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The “Under-Demanded” Office Market – WOLF STREET

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Inflation & Devaluation
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 every effort to lure them back, they have yet to return in meaningful numbers.
No less flighty, workers abandoned their office buildings in 2020. They, too, have migrated elsewhere. Those in real estate ask themselves when office employees will return. Others wonder if they’ll return. Back to that existential question in a moment.
CBRE has just published the 2nd quarter results for San Francisco’s office market. Almost 29% of the city’s office space—about 25 million square feet—is now available. Vacancies increased by 362,000 feet in the 2nd quarter, and about 550,000 feet of brand-new office space is coming on-line soon. In short, the vacancy rate is climbing toward a cloud-obscured peak. One industry executive wryly observed, “We’re not overbuilt, we’re under-demanded.”
Turning this data around, 71% of the city’s buildings are leased. Sadly, that figure is somewhat misleading. In these covidy times, a building’s occupancy rate is a far more critical metric than its leased rate. Kastle Systems, a workplace security company that requires office employees to swipe entry cards, provides precise occupancy data. As of this writing, San Francisco’s overall occupancy rate—the workers who actually show up—is 39%.
A 39% occupied building may have a happy ending, but—like falling in love with someone with a bad heart—you could find yourself praying in the emergency room before it’s all over. Meanwhile, with the exception of the swankiest buildings—say, Sales Force Tower—rents are plummeting, tech is down 24% on the NASDAQ and shedding workers like winter coats in Miami.
None of this is news to the office world’s big hitters—its major league owners, lenders and brokers. In fact, the country’s biggest banks have all but ceased lending on high-rises and big equity, the kind you need to buy a $500 million building, has run for the exits.
“There is almost no liquidity in the office market today,” a seasoned mortgage broker proclaimed. “No one knows where pricing will be when one of these towers finally does sell.”
I asked a handful of industry leaders how much high-rises had dropped in value over the last two years. Their guesses—yes, guesses—ran anywhere from a decline of 25 to 60%. This broad lack of consensus is part of the problem; without consensus on value, there is no marketplace, leaving office buildings buried under ten feet of permafrost.
Why? Back to those missing workers. No one (including this writer) knows how many employees will eventually return.
Assuming you’re OK with deep recessions, the rosy scenario for a prodigal worker homecoming goes like this: tech’s massive lay-offs will continue, employers will regain the whip hand, and they will force their employees’ return.
One pundit believes that clever workers will come back on their own once they realize that remote working sets them squarely at the lip of Mount Doom. How? If work remains remote—if employers capitulate to it—companies will stop paying $220,000 a year to some 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 tech actually wants its employees back. I asked a half-dozen CEO’s of small to mid-sized tech companies how efficient they were running remote.  This one had total consensus: they’re all humming along, 90-100% as effective as they were pre-Covid.
That may not be true for the FAANG’s of the world, and it certainly isn’t true for start-ups—everyone agrees that nascent companies require all hands to huddle endlessly. But between Google and a garage venture, there must be hundreds, if not thousands, of companies with no need to revisit downtown anytime soon.
This column has recently insisted, that despite all the troubling economic news, real estate would cough up few good deals because of the trillions in opportunity funds desperately seeking yield. Office buildings could prove an exception. In five or six years, we may well look back at 2023-24, whack ourselves on the forehead and swear, “How the hell did I miss that? I could have bought Class A office for fifty cents on the dollar.”
If you’re willing to place a career bet on the return of the swallows, you could possibly reap the biggest reward real estate has offered since 1992. For what it’s worth, I do think the city will right itself, the employees will return and landlords will once again toast 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 now published a novel. Check it out: O’Brien’s Law: A Romantic Thriller.
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Dear Readers,
Many of you have come to appreciate the funny and insightful articles of John McNellis, the author of this article, and a long-time author on WOLF STREET. In addition to his books on commercial real estate, he has now published a novel, O’Brien’s Law: A Romantic Thriller.
Check it out on Amazon, it’s on pre-sale now:
Yes John, good and witty article. And multiple $64,000 questions. Will occupancy ever return to a healthy % and at what type of discount ft2? Who wants to be the first toe in the water and purchase a building if financing can be found?
I see much debate and first hand experience on this point…
“companies will stop paying $220,000 a year to some guy coding from his Snake River shack when they can get the same quality from Mumbai for $90,000.”
Funny I was about to comment on this as well. I’ve been involved in multiple outsourcing initiatives and it usually falls apart #1 due to the time difference. It’s a lot easier to collaborate remotely in the US with at worse a 3 hour time difference than the 8.5-11.5 hour difference with India. Some companies already pay US employees differently based on the cost of labor for a particular market and this does mean that some people will make more than others but there aren’t currently enough developers in these low cost areas to put downward pressure on the salaries nationally at this time.
My experience also. Good software development relies on communication and rapport, and the barriers of working hours differences, cultural communication styles and even accents make this much more difficult to pull off with people on the other side of the world.
I recently helped send a department of non-coder jobs to the Philippines and so far they’re doing a better job than the Americans.
Thanks, patriot. Your fellow Americans appreciate your hard work and will happily wash your car at 9 dollars an hour.
and actually Jon’s post although sentimental does say a bit about your business approach allowing future partners to deselect you based upon your previous choices. all recorded online for posterity. never before did a log of choices mean so much and wield such power to destroy opportunity.
I spent 40+ years in IT. Starting with working as a nighttime computer operator when I was in college. Almost all of that was in supporting business processes. Not primarily as a systems administrator. Data Processing not “computer science”.
I never had to collaborate with people working from Asia.
My experience was working with folks from Eastern Europe after 1989. They all had excellent English skills. Many of them had both Mathematics AND Computer Science degrees and/or training.
The main stumbling block they had was understanding how American businesses worked.
Our commercial firms do things differently than they were used too. They were unfamiliar with American business processes.
So what American managers wanted, or actually NEEDED, was … well … foreign to them.
If you’ve ever tried to take program specifications from an analyst and turn it into ‘code’ to support a particular ‘business process’, you’ll understand that lots of “unwritten knowledge “ is required.
Even at ‘not for profits’.
The issue that I often found was that we speak “American” and they speak “English” and do not understand the American slang language / idioms.
To both Anon and El Katz,
You can’t compare foreigners 30 years ago to foreigners now in terms of understanding American culture. I work for a company owned by a multi-national corp and I interact with people from all over. They often speak better english than a lot of Americans, they know our slang, they are surprisingly familiar with our culture, and they understand capitalism just fine. They’ve watched our movies and entertainment for decades along with our shaping of internet culture, which has changed everything.
There are difficulties with timezones and other practical processes, but translation and cultural unfamiliarity just aren’t the problem they used to be. We’ve been exporting American culture and IP for decades and the world has been consuming it reliably.
Your observation is incorrect and my experience is not 30 years old. I worked for a Japanese company and often had to explain things in “King’s English” rather than American to the Japanese transplants on TDY.
Ditto dealing with the Indian programmers that worked for Accenture and others. I usually had to rely on their American counterparts to “translate” what the issues were.
Watching “Office Space” and living it are two different things.
Then why hasn’t big tech reduced its consumption of H1-Bees?
If WFH=true, then why not Indians first?
The fact is you can’t get the same quality in Mumbai.
I don’t know if that totally matters. I’m seeing the top notch best employers to work for that pay really well are pulling employees back to the office and the more “crappy” companies that struggle to attract talent are still embracing WFH to get talent. I think crappier companies are more open to paying half fare to someone in Latin America in their time zone or even India.
Medical care coordination and case management has been getting outsourced to Latin America.
Like said above, it seems to be the crappiest companies doing this and the results have thusfar been disasterous in my experience. Communications wiped out for weeks & months on end is hardly quality care coordination. No one noticed or cared until Compliance got involved and admin needed to protect their phoney-baloney jobs.
Now AI is in the pipeline to replace medical coding, auditing and utilization review. Anything to keep from paying human living wage to care for other humans. Skynet’s stellar reputation for compassion and all…
SF has one unique problem: What happens if a skyscraper with an active quake-damping system goes bankrupt and can’t pay for electricity?
Maybe other places have buildings sitting on many layers of detritus such as old ships and bay mud etc. pol?
Having looked extensively at ”soils reports” for SF and area, many of which showed all kinds of ”stuff” that has been built on for couple of centuries now, seems unique enough, or at least rare.
Keep the hopium alive that rents in SF will eventually go back to the ( inflation adjusted, far shore ) levels of the late ’60s/early 70s when friends rented a nice 2 bedroom flat just off Haight for $50 PER MONTH!!!
And artist friend similarly for a really nice studio with abundant north light.
We can dream of those days of cheep rents, great artistic focus, and summers of love, eh!!!
Summer of love hippies and Chaz.
My guess is that even *more* of this space becomes vacant. Why would I be interested in a 60% off sale for something I clearly do not need?
COVID has proven, conclusively, that we can all work, collaborate and phuck around just as efficiently as we ever did without the whopping line item known as the office.
Everyone always hated the office anyway.
“Human beings were not meant to sit in little cubicles staring at computer screens all day, filling out useless forms and listening to eight different bosses drone on about about mission statements.”
—Peter Gibbons
Sounds like someone has a case of the Mondays. Some of us miss the office. I see more of a hybrid office for our future with laptops and floating unassigned desks. And a much smaller space. Wework might do better post COVID. most of my workers are fine never coming in again. I don’t mind as long as I see output. Our interaction is now online including the “parties”.
DC city office vacancy rates were close to 14% in 2019 before the pandemic. In 2022 DC office vacancies were close to 18% with reports varying from publication to publication. DC metro area suburban office vacancies are generally higher than downtown office vacancies. Office tenants have been getting concessions from landlords before signing new leases.
Wow, this article and the swallows analogy is spot on. Having lived in San Juan Capistrano mid 90’s until 2020. I took a tour of the mission during its renovation while helping a grade schooler do a report on its history. After the renovation laws were enacted to stop people from “bird proofing” the eaves of buildings and homes ( Orange county Ca. is a bird sanctuary) so the swallows could nest. So just like the swallows, people forced from their central point of congregation spread out to the surrounding residential areas.
My business involved doing maintenance on office and commercial buildings throughout southern Ca. When the lockdowns started I was in L.A. on an 8 story bank building’s roof with the building engineer and we were looking down on the normally bustling city below, there were only a few cars, no one walking. We were discussing how absolutely crazy it was and how/if things would ever return to normal.
“…it was and how/if things would ever return to normal.”
IMO, we are never going back to 2019. The world has changed forever. But the wheel’s still in spin so it’s best not to speak too soon :-).
Agree, 2019 no. Companies and workers will hash this out and when we get on the other side of whatever sh*tshow is on the horizon here I’m sure there will be a variety of ways different businesses organize, many that have not been invented yet.
Oh you can speak alright, but the words are/ will be redefined…
Normal the new .gob def. coming in 5,4,3,…
: the way things should be.
The swallows built their nests on the overpasses on I-5.
“companies will stop paying $220,000 a year to some guy coding from his Snake River shack when they can get the same quality from Mumbai for $90,000.”
Or from Lagos, since coding pays more and is less risky and more secure than being an African prince and we are very willing to code instead, so I think office space will need to find other things to be useful for.
living in a college town and living only blocks from campus – I ask the young folks _” what is the one thing you want from job” the answer is always – ” work from home”
1) Snake River “expert” for $220K. Mumbai corp Pyramid for 90K.
2) Since 2020 we lost millions of small businesses. Their retail stores
and commercial spaces are still vacant.
3) The FANGS are thriving, loaded with cash to finance themselves in a rainy day. High end employees walk their dog on the beach, run in the park, swim in the bay, take hours of vitamin D, before going to work on their sofa. Dolce Vita.
4) Banks assets are in RE.
5) We lost more than a million boomers in the last two years. Their apt have been leased. Demand for apt is high. There is no demand for office
and retail spaces. RE is bipolar.
6) In July employers added 528K workers. In the last three months 2.8
million workers. Wages jumped, but office and retail spaces slumped.
7) IF QQQ bear market rally reached it’s terminal point, the FANG firing
will get a Trigger.
John E McNellis no spin. Thanks.
Yes, I always feel like I am reading as his business partner or something. He is a good fit for this site. Thanks to both Wolf and John. Good stuff.
…And living in a college town, close to campus there is a proliferation
of Private/Public Partnerships in developing office buildings on campus which started about 2018-2019 before Covid. Currently completed and
now mostly vacant.
More wisdom dispensed daily !
In My Humble Opinion, I wouldn’t be interested in Class B (or C) office space at a discount at this time. In my small world, Work From Home is working for employers and employees, interviews, meetings many types of medical, psychological, and legal visits and even government. The genie is out of the bottle. It may take a long time to grow into the existing office space.
Wolf Richter and others on this site have discussed conversion to condos or residential, but perhaps someone with a really good thinking cap will come up with a better idea. When the price gets low enough, the beauty of our capitalist system will shine.
Agree with your sentiment HH.
Anecdotal, but the empty Sears anchor building at the Gateway Mall (Prescott AZ) has been repurposed as an indoor Pickleball Club / gym. As a fitness-obsessed person myself who is saddened by the obesity epidemic in the USA, the use of larger spaces for exercise activities, especially in cold weather states, sounds promising.
I realize the bang for the buck per square foot is prolly not gonna pencil out … but I can still wish !!
I like the swallow analogy! Wildlife always finds the most beneficial place to do their business. They are not bound by leases, shareholders, politicians and such.
Assuming office workers never return in large numbers, why would the market not clear? The answer: potential bailouts. No one wants to sell just before a huge federal bailout is offered to banks with mortgages on these things.
CFOs look at costs. If the consensus on the question of productivity is 90 to 100 percent for remote workers, the next question is why the hell are we paying for massive “downtown” rents? To keep executives in luxury?
Those that can and are nimble enough have already been pulling up stakes and left the “big offices” and even the states that add to operating costs.
If you are competing with one of these, and remain in that high rent office box, something’s gotta go. Usually employees, but then with fewer of those, does it still make sense to occupy the big glass tower offices?
Have no real answer but it seems the subject is much broader than simply WFH vs office.
I am old enough to remember when the american companies started to re-locate manufacturing to lower cost countries – and the labor force would always state to who ever would listen – ” these jobs can’t be sent overseas we have skills they don’t have there- we are better trained and there are no language problems etc” and now its the technology workers making the same arguments – it will end the same as the factories
1) In 1870, after the civil war, there was a lot of gambling on harness races.
2) There were no car races, no baseball, no football and no soccer. People
gambled in tracks in Cleveland, Buffalo, Philly, CT… Horses moved in train from race to race.
3) People bred horses to beat records. The media was obsessed. Cheating were common.
4) To avoid cheating horse were racing in tranches. Under 2:40/mile,
under 2:30/mile, under 2:20/mile. Race tracks prevent 2:20/mile racing with 2:40/ mile.
5) C/S should read Ellen Williams: “Out of the Wood” story of fast horses harness racing.
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They’re praying for a recession to “force” the Fed to pivot. But it’s tough to have an official recession with employment growing, wages surging.

What the Fed did in details and charts.

Forbearance and pandemic cash run out. But a lot of fun was had by all.

Buy-Now-Pay-Later (BNPL) Lenders Face Tougher Reality.

The balance of loans & leases outstanding rose on much higher vehicle prices but much lower sales volume.

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