Secrets of Success: Commercial Real Estate and Construction
PDF of Secrets of Success Booklet from the Silicon Valley Business Journal Structures Issue
On August 13, 2012, the Silicon Valley/San Jose Business Journal sat down with industry leaders of top Silicon Valley companies to discuss the business climate, trends and forecasts in commercial real estate and construction. Below is the full transcript from that morning.
Panelists (in order above)
Dan Amend – President, Toeniskoetter Construction
Ralph Barnett – Executive Vice President and SBA Manager, Bridge Bank
Marjorie Goss – Chief Financial Officer & Treasurer, Cupertino Electric, Inc.
Philip A. Mahoney – Executive Vice President, Cornish & Carey Commercial
Marc Mizgorski – Chief Financial Officer, Hayward Lumber
John Sensiba – Managing Partner, Sensiba San Filippo LLP
James MacGregor – Publisher, Silicon Valley/San Jose Business Journal
Our opening question is for all you, and John, I’ll start with you on the answer.
Now that we’re well into the second half of the year, I’d like you to talk about how you think our year is going, and what you see as the outlook for 2013.
I think our year is going good. And when I say “our” year, I mean our clients, and what’s going on in the Bay Area. The media doesn’t seem to be quite as optimistic. But our clients are doing well. Manufacturing is doing well. Manufacturing drives a lot of what goes on in commercial real estate and occupancy. And Livermore is starting to go up, and Livermore kind of is a wave behind Silicon Valley and the Peninsula. So, as that wave continues to go out, and the Central Valley starts to heat up a little bit, that’s a good sign for all of us.
Bridge Bank has had a great year so far. We hit a high mark in terms of net income for the second quarter. Year-over-year loan growth is what’s driven that. We’ve seen about a 30-percent increase…We see positive signs all the way across the board, from our technology area to corporate banking to, you know, strong signs in residential and commercial real estate, as well; so we do expect those trends to continue.
We operate pretty much from the Monterey Peninsula down to Santa Barbara, so I’m really interested to hear more about the Bay Area, because we hear a lot of positive things.
The good news for us is we’re up, year-over-year. The bad news is it’s very sporadic; it’s very inconsistent. We have markets that are doing better than others. We clearly are – us and our customers – are not out of the woods, but we’re encouraged, since there’s clearly a lot more optimism. I think, with more consistent results, we’re going to feel a lot better. But it’s much better than its been in the past, so we’re encouraged by that.
For Cornish & Carey, it’s our best back-to-back years ever, including ’99, 2000. So I think that speaks sort of volumes for Silicon Valley and the greater Bay Area, ‘cause we’re not just a local firm, as you know.
So we’re seeing a very robust market for—from—our clients’ standpoint. 2011 is not repeatable. What happened there is just unprecedented. That said, 2012 has been very strong, and there are some announcements that I think your paper has already made that may have been a little early (laughter), that will continue the momentum, I think, on the growth in the valley, specifically.
We actually had a huge increase last year in our business. We’d had like a 68-percent increase in our revenue; and this year, we’re tracking at the same rate, so I consider that a very good start.
Backlog continues to build. Bookings are strong. We’re hiring selectively, so our clients are doing well. Things are hanging in there and so it’s, you know – obviously, it’s a benefit to us.
2012, very positive on both sides of our house. We have construction and real-estate development. Construction is growing by leaps and bounds, and is having our best year yet, and development has been solid. We bought a couple things. We’re going to sell a couple things, ‘cause we feel there’s a robust sales market right now for certain types of product. I’d love to see more leasing in the smaller world. I think, you know, Phil’s type of transactions have dominated the headlines, the big stuff.
Moderator: What do you mean “the smaller world”? In terms of 5,000 square feet?
Yeah, five to 50, zero to 50, you know, thousand [square feet], and really, “50” sounds like a big deal to me, too. I’d say 20,000 and below…you know, is kind of the bread and butter that we haven’t seen a lot of activity in.
Marjorie, you mentioned “selective hiring.” I’m curious to see how many people are hiring and what you’re finding in the marketplace.
Hard. Hard to find people, and very expensive, especially in our world. You know, we’re – we don’t have quite the highs and lows of…the tech world, but when tech is doing well, which it is now, it’s very hard to compete on a salary basis. We constantly are trying to hold onto people as, I’m sure, you are…You know, if they’re talented, they’re tough to hold onto.
We have done some selective hiring. You know, it’s really…to kind of go after some of this optimism that we’re seeing in our markets…We’ve had mixed results, but we’re continuing, you know, to the extent we think we’ve got opportunities to grow revenue in selected markets, we’re adding people.
And the same thing. We’re always looking for, you know, good people, and…it is difficult to find. I’d say we’ve probably seen about a 5-percent increase this year in airplanes, so we have expanded. We are looking to continue to expand.
Yes. We’re in much the same situation. It’s expensive. We’re looking to add quality people and, at the same time, our competitors are looking to add people, so our phones are ringing off the hook. I always tell people my job is selling; and, when the economy is down, I’m trying to bring new clients on board; and when the economy is up, I’m trying to bring talented people on board.
Next question for you, Ralph. You know, with a strong commercial real-estate market, there should be an increase in construction activity; but projects require financing, and that financing is tougher and tougher to get. Can you sort of expand on what your clients are experiencing in terms of the financing markets? And share some of the things that perhaps you’d be recommending to them?
Sure. And, you know, looking at the types of projects that are getting financed first, I mean, you can sort of break that down to probably three general areas. First, for that commercial estate, we’re very active in the owner-user market, which does tend to be the smaller-type projects; and, as a general rule, those are the $10-million-and-under type projects we see there. We’re really focusing in on underwriting, too, how well that business is doing that’s going to occupy that property.
Moderator: Is that more SBA-type stuff?
It tends to be more SBA, but we also do a lot of non-SBA owner-user, as well. So, again, the fundamentals are…different there than you see on the investment side, which is a different sector. On the investment side, most of the requests we’ve seen have, instead of being purchases, are really more refinancing. People taking advantage of the extremely-low interest-rate market we’re in right now, locking in five-, 10-year fixed rates. So that’s where demand has been there. Primarily what we’ve seen have been office and retail sector; and, again, the projects, $10 million and under.
And then the third area for us has been on the construction side, and that actually is broken down into three general areas. Again, owner-user on the commercial real estate, which has been very solid. And there, we’ve done and seen projects from special-use type projects, hotels, swim-school type things, to high demand for medical office buildings – we’ve been very active in that – to office buildings.
On the investment side, the demand has not been as strong yet. What we are seeing coming in…generally can be office, retail, with there’s a major anchor tenant in place; or it’s going to be some sort of mixed-use type project…We’ve seen more and more of those coming online, where it’s a mixture of commercial on the ground level, and then residential going in above that.
On the residential-construction side, we’ve been active in that for most of Bridge Bank’s history, and, you know, while we did see a tapering-off of that in terms of demand in 2009, 2010, we did see that come back in 2010. Smaller projects as a general rule, given our size, one to four units, primarily, and usually in higher-end communities. They’re usually speculative-type projects there. And that has been very strong for us, and we see that increasing quarter-over-quarter in terms of demand, as developers get back on track, and they get a comfort level that the market is stable and/or improving.
I want to hear from Dan and Phil on this. Dan, I know that your company is both a developer and a builder. If you look at the last couple of years, has the fact that you’re both been helpful, and when you hear Ralph talk about the types of projects that are getting financed, does that make you feel a little bit more optimistic?
Yes. The last couple years, in particular, having a construction—essentially an in-house construction group—[in addition] to our development operation has helped. It provides speed and flexibility. You know, starting in 2011, the markets came back a little bit; but in ’09 and ’10, the uncertainty that was in the general economy faced every tenant, and so the decision points ended up being at the eleventh hour; and usually, tenant-improvement construction then became the limiting factor of how do we get into this space. So being able to, you know, walk down the hall and interact with the construction team, so we could kind of make those decisions quickly, we were able to solve that problem.
And so, because that’s an opportunity for you, or has been an opportunity, would you expect to see more contractors become developers, and more developers become contractors?
Well, construction is a critical component of development; but, unless you’re, you know, really going to dedicate the resources to, you know, having a freestanding company that’s out there typically marketing independently and what not, I don’t see a lot of developers making that choice. There’s also, you know, an emotional difference between a typical contractor and a typical developer. (laughter)
That being said, if all the stories reported were true, I think Jay Paul formed a – he took some of the top executives from the group he was working with, and formed his own construction company to build out the last of the Moffett Towers. So others have obviously seen the synergies and think it can work.
So that’s a segue to you, Phil, because I know that you work with several major developers. The example of Jay Paul is a good one.
First, can you talk about the types of projects that you see on the horizon in the next 24 months? And then I want to come back to this idea of the developer being a contractor, and vice-versa.
The good news, I guess, from any fears of overbuilding, is that it is tough to finance large projects, single-tenant projects. The lenders’ memories do go back to ’07. They do go back to ’03, and other down cycles. So without a very strong entity like a Jay Paul, like a Sobrato, like a Peery-Arrillaga, that can basically build on their own balance sheet, you won’t see a lot of it, and the REITs are starting to come back and do some of that themselves, EOP (Equity Office Properties), for instance, but even they’ll go out for debt, certainly for construction debt.
So the debt portion? It’s never been cheaper, but it’s up there in some of the hardest times to actually acquire the sort of debt you want, especially on a speculative development, unless you’re in Palo Alto or Mountain View, or some of those rare-air markets. So I’m seeing a lot of Class A, and you’re also seeing rehabs of older R&D buildings,[where] they’ll take single-story 20s, 40s or 90s, like Four Corners did, and they’ll skin it and gut it and, you know, make it very new appeal. You know, they may bring it into the ‘90s in its look, from a ‘70s building; but it certainly has a client base, because not everyone is going into a gleaming new class A 400,000-foot campus. There are a lot that want a nice look. Want to be able to retain their employees and recruit new ones, but their margins maybe aren’t quite the same, or they don’t have quite the same image needs that some others have.
I know we have a couple of CFOs here, in Marc and Marjorie, and I know that subcontractors had it tough during the recession. And, Mark, you’ve talked about how it’s getting a little bit better, but it doesn’t sound like it’s great. And the example you gave, Marjorie, with enormous increases in revenue is pretty significant.
Can you talk a little bit about how you managed your business in the last couple of years? And were there some specific strategies that you would recommend to people? And, Marc, why don’t we start with you?
Sure. Well, obviously, all of our customers were significantly impacted. I mean we have a lot less customers today. We really broadened our focus
Moderator: “Less” because they’re gone? Or is it just because they’ve just cut so far back?
It’s both…I mean…it’s been cut back so far ‘cause, again, we’re mostly residential building, custom-home builders, so there’s less demand; and, you know, the better ones, the older ones, the ones that were more established, have survived.
What we needed to do, though, was really kind of broaden our focus, because there were—there clearly were—channels. There were clearly things that were happening in our market, so it really was more of the cash customer, the smaller job, or it was the large contractor who now was entertaining smaller jobs. So we had to get creative with credit, which, obviously, you know better than me. I mean there’s a lot of risks associated with that; and we’re trying to be there for the customers that, you know, strategically be there for customers that we really thought would be players when things turned around. So we got more creative. You know, knock on wood, that’s mostly worked to our advantage. There was a couple that didn’t.
And then really kind of the cash customer, the guy – I wouldn’t call him quite the “handyman,” but the smaller-job guys, you know, people who were doing remodel projects, but doing much-smaller projects. So we focused a lot on our cash customers, created different programs to really support and track those types of customers. Really better understand what their needs were, and market to them more directly. So that’s helped, really, kind of get us by, and really has built some loyalty with customers.
We found that we don’t want to change strategies depending on whether it’s an up or down cycle, because our customers have their certain expectation of what the experience of doing business with us is like. So a long time ago, the company settled on some core strategies that serve us very well.
For instance, Jean Ravizza founded the company 58 years ago, and I’ve heard a million times about how he talked about the golden rule, and that if you think about the golden rule as you’re doing business, it’s amazing how it will change the experience that your customer has, and your vendors have, also, and your employees have. So those are all our business partners, and so we try to treat them the way that we would like to be treated.
We also are very selective about who we business-partner with, so we’re selective about our customers. We’re selective about our vendors, and we’re selective about our employees. We want to make sure that we all share the same core values. And relationships are really important to us.
It’s important to us that we don’t have a relationship just while the project’s going on, but that we have, at the end of the project, we still have a relationship, and we will continue to have a relationship. And that’s been very key to our business, the repeat-business part of it.
We also have always been at the forefront of innovation. That was just a decision that was made by the company at the beginning, starting way back, you know, with the first chip factory. So we think it’s important for the kind of customers that we have in the valley, that we stay on the forefront of innovation. You know, we decided to be in the forefront on BIM (Building Information Modelling), for instance. It’s a very extensive BIM group, and look to, you know, sort of lead that effort when we’re involved.
And we have a culture of safety. So it isn’t just that, “Okay. You have to have a certain safety score in order to get on the job.” But our people know that we really do care about them, and we do record every single thing, and we do look at it, to make sure we understand what we could have done differently, because we want to send them home in the same condition that they came in. So those are the strategies that we have. Yes, of course you have to do cost control, but we think you have to do cost control all the time.
And I did notice that we did have to have more working capital in play during this time, because our customers needed us to give them that flexibility. So we did that. I will say that – Knock on wood! This is wood? – we’ve done very with that credit. We haven’t had to write off, you know, any bad debts of any kind, so we’ve been selective about our customers, too.
So John, Marc and Marjorie have shared a couple of strategies for success over the last couple of years. Can you talk about some of the recommendations that you’ve made to your clients?
Sure. In early or late 2008—early 2008 would have made us really smart, but in late 2008 (laughter)—we, we partnered with Tatum Financial Partners. The temporary CFO-type folks, and did a bit of a road show for clients and the community on how to manage into a downturn. We had no idea how deep that downturn was going to be. But it’s pretty fundamental stuff, and business owners who are maybe panicked a little bit, sometimes don’t remember the fundamentals.
And so we recommended that folks pay very close attention to the two things that could potentially sink them, and that is excess inventory and excess labor. The inventory thing is pretty easy to manage. It’s “Don’t order so much, burn it off, be careful about your buying. Buy for the job.”
The labor part of it is the more difficult part, because you’ve got people that have worked for you for a long time, and that was a difficult thing for many of our clients. So we helped them work through that. Tried to outplace people. But the reality is, a lot of people lost their jobs, and explaining to a business owner that “You can have 30 percent of your people lose their job, or you can hang on for another six months, and have 100 percent of them lose their job” is really the thing that got through to people, and helped them make the really difficult decisions. But that was very tough.
Moderator: And are those companies hiring back?
Moderator: Or are they slow to hire back because they don’t want to…be experiencing that again?
I don’t think anybody…is going to over-hire. A couple of generations of managers have had some pretty tough schooling over the last three years, so absolutely! People are hiring back, but they’re definitely hiring for quality.
This question is for all of you, and, Ralph, we’ll start with you here, but there was a story in The New York Times last week, and they ran a story about companies’ cutting back on hiring and investing because they are uncertain about the potential tax increases and spending cuts that are scheduled to go into effect the first of the year.
Is this an accurate reflection of what you’re hearing from your clients? And is the uncertainty something that is real? Or is it perceived? And is it something that you’re encouraging your clients to prepare for? And I want to hear from everybody on this, because I think it impacts everyone.
Ralph: The primary client that we work with is a small- to medium-size business owner; and, as a general rule, they tend to be optimistic in nature. And I think we are sort of seeing more of a focus on what is going on for them right now, and they’re starting to feel a little better in terms of the traction they’re receiving, and so we are seeing actually more requests for expansion going on right now.
Part of that might be related to the fact that there is some uncertainty related to the tax credits, and what is going to be changing at 12/31. So they may want to be trying to get that in now rather than waiting; but really, what we hear from our people is, right now is a good opportunity for them to either build, buy some new equipment, expand to a second location. And so that’s one of the reasons, I think, we’re seeing the demand we have on the loan side is that there is some renewed optimism out there, at least, again, in the markets that we are in.
The Bay Area is unique in some ways. Our unemployment rates are significantly lower than what we see nationwide. We’re seeing, you know, some reasonably good investments from the VC into the community here, and that’s sort of what drives our line of business.
I was going to say, so that uncertainty hasn’t specifically impacted decisions that we’re making, but, right, it’s just more broader in terms of how it impacts our customers, and the strength of the recovery for us in our market. So what we need – It’s true; because what we need is less uncertainty, not more, and so this is just another…event that’s out there that makes people skittish, delay investments in different projects – second homes, remodels, right? That uncertainty clearly doesn’t help us.
The larger customers, I think, have to look through a longer cycle; and, for them, they are as worried about, “If we don’t do this” – whatever “this” may be – “Google will.” Or, “If I don’t, Apple will.” So they have a little different competition.
On the smaller ones, you know, we’re seeing a little of the uncertainty creep into some of our markets, but it’s in that smaller range. It’s in that under-20,000-foot sort of companies, and almost all service companies, you know, whether they’re attorneys or accountants, or what-have-you. So that’s where we’re seeing more of the fear of “Hey, what’s coming in? I’ve got to be very careful not to over-hire.”
Less so in the tech, and especially in the start-ups. I mean they are gonna grow or die, so we’re not seeing as much of it there.
And I think the defense-industry people that are still in the valley, they’re feeling it, and they’re being a little cautious. But it’s the same thing. They have long-term contracts. I mean if you’re building a propeller for a sub, you don’t stop today because (laughter) because there’s gonna be a tax problem tomorrow.
Sure. I would say that right now our pipeline doesn’t reflect that there’s, you know, concern. On the other hand, I do know that there is a perceived concern out there, and the problem is that if it stays out there long enough to be perceived, it’s gonna become real, ‘cause that’s what happens. So we continue to watch it; but, at the moment, you know, constructions lags in many ways, so we’re not seeing it yet.
With the real-estate-development hat on, the only specific tax thing that we’re hearing is that, with potential changes in cap gains, influx of sales opportunities in the, you know, third and fourth quarter this year. We have some third-party-asset-management clients who have specifically approached us and said, “Go ahead and get it on the market, because, you know, that might be a 10-percent change to us next year personally.” So, you know, that’s a specific, to try and answer the question, you know, effect of (effective?) taxes.
You know, I’m not in anything where the spending cuts would specifically impact it. But the overall uncertainty in the marketplace, though, which is a little different than the tax question, most people I talk to in my business lunches, that’s the general answer, that very, very few, if any, have ever said, “Yeah. I’ve got a steady traction. I’m growing. Everything’s good. It all makes sense.” It’s, “We’re doing fine.” We’re actually – most people are actually—doing great, but no one feels great about it, and it’s kind of an interesting phenomenon.
So Dan brought up the tax implications, and I’d like to hear from you, John, in terms of what, as we sit here, in the middle of August, what types of things you’re recommending to your clients as they prepare for some of these changes that may or may not happen, come the end of the year.
Well, one of the things that we told people four years ago was that the world may end, or something else might happen. (laughter) If you plan on the world ending, and something else happens, you’re probably going to be in trouble; so let’s plan on the world not ending. And it is a very short-term view to focus only on what’s going to happen at the end of this year. But there are plenty of opportunities, so with historically-low interest rates, and some depreciation and accelerated-depreciation provisions going away at the end of this year maybe – they’re scheduled to go away – we are encouraging people, if it makes business sense, and the timing can be managed, to place assets in service prior to December 31st.
Moderator: “Place assets in service.” So what is that?
So if you’re going to buy a large piece of equipment, get it, and have it in service, so that it’s eligible for either the 50-percent bonus depreciation, or a higher expensing election. Just buying it by the end of the year doesn’t get it done. It has to actually be in service. So that means if you’re going to have a big purchase, you better start – you better be thinking about it already, and negotiating a price, so that you can take delivery and get it in service by the end of the year.
Then, of course, on the personal side, the $5 million exemption for estate taxes. There’s a lot of anxiety and uncertainty around this. As a matter of fact, if people don’t have that in place right now, if you’re not already getting your valuations to be able to do some discounted gifting, family transfers, you’re probably not going to find somebody to do the work between now and December 31st. Those guys are going off the charts. So those are the big considerations for people who have significant assets either invested in real estate, or in their closely-held corporations, transferring that wealth to the next generation is a huge issue.
Moderator: So tax-concern slowdowns [are] creating a ramp-up.
Moderator: Buy those airplanes before the end of the year.
John: That’s right! (laughter)
So Phil, Dan, Marc, and Marjorie, this question is for you, and Phil, we’re going to start with you. In many industries, there has been a tremendous amount of consolidation in the last couple of years. There’s been some in, you know, with contractors and subcontractors and certainly in commercial real estate. I’m interested to hear how consolidation has impacted your industry and your clients.
In the industry, few have had the consolidation that we have had. It’s been huge, and I think a lot of that is based on both the cost-structure side as well as the performance side for your clients. So, on the cost-structure side, it’s very hard to stay in the IT race. In our industry, if you’ve got, you know, 40 or 50 brokers in two offices or something, you have no buying power. It’s very hard to do that – and it’s not just IT; it’s health costs, it’s everything – versus, you know, having 4,000 or 5,000 employees in multiple offices. So, on that, the smaller groups don’t get the economy of scale.
On the service side, it’s harder because the clients increasingly want global service. It’s not just Silicon Valley, although they want the best of both worlds. They want the best local expertise, but they also want to have a cost-advantaged approach on a global basis. So that’s what we’ve seen – a tremendous amount of consolidation and partnering, as we have with Newmark [Grubb] Knight Frank, and seeing Grubb & Ellis go down. That was as much due to them becoming a property owner, but, nevertheless, they were, in their core business, also having some troubles, as well, given competition. So we’re certainly seeing it.
As to our clients, no question. I mean look at the consolidation that HP has gone through. And it has strange ramifications. They over-consolidated in Cupertino, and that’s why they ended up in Moffett Towers, because they actually needed more space when they sold everything. I think you’re seeing that with Motorola, the announcements today. And, again, I’m just thinking of another local example might be Atmel, who is off-shoring their—a lot of their—manufacturing needs. And so they very much need to stay here to be cutting-edge from a technology standpoint and engineering standpoint. They just didn’t need, perhaps, the manufacturing floor and test floors that they once had, so they consolidated out of 300,000 feet in San Jose into a very different building at the airport, into 200,000, which is reflective of their changing employee makeup.
Marc, Marjorie, I want to hear from you, because I know, in your business, especially in the subcontractor business, as you’ve already mentioned, several folks have gone away, and how has that consolidation impacted your business? Has that opened up some opportunities for both of you?
I can’t think of any way that it’s been a serious impact to us. We’ve had some vendors who have consolidated, but it’s more of a roll-up effect at the moment, so it’s just been I have a new parent.
They have a new parent. So our experience with them isn’t changing. Maybe their cost structure is a little more efficient, so maybe we can expect a little-better pricing; but it hasn’t really changed our relationship with them.
And customer-wise,…you know, we have been – we are very selective about who we do business with, so it hasn’t had a lot of an impact there. So I really – I can’t see that it’s had much of an impact on our business.
Yeah. And I would say that, from our perspective, the consolidation has come from just there being fewer players, not from kind of a dominant player going and acquiring. We have seen some interesting things, though, where suppliers have become competitors, because they were over-extended with certain customers, and took on the operation to try to recover some of their debt.
We had an opportunity where we, with one of our – It wasn’t a window manufacturer of ours, but it was a business up here in the Bay Area, and so we took on new distribution. The manufacturer approached us in terms of the opportunity, that their dealer wasn’t cutting it, and so that was an opportunity for us to align with this manufacturer and to not take over, but become a new dealer. So weak — weaker players have dropped out, and it’s kind of created a vacuum. But, again, we’re struggling through some of the structure of that company, and see what struggles they were having, and trying to get that business model right, so we finish on the right side of that deal.
Dan: Construction’s been a really interesting one to watch, because it was highly anticipated that generals and subs were gonna just fail left and right, and they didn’t.
Moderator: Why not?
Well, I think what, you know, digging into it a little bit, it looks like that, you know, if you had 50 employees, maybe you only had 10, but you were still in business; and it was still the principal, and we had subcontractors who were not insignificant companies, and you’d see the principal on the job doing the work in 2009 and 2010, which, you know, I’d go out to my job sites, and I’d look at them, and say, “Okay! We’re going through a downside right now.” But they didn’t go out of business, and so, you know, only a small handful actually went out.
But – and I really haven’t seen anything in terms of, you know, Cupertino acquiring five small [companies], you know – There wasn’t that kind of stuff going on, either; so just I think everyone — The labor was the critical component. They were this big before. Now they’re this big now. That, actually, I think, impacted 2011. When things started heating up again, no one had the staff that they needed to. So if you were going after key subs to do certain work, it was tough to – you know, they got…over-extended very quickly, and would have to say no, which, you know, that was, I think, the result of not in time.
I want to follow up on this, because I know John has mentioned this. I know it’s happening in banking and financial services. It seems you either have to be, to Phil’s comment, a big player with lots of IT, or you’re very, very “niche,” and I know that Chuck Toeniskoetter, his line has always been, he didn’t want to do a project that was more than 80 miles away, or 100 miles.
But in the marketplace that we’re in, and I do want to talk about where some of those opportunities are, but it just seems to me like you either have to have a whole lot of scale, with the ability to do a lot of different things, or you have to be very niche. And everybody in the middle, it gets pretty squishy. Is that accurate?
I would say so. We’re seeing that in the client bases, where people are saying “I’m focused on X,” means “I’m no longer accepting Y.” You have to take a risk. And people who take that risk tend to be more successful.
I’d say that that’s correct. I mean we see that with our clients, partially because that’s how we do our sales. I mean Bridge Bank is a business bank. We don’t view ourselves as a community bank. We’re definitely not a large megabank, and so we can’t be all things to all people,; and so we try and, you know, partner up with the business, and that includes on the development side, as well, and we are very selective about who we work with. You know, we didn’t see a major restructure in how we underwrite deals as a result of the downturn. We always stuck pretty much to the fundamentals.
As it was, we know and we deal with an experienced developer. They have a good contractor in tow. They have good equity in the project, and the project makes sense. We try not to fall in love with our projects. We want to make sure that it’s economically viable, and so we try and work with them and advise them on that, but we are very selective about who we work with on it, and, you know, if somebody wants to come in.
You mentioned earlier about that developer that wants to become a contractor. We do have some very successful companies we work with that do that. I would be a little reluctant to be probably the first one out of the box with them, though, because it takes a while to handle either one very well, and it’s – you know, they are different skillsets in there. And so we are very selective about who we work with, and it’s a lot of repeat business with the same developers, or people that can demonstrate that they have the skillset to do what it is we’re looking for on a construction project.
Speaking of construction and green building, it seems that “green” construction and “green” building gets a lot of attention. But the reality is, is that the actual viability of those projects often require some government support, and if you’re going to build a green building, and try and have tenants in it, it often comes with a higher price tag. John, if you could talk a little bit about some of the tax incentives for green building and green construction, kind of where those are?
Sure. Well, they come and go, based on what’s popular in Washington. But right now, section 179D encourages energy efficiency, and you get accelerated depreciation for having efficient lighting, efficient HVAC, or what they call “the envelope” of the building. So that applies to improvements to buildings.
We’ve got a large client down in the Morgan Hill area that did some improvement in lighting in a large facility, and it was a very good tax move on their part, and it was economically a good move. I think they would have done it even without the tax incentive, but that certainly helped. And you can do it for a new building, a well, so that’s an incentive to be “green,” and I think it has changed some projects from un-fundable to fundable, based on the tax benefits for the energy that was due in the building.
The cash-in-lieu, 1603, was a big deal up until the expiration about a year and a half ago, and this is a rather uninformed opinion, but just in the reading that I do regarding green building, that’s starting to switch. I don’t know that there does need to be as much government encouragement. I think the economics are starting to make sense so that people can pass on lower costs to their tenants, and have a more-efficient building, and it’s a good marketing point for landlords trying to rent buildings. So there are less incentives than there used to be. I think there will be more coming, but I don’t think they’re going to be required as much in the future as they have been in the past.
I want to hear from Phil and Dan on that, because if you have a building that is “green,” and you have to pass those costs along, is that important for a tenant? Does it matter?
It’s a discussion point, but most—again, most—of the larger ones, the household names, they envision [themselves] as being ahead of that curve, and the building is sort of behind where they want to be. You do run into existing building, EB, versus LEED, ground up, but it’s also becoming required.
You’re not going to build a new office building, certainly in Sunnyvale, Mountain View, Palo Alto, probably now, Santa Clara, that isn’t LEED Gold. A, you’re going to be required to do it, and B, the market is going to require you to do it, because your competitors will. And the difference between Certified Silver and Gold is not that great, and there are real cost savings to the tenant over time, and these are long-term leases, so it does make sense.
Where you make the leap, like someone down here, Adobe, has done, from Gold to Platinum, that’s a different discussion, and that’s a longer payback, and that’s really up to the tenant. That’s not being required by the governments, and I hope it doesn’t, because that could really work in reverse, I’m afraid. So we’re seeing some of that, but not a lot of it.
Yeah. Phil makes a great point. The difference between existing building and new construction is significant, because when you go to new construction, just Title 24 in California gets you almost to LEED Certified. So, you know, the step-ups to get to Silver and Gold, you have to do some things, but if you plan them on the front end, there isn’t a significant cost impact.
And if you’re someone in this marketplace, where there’s still a huge discrepancy between 10 minutes on 101 to North San Jose, up to where, you know, the rents are 3X, you know. Well, if you’re going to make the – You know, there’s obviously a market dynamic there that’s gonna justify going to a LEED Gold building, ‘cause those types of tenants want that.
If you’re taking an existing building in North San Jose right now, and saying, “I need to go remodel it. Do I care whether it’s LEED Gold or LEED-Certifiable or not?” We’re seeing it’s more the — If a landlord is doing it, it’s not to their benefit, ‘cause the savings they’re providing in a typical triple-net-lease scenario is for the tenant down the road. So there’s a little bit of a market – There’s a marketing side to it, so you’d have to really believe, “I’m going to get that better tenant, or I’m going to get something better because of it.”
Or it’s a tenant’s corporate philosophy-driven. That’s what we’ve seen on the construction side. It’s the law firm that says, “My Seattle office is Platinum. I’ve got to be Gold here, or else, you know, at a minimum. In fact, really, let’s see if we can get it Platinum.” And that becomes a corporate-mandate-, corporate-philosophy-type thing. Yet, really, unless it’s corporate –owned real estate like Adobe, and I’ve talked with those folks, and they — You know, they saw a good payback on all the green investment they did there, because they’re covering all the operating costs. It’s a little different when it’s a landlord.
I’ll speak a little bit to that, as well, because – on a couple different fronts. On the owner-user commercial real-estate side, we do see them gravitating towards that for the reasons that you mentioned in terms of long-term savings. The government does have a program to encourage that type of financing; and, again, that’s on the owner-user commercial real-estate side.
But on the residential side, interestingly, most of our developers have not seen a significant value, either from a marketing perspective, or translating to increased market value as a result of having a green-built house, so to speak. But I do agree with John that this is something that’s going to become more sustainable. We actually—the bank actually—started an EIG, emerging infrastructure group, to focus in on lending on these construction projects where they’re really devoted towards putting that green infrastructure in place; but that, in its turn, then the power is then sold off to the utility companies. And so that’s a different model that we are seeing there, where those are vital projects even when the subsidies are removed from the picture.
Moderator: So you’re financing the zero-down leases for solar?
Not so much on the residential-type side. This is more on the commercial side, so they tend to be larger projects. They’re not large enough to attract the very large (unintelligible). Again, down to “selective,” in terms of which niches can we play in. But these are in the, you know, $10 million-and-under projects, which don’t attract the big boys out there. And there has been a shortage of financing things on that.
I want to talk about the Bay Area market, and the “Bay Area market” means different things to different people on different days. And Phil’s talked about certain markets like, you know, Mountain View and Palo Alto. You’ve talked about North San Jose. We had a conversation before we started about the high-rise projects up in San Francisco. You’ve talked a little bit about the East Bay.
I’d like to hear from each of you, as you look at the Bay Area economy, and the fact that there are so many micro markets in that, where do you think the growth will be, especially when you see, in a market like a Palo Alto or a Mountain View, that is just so much more expensive than coming 10 minutes down the road? And I’d be interested to hear, for your business, and then for your clients, what you would be recommending to them in terms of site location and where they should be, all based on what’s happening in the market? John, why don’t we start with you?
It’s heavily dependent on where your resources are. So if you need intellectual capital, you’ve got to look and see where that is. People don’t want to drive an hour.
Back to the Golden Rule, which I absolutely love. We run our business the same way. You treat other people the way you want to be treated. I don’t want to sign a bunch of people up to be driving from Tracy to come here, right? So if you’ve got a labor pool in Tracy, then you ought to be looking to build a facility out there.
In terms of opportunity, the Peninsula is becoming cost-prohibitive to all but the very best-financed companies with the highest margins, so the 880 corridor is ripe for redevelopment, from San Jose all the way up to Oakland. It’s closer to, maybe, that labor pool, the skilled-labor pool. Land is still relatively cheap. Costs are down. So I see that as a real opportunity, especially for manufacturing.
In terms of our business, what a great place to be in business! We’re in the Bay Area, and I think our growth potential is unlimited. We aren’t currently in San Francisco or Oakland, two major cities, so that’s our next frontier; but, you know, you don’t need to leave the Bay Area to build a really big professional-services firm.
It just depends, too, you know, what’s your time horizon would determine growth. Is it three to five years? Is it five to ten? So some of that changes. I think, in the intellectual-capital-driven growth, you’re going to see a surprising number of infill projects continue to just squeeze what they can, get the coverage they can.
Jay Paul’s new Moffett Place project is a good example of that, taking 30-odd acres of 1970 sort of buildings. Plowing them under, and putting something in Sunnyvale. Just in physical constraints, though, it is spilling into Santa Clara and into North San Jose, which has the space, if you will, the land, to actually absorb it; but, again, at higher densities, it’s got to be smart growth, etc.
You know, long-term, having done this for 30 years, you keep hearing about how Coyote Valley is going to be – And it just – it just doesn’t happen, and it depends on your business. I mean Fremont’s growth is a different margin business, as a rule, than that in Sunnyvale. And so with 16 major industries in the valley, you can’t say one size fits all. So it really does depend on the industry that’s driving it, and that will help on the location, and, thereby, the opportunities.
Definitely agree. This time, on terms of the – it’s going to be different, based on what the needs are for each user. But if I had to pick a specific trend of what we are seeing in terms of some of the requests that are coming in, I think a lot of it, a lot of demand coming in towards good transit corridors. We’re seeing that definitely coming down the Peninsula, coming up through Palo Alto, Menlo Park. People enjoy being – They don’t mind being in a smaller place, and so we’re seeing a little more demand for that. So a little higher-density, a lot more mixed-use-type projects coming online.
Moderator: Is that all over the Bay Area?
Most of our lending, we lend primarily Santa Clara County, San Mateo County, and so I’d have to speak primarily to that. On the owner-user side, it’s a little different story. There, they’re looking at a lot of things in terms of freeway access, access to people. As John mentioned, where are my employees located. But on the new-development side, it tends to be more driven by some of the current trends, and that might be shorter-term in nature, but I do think that’s going to eventually translate over to longer-term-type prospects in terms of how people are going to be locating themselves, both business-wise, in terms of their business, as well as where they want to live.
And, Marjorie, if you’ve grown by almost 70 percent in each of the last two years, that’s pretty impressive, and that growth has come from high-rise building in San Francisco? Or is it more north? Is it more south?
No. A lot of it came from the PV, the solar, ‘cause there’s a lot of activity there, and we’ve done a lot of work for PG&E, and we’ll continue to. We have projects all across the country. Data-center work up in the Washington area. Data-center work back East. It’s across a lot of different areas and industries.
All based on where you are, and where the opportunities are for your business, are there certain segments, are there certain pockets, are there certain areas that you think offer more of an opportunity for you?
You know, we’re fortunate to have two markets, Santa Barbara and the Monterey Peninsula. So those markets have been hit very hard; but, you know, obviously, we’re optimistic that they’re continuing to rebound. I think the next market – We’re in San Luis Obispo, San Luis Obispo County – that is, you know, San Luis, or Santa Maria is more affordable than San Luis.
The issue, though, is their economies, and how quickly their economies are going to rebound. So, you know, in terms of San Luis County north, we see a lot of opportunity there, in that market, right? It’s got the university. It’s got a lot of demand. There’s a lot of agriculture in terms of grape production.
I think technological innovation is going to have an impact in the next 12 months. It’s changing the way we do things very rapidly. There’s a much- higher expectation for collaboration on projects, and, with the BIM, especially, that has changed the entire way that we collaborate.
I think the social-media concepts will end up being applied to integrated project delivery, so that you get a collaboration platform that’s far more effective. I’m waiting for somebody to do that. So I’m going to say it here. Anybody out there?
And then I think also we’re getting more data, and, you know, you have to be a data-driven business in many ways. So there’s more data, but then you need the tools to be able to manage that data and turn it into information. So I see technology is something that’s going to be changing things.
I think, not unlike recoveries of the past, that the trend that we will watch most closely is the Nasdaq and the IPO, you know. As long as the Nasdaq stays solidly ahead of 3,000, as long as we have a couple of IPOs that matter a month, the rest will take care of itself. All of our industries will do just fine, whether it’s a second home, whether it’s, you know, a data center. They’ll all do just fine. Your circulation will go up. It will all be good! (laughter)
If…we go back into that black hole of ’08, when there were no IPOs, or very few, that’s a different model for us, and,…given our cost structure, we need that secret sauce.
You know, for us, in our market, it trickles down, right? So I would agree with what Phil is saying. So as long as that’s moving in the right direction, you know, we’re more optimistic about where our business is going. We think there will be technology as it relates to how homes are built, and we think that that will accelerate. We’re going to build – You know, building science continues to evolve, and we’re going to continue to watch that, and help our customers be on the forefront of that.
Being a banker, it’s all about the money, and the cost of the money; and so there’s actually two different things that, you know, that, I think, bear watching. One of them is going to be the capital-allocation rules that go into play, especially as it relates to construction and land loans.
What the regulators have proposed, and is in place to go into effect, is a significant increase in how much capital needs to be allocated towards a construction or land project, and it will probably increase our costs 30 to 50 percent. So one of two things [is] going to happen there. You’re going to see either lenders making a decision to not get in there because it’s too economically prohibitive, or those costs are passed along to the borrower. And, you know, so one of those two things [is] going to happen there.
Moderator: How much is the percentage supposed to increase? Is that uncertain?
No, I think that…depends a little bit on the types of projects, but we’re probably looking at about a 40- to 50-percent increase in terms of how much capital needs apply. I understand one of the large megabanks out there – let’s say that right now, they’re forecasting they’re at an 11-percent capital ratio right now, with their lines of business. It will drop it down to an 8-percent capital. A significant difference. And so they’re going to just make decisions not to be in that market any longer; or, again, pass that cost along.
The other one that definitely bears watching: We’re in an extremely low interest-rate environment right now, which impacts everything from the affordability factor on the residential side to…something as simple as, let’s say, the cap rates which drive on the commercial real-estate side. And so if interest rates go up—you know, long-term rates go up—by 1 1/2 percent, let’s say, you know, from, let’s say, you know, 4 percent to 5 ½ percent, a typical let’s say $5 million building is probably going to lose about 15 to 20 percent of its value. Nothing has changed in terms of the tenant mix in that building, the costs, anything along those lines. The cash flow is all the same. What happens, though, is the marketplace all of a sudden says, “This thing is now worth $800,000 less on that $5 million building.” So that’s something else that needs bear watching.
Moderator: John, last word to you.
Well, in our industry, in CPA professions, there will be unprecedented consolidation over the next five to ten years. Competition is healthy, and I’m concerned that, with fewer firms, our profession could repeat some of its past mistakes. Particularly here in Silicon Valley, where the competition for technology audits is such that people do them below cost for the hope of taking them public, and cashing the big checks, as they take them through the public process, so that they lose their independence related to the attest service. And our business is to serve the public trust, both in tax preparation and financial-statement attestation, and I’m concerned that, through that consolidation, and through the lowering of a number of competitive firms, that we could go down the wrong path. Hopefully, we won’t; but consolidation is the key.
Consolidation is the key. Appreciate your time this morning. Thanks, everybody! It was great!