“There is almost no liquidity in the office market. Nobody knows where the prices will be when one of these towers is finally sold.”
By John E. McNellis, director of real estate developer McNellis Partners, for WOLF STREET:
Swallows abandoned San Juan Capistrano in the 1990s. Their home – the historic mission – has undergone a renovation, the birds have lost their ancestral nests, and despite all efforts to lure them back, they have not yet returned in great numbers.
Workers abandoned their office buildings in 2020, no less difficult than working, and also migrated to other places. Those in real estate ask themselves when The office staff will return. Others ask if They will return. Back to this existential question for a moment.
CBRE just published second-quarter results for the San Francisco office market. Nearly 29% of the city’s office space – about 25 million square feet – is now available. Vacancies increased by 362,000 feet in the second quarter, and approximately 550,000 feet of new office space will soon be available. In short, the vacancy rate is trending towards the peak obscured by clouds. One industry executive remarked sarcastically, “We don’t over-build, we’re under-demanded.”
Fluctuation of this data, 71% of the city’s buildings were rented. Unfortunately, this number is somewhat misleading. In these trying times, a building’s occupancy rate is a much more important metric than the rental rate. Kastle Systems, a workplace security company that requires office workers to swipe access cards, provides accurate occupancy data. As of this writing, the overall occupancy rate in San Francisco—workers already showing up—is 39%.
A 39% haunted building may have a happy ending, but — like falling in love with someone with a bad heart — you may find yourself praying in the emergency room before the whole thing is over. Meanwhile, with the exception of the most luxurious buildings – say the tower of the sales force – rents are dropping, technology is down 24% on the Nasdaq and shedding workers like winter coats in Miami.
None of this is news to the world’s biggest hitters – league owners, major lenders and brokers. In fact, the country’s major banks have stopped lending high-rises and big stocks, the kind you need to buy a $500 million building, and have fled in order to get out.
“There is almost no liquidity in the office market today,” declared the veteran mortgage broker. “No one knows where the prices will be when one of these towers is finally sold.”
I asked a few industry leaders how much taller buildings have depreciated over the past two years. Their guesses—yes, guesses—ranged anywhere from a drop of 25 to 60%. This widespread lack of consensus is part of the problem. Without a consensus on value, there is no market, leaving office buildings buried under ten feet of permafrost.
why? Back to those missing workers. Nobody (including this writer) knows how many employees will eventually return.
Assuming you’re okay with deep recessions, the rosy scenario of the wayward worker’s repatriation goes like this: Massive tech layoffs will continue, employers will regain the whip, and they will force their employees back.
One critic thinks smart workers will come back on their own once they realize that telecommuting puts them squarely on the edge of Dom Mountain. How? If the business stays away — if employers succumb to it — companies will stop paying $220,000 a year to someone coding from his Snake River shack when they can get the same quality from Mumbai for $90,000.
The problem with this homecoming expectation is the underlying assumption that the technology actually wants its employees back. I asked half a dozen CEOs of small and medium-sized tech companies how good they are at working remotely. This got complete consensus: they are all on the go, 90-100% as effective as they were before Covid.
This may not be true for the world’s FAANG, and it certainly isn’t true for startups – everyone agrees that startups require all hands to come together endlessly. But between Google and the garage project, there should be hundreds, if not thousands, of businesses without having to visit downtown anytime soon.
This column insisted recently, that despite all the troubling economic news, real estate may offer few good deals due to the trillions in revenue-seeking opportunity funds. Office buildings can be an exception. In five or six years, we might look back at 2023-24, beat ourselves up on the front and swear, “How the hell did I miss that? I could have bought a top-notch desk for fifty cents on the dollar.”
If you’re willing to place a functional bet on the return of the swallows, you can reap the biggest bonus real estate has offered since 1992. For what it’s worth, I believe the city will correct itself, the employees and the owners will once again toast each other’s brilliance. I’m glad I don’t have to bet on it.
By John E. McNellis, who has just published a novel, as well as his books on real estate. Check it out: O’Brien’s Law: Romantic Thriller.
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