Publication Date: Wednesday, February 16, 2005
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(February 16, 2005) Vacancies still abundant, but rental rates have stabilized
by Jocelyn Dong
From the deck outside her rooftop office in downtown Palo Alto, white Christmas lights still wrapped around the railing, Anne Marie McGraw pointed out a sign posted on a tan building below.
"It's everywhere," she said.
"It" is office vacancy, and the sign -- a red and white "for lease" placard -- is one of a dozen hanging in windows and slapped onto the sides of buildings in the blocks surrounding McGraw's Hamilton Avenue office.
The signs are hard to escape -- not only in the University Avenue district, but also in the commercial areas by the Baylands and in south Palo Alto. It's enough to give the impression that Palo Alto's thriving boomtown has become a ghost town -- and that property owners are getting more desperate.
Months before, McGraw had been out there, scouting out signs and calling up real-estate brokers to view properties in a market awash in space. In August, McGraw launched a consulting firm, Opus Environmental, and was eager to find an office that would lend her business the appropriate "legitimacy," she said.
Despite the office glut, it took awhile for the entrepreneur to find the right fit for her startup. Spaces were too big, too small, too run-down -- or, even in these post-bust times, too expensive.
In mid-December, she finally came across the fourth floor of 167 Hamilton Ave., a funky space painted baby yellow with a front door that is essentially the elevator. Liking what she saw, McGraw promptly moved her company in, along with several employees and a 3-year-old Boxer, Duke.
"We were looking for something a little bit more unconventional. This was the perfect space for us," she said last week, as sunlight shone through the large windows and Duke chased a bird out on the deck.
Palo Alto's economic recovery is depends on people like McGraw. With every lease that's signed, the city's grindingly slow economic recovery seems to move one more notch forward.
At the end of 2004, the city's office vacancy rate hovered between 11.4 and 15.7 percent, depending on which brokerage firm crunched the numbers. That's more than the boom days, when less than 2 percent of the city's offices lay vacant, but a significant improvement from the beginning of 2003, when more than 20 percent of the city's office space was empty.
Asking rates have apparently stabilized. The heady $12 per square foot reported in 2000 didn't last long, but even two years ago property owners still had the temerity to ask $4 or more. Now the averages run more toward the $2-$3 range, depending on the services provided, according to reports from Cornish and Carey and BT Commercial.
One segment of the market even appears to be rebounding. Class A office spaces -- generally the highest quality, best-equipped and most desirably located -- are commanding slightly higher rents than before, according to Mike Cobb of Colliers International.
As positive as these signs are, the long haul to get here had its casualties. The companies that didn't fold either hunkered down or fled.
Ellen Lehman, a partner of Artefact Design, a graphic design and communications company, took her business last year and ran to Menlo Park.
Artefact had operated out of a downtown Palo Alto loft since 1994, after Lehman and her colleagues chose the spot to be close to Stanford, where many of their clients were located.
"We were very happy there," she recalled recently, chatting on the phone from her new digs on Chestnut Avenue. Then the boom hit, and the rent started going through the roof.
"At one time, we were paying four times what we originally paid" for the 2,200-square-foot space, she said. "It got to be a strain. We began thinking about whether we could stay, (and) honestly, we didn't feel we could."
Because many of their clients are nonprofit organizations, charging more didn't make sense, she said.
After 10 years in downtown, the search was on. Lehman and partner Paula Murray looked in south Palo Alto and California Avenue, hoping to stay in the city.
"Even with so much space for lease, it seemed odd for us, last spring, that landlords were not negotiating too far. Our landlord felt he could get $3 per square foot," Lehman said.
Following that discouraging hunt, Lehman and Murray turned their sights beyond city limits -- and wound up with space a mile away in Menlo Park, renting for about $2 per square foot.
"We're paying less than what we were paying in 1994," Lehman said. There are things she misses about downtown Palo Alto -- she still exercises at Reach Fitness on High Street -- but for her, the bottom line was all that mattered.
"Economics trumped convenience," she said.
Like survivors of a cataclysm, other companies appear to be picking themselves up and dusting themselves off.
Sensing fairer weather ahead, venture capital firm Allegis Capital is moving to new quarters this spring. Their game plan: an upgraded work environment, suitable for a new round of fundraising planned for later this year.
Though they could have renovated their current Hamilton Avenue office -- where they've been since 2001, when rents were 20 percent higher -- they decided to seek other options.
They naturally cast their gaze on the Mecca of venture capital, Sand Hill Road, but asking rates there still stand at $5-$6 a square foot, said Allegis CFO Shirley Wong.
When their broker showed them 130 Lytton Avenue, a building formerly occupied by Compaq Computers, they found an acceptable deal.
The clincher: tenant-improvement dollars.
"They were willing to negotiate," Wong said of the Lytton property owners. The new space will be slightly smaller than Allegis' current property, but they'll still command 6,000 square feet for 14 employees.
The renovations will include a new lobby in the currently vacant 25-year-old building, along with restrooms and seismic upgrades, according to Roger Fields of Cornish and Carey.
"We did receive very good terms, which all Palo Alto office spaces didn't (offer)," said Wong.
They anticipate moving in April, as the building's first tenant.
"We are definitely feeling more enthusiastic this year than last," Wong said. "We have a couple of companies doing very well and are very optimistic. We cannot forecast if this will continue, but for us to sign a five-year lease, we feel we'll be in business for five years."
That's the kind of optimism that seems to be turning the market around, despite indications that the valley is in the midst of a jobless recovery.
"Everyone's concerned about having enough space. In the past few years, people were concerned about having too much space," said Howie Dallmar, executive vice president with Cornish and Carey.
Chop Keenan, one of the kingpins of downtown real estate, said the recovery is being led by the traditional mix of businesses: venture capital, law firms and accounts.
"We have one tenant who does nothing but job searches for lawyers. They're busy," Keenan said.
Other brokers are seeing clients take risks again.
"CEOs are going into startups again. They're secure," said David Dove of BT Commercial. They're willing to "roll the dice," he added, believing that they won't be risking their homes if they do.
Not all of Palo Alto office space is coming back to life, however.
At the end of Embarcadero Road, the office buildings are so empty, a paper plane can sail down a row of cubicles and not hit a single soul. About 30 percent of the buildings larger than 5,000 square feet were vacant at the end of December, according to a Cornish and Carey report.
The continued stagnation is not a surprise, given that the class B and C buildings there have always been a soft market, according to Dallmar. The Bayshore area may offer the Palo Alto address, but cities to the north and south offer better values.
South Palo Alto -- excluding California Avenue, which has a vacancy rate of about 7 percent due to its limited number of properties -- is also a challenge these days.
"I've got 7,000 square feet in south Palo Alto I can't get any offer on. I might break it up into smaller spaces," said Roxy Rapp, another Palo Alto real-estate kingpin.
The Stanford Research Park -- which has nearly 3 million square feet of office space, compared with downtown's 2.4 million and Bayshore's 2.2 million -- is doing relatively well, thanks again to law firms and other professional services. Its vacancy rate was 8.9 percent at the end of last year.
The economic recovery is good news, and not just for property owners who've wondered when the lean times would end, but also for the city's gasping retail sector.
Office space and retail have always had a symbiotic relationship, said Susan Arpan, manager of economic resources planning for the city. With employees come spending dollars. She cited the entry of businesses like A9.com, a subsidiary of Amazon.com, into the downtown market as cause for celebration.
Keenan likewise noted the effect the recovery of the office sector has had on retail.
"You can see it in the vibrancy of the restaurants. Things have picked up significantly from two years ago. Last year was a slow climb out," Keenan said.
The restaurants and other amenities were precisely what drew McGraw to downtown. She wanted to enjoy the dining and after-work life.
McGraw's Opus may be one of those small businesses that are perking up the local economy, but reminders of the bust still hover close by. Two of floors in her building are empty.
These days, McGraw doesn't have much to worry about office space, aside from talking with people who pop up to her floor, looking for information on the empty office spaces below. Instead, she worries about the routine responsibilities of running her business -- such as finding parking for her clients.
She recently hosted a training session and had to schedule time for people to move their cars. From the vantage point of the rooftop deck, she can scan the surrounding streets for available parking spaces.
"Go move your car down to the coral zone," the entrepreneur told them, laughing.
Senior Staff Writer can be reached at jdong@paweekly.com.
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