A Tale of Six Cities

Las Vegas

• Avg. rent per sq. ft., Class A: $29.48

• Avg. rent per sq. ft., other classes: $21.01

• Large employers: Clark County School District; Clark County; Bellagio; Wynn Las Vegas; MGM Grand Hotel/Casino; Mandalay Bay Resort and Casino; University of Nevada, Las Vegas

• Percent of population over 25 with bachelor's degree or higher: 20.2%

• Percent with advanced degree: 6.8%

• Median home value: $320,800

• Venture capital invested in 2007 (through Q3): NA

Sources: Reis Inc., U.S. Census Bureau, UNLV Center for Business & Economic Research

San Francisco
The good news is that San Francisco seems to be regaining its former eminence as a technology hub, with such companies as MySpace and Bebo.com joining Salesforce.com and Yahoo as major downtown tenants. Vacancy rates have dropped from 23 percent in 2002 to about 12 percent this year.

The bad news is that with the new presence of New York–based private-equity landlords like Broadway Partners and Morgan Stanley come rents in the $100 per-square-foot range, which haven't been seen since the dot-com boom, when vacancy rates were below 1 percent. About 70 percent of the downtown buildings have been sold in the last two years, says Steve Barker, executive vice president at Studley, boosting rents 40 to 100 percent despite only a nominal increase in demand. "There's a total disconnect between supply and demand," he says.

One example of the new velocity: One Market, perhaps the toniest building in the city, had three owners within four months, passing from EOP to Blackstone to Morgan Stanley (which recently sold a 50 percent stake in the building to the Paramount Group). Rents for several vacant top floors have gone from $50 to $70 to $90 to $110 per square foot with each transaction, according to Barker. That has spurred some tenants to look for better deals: law firm Barg Coffin Lewis & Trapp decided to leave the building when rent would have doubled to $100 per square foot, and more companies are following suit. "It's definitely a phenomenon that's happening across the market," says Barker. "There aren't that many tenants that can afford to pay those prices."

How to cope? Unlike Chicago, San Francisco has a fairly concentrated downtown area. Companies that try moving out to the East Bay or South Bay will save little on rent, though they will save the city's 1.5 percent payroll tax, which can translate into a $5-to-$8-per-foot savings when applied to real estate, says Barker.

Most experts believe rents will come down to meet demand, but that it will take a while. PPR predicts that the rent growth will drop to about 4 percent in 2008 and 3 percent in 2009, as landlords swallow their pride and the supply of office space expands, with some 3.5 million square feet coming onto the market in the next two years. That means that if your lease is up this year, or growth is driving the need for more space, the best strategy may be to aim for a short-term deal and hope rents are more rational when it is time to renegotiate.

San Francisco

• Avg. rent per sq. ft., Class A: $38.17

• Avg. rent per sq. ft., other classes: $31.20

• Large employers: State of California, U.S. Postal Service, AT&T, Safeway, Gap, Kaiser Permanente, Wells Fargo

• Percent of population over 25 with bachelor's degree or higher: 42.4%

• Percent with advanced degree: 16.4%

• Median home value: $702,600

• Venture capital invested in 2007 (through Q3): $1.8 billion

Sources: Reis Inc., U.S. Census Bureau, San Francisco Business Times, PwC/NVCA MoneyTree Report

Alix Stuart is a senior writer at CFO.

Coming to Terms

With office buildings changing hands so quickly, it's pretty much impossible to avoid highly leveraged, rent-hungry landlords in New York, Los Angeles, San Francisco, or Boston. Here are a few tips for dealing with them.

1. Call the current tenants. Alex Randall, a real estate attorney with Goodwin Procter and head negotiator for the firm's office space, recommends asking them how tough or generous the landlord is, since "that might dictate how detailed a term sheet you negotiate."
2. Nitpick. Assuming the landlord is a financial buyer who likely isn't looking to build a long-term relationship, Randall will drill down, clause by clause, into areas where owners typically nickel-and-dime tenants. Before any negotiations start, he says, it is important to ask about items like future increases for operating costs, the markups on after-hours air conditioning or freight-elevator use, and construction-oversight fees, looking for any chance to negotiate limits.
3. Consider Section 467. Tenants might also look for a bigger upfront tax deduction through this section of the tax code, which allows tax to be paid equally over the term of the lease even if rent is initially free — at the price of higher income taxes for the landlord.
4. Guard against landlord turnover. In this instance, the "critical factor is to have a very tight and artfully crafted subordination nondisturbance agreement," says Robert L. Freedman, chairman of GVA Williams's New York office. These agreements ensure that "no one can mess with your tenancy" during the term of your lease.
5. Envy the clever deal-makers. In smaller markets, at least one CFO has found a way to profit from the rise in commercial real estate. When wireless-equipment distributor and manufacturer Infosonics moved into a single-tenant office building in San Diego three years ago, CFO Jeff Klausner negotiated for both a cap on operating cost increases and an option to buy at a fixed price. This year, he was able to exercise that option and immediately turn the property over to another buyer, pocketing more than $2 million for Infosonics in the process. And, he is still saving $120,000 a year in rent by moving to a space in San Diego that was better suited for Infosonics's headquarters, and relocating some operations to its facility in Miami. — A.S.

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