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San Francisco CRE Outlook Offers Reasons for Optimism: Panel

Is San Francisco’s commercial real estate (CRE) market in an “urban doom loop” or on the verge of a comeback? Curt Spaugh, SitusAMC Senior Director, Special Servicing, is hopeful about recovery. He discussed the factors fueling his optimism at a panel discussion on challenges and opportunities in CRE presented by the CREFC Young Professionals Network on November 2. He was joined by Kurt Altvater, Senior Vice President, CBRE Loan Sales; Jean Baker, Head of West Coast Origination, LoanCore Capital; and Ian McConnell, Director, KKR. Jocelyn Friel, Managing Director, Prime Finance Partners, moderated.

The city’s office vacancy rate was about 34% at the end of 2Q 2023, and expected to rise as leases expire, while transaction activity has declined sharply. “This situation is not unique to San Francisco,” Spaugh said. “We've seen this across the country, as high-paid, high-knowledge workers in CBDs, with big commute times, like New York, Chicago and downtown L.A., have all (adapted) to hybrid work.” 

What is unique to San Francisco is the technology boom and bust, Spaugh said, with tech firms representing about 45% of the city’s 90 million square feet of office space before the Covid-19 pandemic. Such firms tend to lease about 20% more space than they actually need to accommodate anticipated growth, and these firms were the quickest to adapt to remote and hybrid work. “They've reduced their headcount and have a large surplus of office space,” Spaugh said.  

The media has focused on an urban doom loop scenario in which the sharp decline in downtown office workers empties transit systems and drives retailers and restaurants out of business. Homelessness and crime rise, further deterring residents and visitors. Property values and tax revenues fall, so the government is forced to cut services, exacerbating quality of life issues, and the cycle continues. San Francisco also continues to suffer from an affordable housing crisis. 

“I think some of the things contributing to challenges are pre-COVID,” Spaugh said. "The cost of living has been skyrocketing for years. I've commuted into San Francisco since the mid 90s from the East Bay on BART. The commute has gotten trickier with crime.” But BART is rebounding, with a new fleet of trains, Spaugh noted, and increased ridership, as companies such as Alphabet and Meta lead the return-to-office movement. Major quality of life issues like drugs and homeless encampments tend to be focused in specific areas, such as the Tenderloin, while other city neighborhoods are bustling with new restaurants, small businesses, parks and weekend festivals. 

The panel noted that artificial intelligence offers a new driver of demand, with a fresh wave of startup activity. Two in five companies in the Forbes AI 50 are located in San Francisco. Open AI, the company behind Chat GPT, recently subleased nearly 500,000 square feet of space from Uber, in one of the largest office transactions in years. While the industry is expected to produce fewer jobs than previous tech waves, advances in AI could draw other industries to San Francisco seeking to capture the benefits of early innovation. 

Despite high office vacancies, the city has seen a pick up in demand and higher rents for Class A, highly amenitized properties in desirable locations. Total demand reached 5.2 million square feet by the end of the second quarter of 2023, according to CBRE the highest since before the pandemic. “A flight to quality is really happening,” Spaugh said. “I think ...the quality properties will fill up, the retail market takes off again, and people start getting back in the city. It's a real opportunity right now for people with a positive outlook.” 

In addition, funds are accumulating capital to scoop up bargains downtown and transactions are restarting. For example, a local developer just purchased the office tower 60 Spear Street for $41 million, which the previous owner had paid $107 million for in 2014. “It's definitely a market for opportunity,” Spaugh said. “Especially in the last three months or so there’s a little bit more energy, and you're hearing about people wanting to deploy capital and get in on that basis play relative to other markets. 

"Tech boom-and bust scenarios played out in the early 90s, in the early 2000s and after 2008, and we bounced back every time,” Spaugh said. “I expect the same.” 

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