a possibility of a full-blown recession in 2005, but "it is still too early to tell." Current huge trade deficit ( -$500 Billion ) increases and possible geopolitical event(s) add uncertainty to the future.
  
• Offshore hiring a " structural change because companies must be competitive" and "what's good for corporate America isn't necessarily good for laborers in America." Global labor arbitrage will continue.
  
• Inflation will increase in 2005 by 2-4%. Stock market will struggle to go up.
  
• Fed will raise interest rates after the election, likely waiting until 2005.
  
• Las Vegas: fastest growing city and hottest spot for investing in the U.S.
  
• Is real estate is too expensive? No, especially relative to rates of return for alternative investments.
  
• "It's time to reform Prop 13 and return revenue sources to local governments for much-needed services." Suggests raising annual cap from 2% to 5%. (Stunned silence from the audience.)
  
• Top 2 Bay Area industries which will drive recovery are healthcare and defense spending.
  
• California housing prices are up 40% in the last 2 years. Should get a correction in next 18 months.
  
• San Francisco vacancy rate of 20.1%. Time needed to recover is 3 years minimum and as much as 7 years. "A longer road than people think."
  
• Superstore cannibalizing will continue. Will see many old companies disappearing in the next 10 years.

On the Move and Recent Transactions: (usually excludes renewals, except sometimes not, and numbers may differ slightly from actual square footage leased) Nokia subleased 25,195 square feet at 650 Townsend, while SBI & Company moved into 19,900 sf at 410 Townsend Street. Wells Fargo Bank's new lease at 201 Third Street takes 53,450 square feet. Allen Matkins Leck Gamble & Mallory LLP is moving to EC 3 after many years at 333 Sansome, taking approximately 35,000 sf with another 5,000 sf expansion, while KPMG moves out of EC 3, into 90,000 sf at 55 Second Street. Signing Bonus for KPMG: the building will be named after them. Conifer Securities's move to the Ferry Building into 35,000 sf takes that successful project to 95% leased (only 1 more tenant to go for 100% occupancy.) Dmax Imaging leased 11,978 sf at 400 Second Street, and anti-spam firm Cloudmark left 500 Third Street to take 15,500 sf at 128 King Street. Macy's added 50,000 sf to its current 70,000 at 22 Fourth Street. OQO, Inc. (makes personal computers) took 21,000 sf at 2394 Folsom for new headquarters. Hyde Street Community Services leased 17,750 sf at 134 Golden Gate Avenue. Renewing and expanding at 1 Market's Spear Street Tower: Morgenstein & Jubelirer LLP just about doubled its space to occupy 37,700 sf. Also in One Market, at the Landmark, is new tenant Harb Levy & Weiland in 19,000 sf. Glass, Lewis, and Co. moved to 575 Market into 11, 670 sf. JMP Securities and JMP Asset Management moved into 34,400 sf at the Pyramid, 600 Montgomery, as did Driver Alliant Insurance Services with 19,860 sf, moving from around the corner at 500 Washington. Keker and Van Nest LLP renewed and expanded into 64,000 sf at 633 Battery Street. Kirkland & Ellis LLP took 47,000 sf at 555 California, while Piper Jaffray left 353 Sacramento to join its other office already in 345 California, occupying 61,500 sf. 201 Sansome lost 2 major tenants as Quinn Emmanuel Urquhart Oliver & Hedges LLP leased 18,700 sf in 50 California Street and The Furth Firm LLP leased 18,900 sf in 225 Bush. Jewish Vocational Services is moving into 21,000 sf at 225 Bush, while Human Service Management Corp and PACE together are taking 15,600 sf at 114 Sansome. The Daily Journal Corporation leased 12,421 sf at 44 Montgomery, leaving 1145 Market. The Body Shop subleased 12,970 sf at 111 Sutter Street for its headquarters operation. And last but far from least, newcomer Equinox Gym moved its administrative offices of 8,450 square feet to 155 Sansome and is also in the process of constructing a health club at the ex-Pacific Coast Stock Exchange historic building on Pine Street, all 25,450 sf of it, including a swimming poo l in the basement level.

Still Cooking: California Culinary Academy now appears to be serious about 85,000 sf at 350 Rhode Island instead of Gymboree, which appears to be honing in on Foundry Square IV, Sun Microsystem's 160,000sf sublease offering.

New, Real Jobs Into the City: Zinio left Brisbane for 139 Townsend Street and 11,000 square feet of new space.

Future Jobs Into the City: This is rather premature to be counting new jobs from Lucasfilms Ltd. at the Presidio, but at least know that this is one of the most important projects in San Francisco for adding employees. Approximately 1,500 people are scheduled to leave Marin to work here. Of course, they won't be downtown or even anywhere near downtown, but the impact nonetheless will be huge for the 23 acre, 850,000 square foot Letterman Digital Arts complex under construction at the Presidio.  Industrial Light Magic special effects company, LucasArts, Lucas Learning Ltd., Lucas Online, and the George Lucas Educational Foundation will all move to the site. There are plans for a high-tech Presidio museum and a seven acre "Great Lawn" that will be open to the public. The first buildings are scheduled for completion in 2005.

Moving Down and Out: Bechtel Corp is sending " several hundred jobs " to Maryland (the rebuild Iraq division) out of the some 1400 people employed here. In addition, the U.S. Treasury Department is trading in 390 Main for new offices in Emeryville, taking 82,000sf at the Atrium. That's surely at least 300 more jobs San Francisco will lose.

The Shrinking Cubicle and Movable Office: Real Estate Forum's January 2004 issue spotlighted a panel of corporate real estate managers discussing various concerns, with a partner in Ernst & Young LLP's real estate advisory practice, Thomas Bogle, confirming that each E&Y employee at the new Manhattan headquarters building is allocated only 180 square feet. And because they practice the " hoteling" office concept, only the CEO has a designated office. In doing space planning estimates, as brokers we used to commonly allocate 225-250 square feet per employee, now too generous by today's standards. This measurement is not just the size of the cubicle or office, however, but takes into account a rough prorata share of other areas in the office space, including circulation. The estimation several paragraphs above of at least 300 lost jobs to San Francisco when the Treasury Department moves to Emeryville into 82,000 square feet was derived by using 250 square feet as an average in order to guesstimate employees. By substituting 180 square feet per employee as an actual size, then 455 people and their jobs would be lost to the East Bay. Big difference: more people in less space, more jobs lost, and fewer square feet leased.

Reduced size for cubes and offices is an issue quite overlooked in trying to figure out how long the commercial real estate market recovery will take. Indeed, "create new jobs" is a requirement in order to fill the empty buildings; but changes like this one whereby some companies cut their space requirements by mandating a 20-25% reduction per employee have huge ramifications for the office market-- impacting everything from absorption, vacancy, rental rates, and new building starts.

Add other important policy changes such as fewer workers doing more (see last issue), outsourcing, and offshoring and the commercial real estate landscape that we know today will likely be very different in the next decade. Of course, pundits have been saying for years that the trend of working from home will reduce office requirements dramatically-- that has yet to happen in any major way.

Speaking of sending work offshore, I recently discovered that I became a contributor to this trend. It was inadvertent and certainly miniscule in the scope of things, but nonetheless I am offshoring my new website's coding to...yep, China. In the process of combining an old website with a new one (soon to be unveiled), I hired a web designer recommended by a consultant I had previously done work with. Faith Seekings and her team all live in Toronto, but as happens in today's world of technology, this really did not matter. When the site was nearly ready to be coded, she informed me that the person who does this for her had just moved his family to China from Toronto and would do all the work from there!

This is a complicated subject, no doubt. No matter what local, state, or national governments do to retain their current companies, inevitably some companies leave. Back in the mid to late ' 80' s, when I was working out of Walnut Creek in the East Bay market, there was a huge migration out of San Francisco into the suburbs of Contra Costa. Frankly, some considered that offshoring. Yes, prices were attractively lower there; but the main reason most firms re-located was that the president of the company, and often other officers, lived out there already. Few criticized the board of directors or managing officers for such decisions because both the pond and the ripples were much smaller then. Community, state, and national groups are increasingly vocal now, with more to lose and different issues to confront. Nonetheless, foreign ports, however they are defined, will continue to beckon companies. San Francisco, now more than ever before in its history, must make good business choices to counteract the siren call of other locations to its resident companies.

Insurance Intricacies: I don't even pretend to talk insurance-ese, but this subject is such a major part of operating expenses and lease negotiations that I feel compelled to put in this section after hearing an excellent talk on the subject. Alex Glickman of Arthur J. Gallagher spoke to the monthly lunch group Real Estate Roundtable. You will definitely need a very good attorney to interpret this esoteric subject, but here's the short version. First, she announced that insurance premiums for property and commercial general liability are stabilizing, with as much as 15% decreases over 2003 prices in some asset classes. Terrorism premium rates are also dropping. In both cases owners and tenants should be winners.

She admonished the group to get rid of the term "comprehensive general liability" insurance in leases, as there is no such animal any longer, and to add updated language for terrorism and environmental coverage. Alex mentioned several gray areas pertaining to costs: if the building occupied is in a portfolio program (all the rage in insurance circles, evidently), can the cost of portfolio insurance be passed through? Is the building even covered? Alex gave an example of the World Trade Center, which "forgot" to insure $3.7billion because of a portfolio program.

Tenant attorneys were cautioned to look carefully at language regarding earthquake insurance and its deductibles, making sure that owners have enough capital to pay the deductible. For example, if there's a $100,000,000.00 claim, the deductible would be 5% of the replacement cost of the asset, or $ 5,000,000.00 in cash required before the owners can even get to the insurance. Ask: where will the money come from? Finally, "Reputational Underwriting" is the new buzzword, such that management and ownership impact rates very strongly, with insurance pricing on more than just spreadsheet information. This gives new meaning to tenant's " flight to quality", up from Class C to Class B to Class A. Really scrutinize and pay attention to these insurance clauses and how they impact your company's cost of doing business under different ownerships in all classes of buildings.

Don't Go, Please Stay, Please Pay: Surveys by companies such as BOMA and ULI find that the main reason tenants renew is because of service, with occupancy cost and location consistently coming in after that. In a newsletter from http://www.researchworldwide.com/ dated 10/17/03 entitled "Occupancy Cost is Only the 7 th Most Important Factor in Head Office Locations," Tokyo was cited as the most popular location for head offices, with 61 of the Fortune Global 500 Companies. Just how much are rental rates there? $118.00 per square foot, placing it as the second most expensive city to do business in. London is themost expensive, at $151.00 per square foot, yet it has the third largest number of Fortune Global 500 Companies, 22 in all. New York also hosts 22 companies, at $57.00 per square foot. San Francisco, by the way, has no Fortune Global 500 Companies. "There are enough examples worldwide to show that corporate head office locations and buildings are not entirely influenced by rational decision making."

What does " service " mean to tenants? From a down and dirty survey I conducted with a few clients: elevators that are in, not out of, service, (elevators that are really zippy get extra points); clean elevator floors and marks on the cabs removed; bathrooms cleaned more often than end of the day (especially women's); a security system that doesn't severely inconvenience guests; security personnel that actually know how to quickly operate new security systems for visitor passes; HVAC systems that cool offices in the summer and heat them in the winter instead of just the opposite; responsive management (with a smile) to tenant's concerns. Sounds reasonable but execution appears to be spotty. Send me your pet peeves and I'll update the list.

Connectivity: Here's a revolutionary concept. Pikenet Dispatch of 1/13/04 featured a company, SENTRE Partners, which "treats broadband access as a utility, like water and electricity, and adds Wi-Fi wireless connectivity as an amenity. " The company, based in San Diego, operates its own building optical network and achieves savings by ".aggregating the demands of multiple users. Tenants pay only about $250 per month for 100 Mbs speed. Translation: that's about one-fifth the cost and sixty times the speed of a normal T-1 line."

From their website www.sentre.com, partner Matthew Spathos elaborates, "Our concept is really simple...provide bandwidth as the 4th utility and Wi-Fi (wireless internet) as an amenity.. The real estate industry needs to help set the agenda. This is really no different than the move from kerosene to electricity or stairs to elevators. Owners did not rely on third parties to pay for, install, and own the electrical network or the elevator system. We would be crazy to let a third party own this essential building infrastructure. Optical wires and switches should be treated like electrical wires and the transformer.owned by the building, managed by a third party for the benefit of our tenants. Bandwidth is purchased in bulk off the bandwidth grid in the same manner power is purchased off the power grid."

Making the system even more useful to tenants, SENTRE will use a web- based work order system using the wireless infrastructure. "Our engineers will carry web tablets and Pocket PC's, opening and closing tenant work orders on the spot. No more forms in triplicate," says lead building engineer Reese Layton. "We will also use the wireless infrastructure in the deployment of wireless web enabled security cameras and voice over IP communication."

Who will be the first San Francisco building owner to provide tenants these services? So far, the financial district tenants which are installing wireless systems in their offices tend to be larger users. Several of the ones I know about are installed but not used. Security issues? Receptivity? What?

Property Tax Bills Revisited: If you would like to look at a tax bill for any commercial building (or any property, for that matter), go to the very useful SFGov web page, SF Gov, and hit "Begin" at the bottom of the page to then enter the address or parcel number.

Site Seeing: The best $10.00 hour-and-a-half adventure in town (and only $5.00 for children) is the behind-the-scenes tour of the San Francisco Giants' stadium, sometimes known as SBC Park. A walk through the waterfront ballpark gets you into the dugout, locker room, and other secret spots the public never sees. Click here for all the details: SF Giants

Thank you for reading. Please feel free to send me feedback on this issue and suggest topics for the future. To receive this issue quarterly, send your email address to janine.watson@grubb-ellis.com and type "Send newsletter" in subject line; to be removed, type "Remove Name." Note that all content represents the opinion of the author and does not represent those of Pacific Union Commercial Brokerage. Privacy Policy:  your e-mail will remain confidential and will never ever be shared in any way. For more information about office marketing, buildings for sale or lease or any other aspect of commercial real estate, please feel free to contact me. Referrals are always appreciated.

"It was inadvertent and certain miniscule in the scope of things, but nonetheless I am offshoring my new website's coding to.yep, China."