Unless you have been stranded on a desert island lately, you are no doubt aware of theturmoil that has been created in the residential real estate market by the relatively large numbers of nonprime mortgages that have defaulted over the past year. The difficulties have impacted home loan borrowers, lending institutions, investors in subprime mortgage securities, and the various financial markets themselves. But what has remained largely untouched todate has been commercial real estate. Even with the recent announcement that the deal to buy Carl Berg’s $1.8 billion Mission West Properties’ portfolio of commercial real estate had fallen through due to the inability of the prospective buyer to secure financing, the commercial real estate market remains strong and largely untroubled.

“Thus far, the fallout from the subprime residential loan crisis appears to have had a limited effect on the local commercial real estate market,” said Edwin K.S. Ryu, principal and co-founder of Legacy Wealth Advisors, LLC, a San Jose-based investment advisory and wealth management firm.

Underpinnings Still Strong

In examining the commercial real estate market, virtually every pillar supporting the industry in Silicon Valley remains solid.

• Recent earnings reports by Silicon Valley leaders such as Cisco Systems and Apple have been almost uniformly positive.
• Unemployment rates in the Valley have been trending steadily downward, even as job creation rates have been rising.
• The conversion of older R&D and industrial space into residential space in large areas of the Valley coupled with comparatively little new construction the past few years has resulted in a shrinking supply of commercial space.

Increasing demand in the face of a decreasing supply has led to significant declines in commercial real estate vacancy rates in Silicon Valley, according to a Grubb & Ellis report. Vacancy rates for the Valley as a whole have broken through the 10 percent threshold for the first time in several years, spurring the construction of new office space. In the meantime, according to the same Grubb & Ellis report, lease rates for premium Class A commercial space rose nearly 6 percent in the most recent quarter, while lease rates for Class B space have increased approximately 3 percent.

Clearly, this is not the case for residential property, where recent defaults have driven home prices considerably lower, and reduced loan availability as lenders try to increase liquidity as quickly as possible.

What It All Means

While taking a wait-and-see approach or making low offers on desired properties may be a viable approach in the current residential real estate market, it is not likely to be a successful strategy in commercial real estate in Silicon Valley, according to Ryu—who was recently selected as one of the top 150 financial advisors to doctors in the nation by Medical Economics magazine.

“Value comes from scarcity, and there is only so much commercial real estate available here in Silicon Valley, perhaps the choicest place in the world to do business,” Ryu remarked. “There will continue to be cycles, which we need to understand and respect. But in the long run, I view the overall market as a bullish one.”

For further details or to review the latest commercial real estate information, contact Borelli Investment Company at (408) 453-4700, or e-mail info@borelli.com.

Silicon Valley Commercial Real Estate Market at a Glance

• 5.67 – 6.76 million sq. ft.: range of 2006 qrtly. gross absorption ¹
• 5.71 million sq. ft.: 1st qtr. 2007 gross absorption ¹
• $2.2 billion of venture capital invested in 1st qtr. 2007 ²
• 21,500 new jobs added in 12 mos. ended 3/30/07 ¹
• 4.4% unemployment rate in 3/07, down from 4.6% in 2/07 ¹
• .03% delinquency on comml. real estate loans, lowest in 5 yrs.³
• Less than 10% vacancy rate on comml. real estate⁴
• 6% increase in rental rates on Class A office space⁴
• 3% increase in rental rates on Class B office space⁴

Sources
1 Colliers International 2007 1st Quarter Report
2 Dow Jones Venture Capital
3 California Mortgage Banker Association
4 Grubb & Ellis