Of San Francisco, Mark Twain once famously quipped: “The coldest winter I ever spent was a summer in San Francisco.” But it’s another quote, also attributed to him, that the city hopes is more accurate: “The reports of my death are greatly exaggerated.”
Much has been written about the demise of San Francisco and fears of a never-ending doom loop narrative that will forever plague the city. Unfortunately, downtown San Francisco has become the poster child of many crime-ridden U.S. cities that exhibit various stages of decay. The global pandemic drove people out of city centers and residual work-from-home mandates have endured, a death knell for the five-day-a-week, in-the-office legacy.
Downtown San Francisco has been acutely impacted and with roughly 30 million square feet of office space currently vacant, it is trailing many of its peers and, therefore, experiencing a torpid recovery. The massive reduction of daily office workers has also adversely affected the urban core’s retail sector, resulting in swaths of vacant storefronts.
San Francisco is a city with a long and rich history. The area’s natural and scenic beauty and temperate climate have made it an attractive, albeit expensive, place to live, visit and build. Today, San Francisco is one of the most populous cities in the U.S. and is known for its diverse population and as a liberal bastion. But the global pandemic hallowed out business activity in San Francisco’s core and devastated its tourism industry. Downtown’s post-pandemic recovery has been anemic and in addition to a shrinkage of population, the city’s core is threatened by crime and homelessness, a situation which has been sensationalized around the world by the media.
Like other knowledge-based industries, the tech sector has embraced working remotely and has been generally lenient on return-to-office policies. Coupled with historic levels of congestion downtown, the work-from-home phenomena will likely result in a permanent reduction of half the city’s pre-pandemic workforce.
Downtown San Francisco’s commercial real estate market is experiencing the effect of a one-two punch of lower demand and rents and the recent rise in interest rates. The good news is that firms in the growing artificial-intelligence industry are leasing large blocks of space, signaling that San Francisco’s downtown appeal as a tech hub has not evaporated. The city historically has been a gateway for Asian corporate and leisure travelers and will again be when inbound international travelers return to pre-pandemic levels.
CRE IN THE CROSSHAIRS
Earlier this year, it was widely publicized that Park Hotels & Resorts had ceased making payments toward the $725-million non-recourse CMBS loan it secured by two of its San Francisco hotels, the 1,921-room Hilton San Francisco Union Square and the 1,024-room Parc 55 San Francisco. The debt was scheduled to mature in November 2023 and recently the hotels were placed into a court-ordered receivership. Although many sector sponsors have written off downtown San Francisco, there are visionaries, including EOS Investors, who recently acquired the 221-room Hotel Zoe Fisherman’s Wharf from Pebblebrook Hotel Trust for $68.5 million, or $310,000 per key, clearly an amount significantly below replacement cost. Additionally, earlier this year, a venture between Flynn Properties and Highgate acquired the shuttered 135-room Huntington Hotel in Nob Hill, with a plan to restore and reopen the historic property in 2025.
Within downtown San Francisco’s office sector institutional owners, including Blackstone, Clarion Partners and Wells Fargo, have capitulated and price discovery has evolved due to several recent sale transactions of major buildings, at levels that are a fraction to replacement cost.
Examples include:
- 60 Spear Street for $40.9 million, or $260 per square foot, which equates to a 60% discount from the price paid in 2014.
- 350 California Street (Union Bank Building) for $61 million, or $205 per square foot, representing a 75% discount from the asking price sought in 2020.
- 550 California Street for $41.7 million, or $114 per square foot, equal to a 60% discount from the price paid in 2005.
- 201 Spear Street is reportedly going under contract at nearly 50% less than what it traded for 10 years ago.
On the positive side:
- APEC 2023 United States is the year-long hosting of the Asia-Pacific Economic Cooperation (APEC) meetings, which is being held in San Francisco.
- Bayhill Ventures, a San Francisco-based real estate development and investment firm, has submitted plans for approval to build the city’s tallest residential tower, a 71-story tower at 530 Howard Street.
- San Francisco International Airport recently said that the number of international flights is now at 97% of pre-pandemic levels, and should exceed 100% by year’s end.
- The NBA announced that the Bay Area will host NBA All-Star 2025.
- The NFL has awarded Super Bowl LX to Levi’s Stadium, in Santa Clara, Calif., home of the San Francisco 49ers.
- Following uncertainty, Salesforce said that its annual Dreamforce conference is returning to San Francisco in 2024.
History has shown that often the best opportunities are discovered when markets are out of favor and the investor narrative becomes exceedingly pessimistic. For decades, San Francisco has experienced real estate boom and bust cycles. For many years that preceded the pandemic, San Francisco was a darling hotel market, typified by strong demand in all segments, healthy room rates and high barriers to entry for new lodging supply.
Smart money that is patient has already called a bottom and believes the market is ripe to acquire commercial real estate assets, including hotels, in San Francisco. Sponsors with cash and strong balance sheets are in an ideal position to purchase downtown properties with a “buy low, sell high” investment thesis.
Look for more buyers to come off the sidelines to further establish once-in-a-decade, market-clearing prices, which will ultimately spur more investment activity, while placing upward pressure on values.
Now is the time for long-term investors to jump in. Because while you can never perfectly predict the bottom, you can, ultimately, lose out on the opportunity.
Maybe Mark Twain said it best: “You can’t depend on your eyes when your imagination is out of focus.”