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Why Some BrokersThink San Francisco's Commercial Real Estate Market May Take Decades to Recover

iconBenzinga

2024-06-21 15:28

Meta-Description: According to analysts, high vacancy rates and declining rents have hurt San Franci

  Meta-Description: According to analysts, high vacancy rates and declining rents have hurt San Francisco's office market so badly that it could take almost 20 years to recover.

  San Francisco's once-booming commercial real estate market has been severely damaged by the post-pandemic vacancy crisis, prompting some analysts to predict it could take nearly 20 years to recover. Analysts from real estate firm Avison Young made this prediction in the San Francisco Chronicle, based on historical market data. If their forecasts hold true, San Francisco's office market may not return to pre-pandemic levels until 2042.

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  Since the pandemic, San Francisco's office market has been particularly hard hit, with remote work and decreased occupancy sharply reducing rental revenues. Given that the value of commercial real estate hinges largely on rental income, declining occupancy rates have significantly impacted asset values.

  This situation is especially concerning for mortgage lenders. The Mortgage Bankers Association estimates that over $700 billion in commercial loans will mature in 2024. The problem is a simple math equation. According to information in the Chronicle, San Francisco's commercial vacancy rate is 30%, the highest in the country. The target occupancy rate for a commercial loan is typically 10%. Most assets struggle to service debt or generate profit once the vacancy rate exceeds 10%.

  In an interview with the San Francisco Chronicle, Mark McGranahan, a commercial broker for Avison Young, summarized the importance of the 10% vacancy ratio by saying, “Ten percent is sort of the magic number — vacancy falls below 10%, and landlords become emboldened. Rents start to rise. The market tightens up, and people start thinking about new development.”

  Therein lies the dilemma for commercial property owners and explains the logic behind what McGranahan calls the “worst-case scenario” prediction of a near 20-year recovery period. Once occupancy dips under 10%, it sets off a series of cascading events that damage the market even further. High vacancy rates force landowners to lower rents. Under that scenario, the asset is still underperforming even if it claws its way back to the target 10% occupancy rate.

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  McGranahan explained it like this, “If that's the target (10%), historically speaking, then it's a numbers problem: Let's say the office market is 100 million square feet, you have 30 million square feet of vacant space and need to get down to 10 million square feet before the market starts shifting. How long does it take to absorb 20 million square feet?”

  The Avison Young prediction is based on area brokers and businesses signing leases equivalent to an additional 1,000,000 leased square feet of office space per year. Under that scenario, it would take roughly 20 years to lease all the vacant office space in San Francisco and return to its pre-pandemic performance levels. That's the basis of Avison Young's projection that it could be 2042 before San Francisco's office market fully recovers.

  If that scenario comes to pass, there could be catastrophic consequences for regional banks and commercial property owners. Dozens of commercial assets in downtown San Francisco could fail to service their debts and face foreclosure. The problem for lenders is that the more properties they foreclose on, the more distressed assets go up for auction.

  This would depress the area's commercial real estate values even further. Imagine a neighborhood where one-third to one-half of the homes are in foreclosure or at risk of foreclosure. It would be difficult for sellers to get top dollar for their homes in an environment where speculators can buy distressed assets for pennies on the dollar at foreclosure auctions.

  However, Avison Young notes that different scenarios could exist where San Francisco makes a stronger comeback much sooner than 2042. For example, there have been years when 2,000,000 square feet of office space was leased in San Francisco. If that were to happen for eight or nine consecutive years, it's possible that San Francisco's office market would recover by 2033.

  Some analysts wonder if it's realistic to expect San Francisco's office market to duplicate its pre-pandemic performance. When the vacancy rate was in the single digits in 2019, the tech industry was booming, and venture capitalists could borrow money at low interest rates. Tech is still a strong sector, but high interest rates have also put the clamps on VC startup funding, translating to less office space being leased.

  In a recent interview with the San Francisco Chronicle, Colin Yasukochi, who heads up the Tech Insight Center for CBRE, said, “The office market recovery will likely evolve by building quality. The best quality buildings … will recover first. The lesser quality buildings may languish in high vacancy for an extended period of time and eventually be repurposed or decommissioned. Thus, total vacancy may not be the best indicator of specific market conditions.”

Disclaimer:The views in this article only represent the author's personal views, and do not constitute investment advice on this platform. This platform does not guarantee the accuracy, completeness and timeliness of the information in the article, and will not be liable for any loss caused by the use of or reliance on the information in the article.