The “under-demanded” office market | wolf street

“There is almost no liquidity in the office market. No one knows where the prices will be when one of these towers finally sells out.

By John E. McNellis, director at a real estate developer McNellis Partnersfor WOLF STREET:

The swallows abandoned San Juan Capistrano in the 1990s. Their home – the historic mission – underwent a renovation, the birds lost their ancestral nests and, despite all efforts to attract them, they have yet to return in significant numbers. .

No less fickle, the workers abandoned their office buildings in 2020. They too migrated elsewhere. Real estate players wonder when office workers will return. Others wonder if they will come back. Let’s come back to this existential question in a moment.

CBRE has just published the results for the 2nd quarter of the San Francisco office market. Nearly 29% of the city’s office space, or approximately 25 million square feet, is now available. Vacancies increased by 362,000 square feet in Q2 and approximately 550,000 square feet of new office space will soon come online. In short, the vacancy rate climbs to a cloud-obscured peak. One industry executive observed wryly, “We’re not overloaded, we’re under-demanded.”

Returning this data, 71% of the buildings in the city are rented. Unfortunately, this figure is somewhat misleading. In these covid times, a building’s occupancy rate is a far more critical metric than its rental rate. Kastle Systems, a workplace security company that requires office workers to swipe entry cards, provides accurate occupancy data. As of this writing, San Francisco’s overall occupancy rate (workers who actually show up) is 39%.

A building that’s 39% occupied can have a happy ending, but like falling in love with someone with a sick heart, you might find yourself praying in the ER before it’s all over. Meanwhile, with all but the swankiest buildings — say, Sales Force Tower — rents are plummeting, tech is down 24% on the NASDAQ, and workers are shedding like winter coats in Miami.

None of this is new to the big names in the office world – its main owners, lenders and brokers. In fact, the biggest banks in the country have all but stopped lending on high-rise buildings, and big capital, the kind you need to buy a $500 million building, has fled.

“There’s almost no cash in the office market today,” proclaimed a seasoned mortgage broker. “No one knows where the prices will be when one of these towers finally sells out.”

I asked a handful of industry leaders how many skyscrapers had fallen in value over the past two years. Their guesses – yes, guesses – ranged from 25% to 60% downside. This broad lack of consensus is part of the problem; without consensus on value, there is no market, leaving office buildings buried under three meters of permafrost.

Why? Let’s get back to those missing workers. No one (including this writer) knows how many employees will eventually return.

Assuming you’re okay with deep recessions, the rosy scenario for a prodigal worker coming home looks like this: Mass tech layoffs will continue, employers will take back the whip hand, and they’ll will force the return of their employees.

One expert thinks smart workers will come back on their own once they realize that working remotely puts them squarely on the edge of Mount Doom. How? If work stays away – if employers capitulate to it – companies will stop paying $220,000 a year to a guy coding from his Snake River shack when they can get the same quality from Mumbai for $90,000.

The problem with this homecoming prediction is its underlying assumption that technology actually wants its employees back. I asked half a dozen CEOs of small and medium-sized tech companies how well they operate remotely. This one was the subject of a total consensus: they all purr, 90 to 100% as effective as they were before the Covid.

That may not be true for the FAANGs of the world, and it certainly isn’t true for start-ups – everyone agrees that fledgling companies need all hands to come together unending. But between Google and a garage business, there must be hundreds, if not thousands, of businesses that don’t need to revisit Downtown anytime soon.

This column recently insisted that despite all the troubling economic news, real estate would spit out few bargains due to trillions in opportunity funds desperate for yield. Office buildings could be an exception. Five or six years from now, we might just be looking back at 2023-24, slapping ourselves on the forehead and swearing, “How the hell did I miss that? I could have bought a Class A desk for fifty cents on the dollar.

If you’re willing to bet on the swallows coming back, you might just reap the biggest reward real estate has offered since 1992. For what it’s worth, I think the town will recover, the employees will come back, and the owners will once again toast to each other’s brilliance. I’m just glad I don’t have to bet on it.

By John E. McNellis, who, in addition to his books on real estate, has just published a novel. Check it out: O’Brien’s Law: A Romantic Thriller.

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Jose C. Birney