'When There's Blood in the Streets, Buy Property?'
Famous saying by Baron Rothschild needs plenty of qualifications, especially in a post-Covid world. By Benjamin Tan
I was in San Francisco recently for an Enneagram conference in late July. My prior visit was in 2019, and I was curious to experience the city in a post-Covid world.
San Francisco is the global headquarters for many technology companies, and the industry has minted countless entrepreneurs and investors. Salesforce (CRM 0.00%↑) is among the largest software companies based there, and its gigantic Salesforce Tower—completed in 2018—represents a crowning achievement for its founder, Marc Benioff.
He writes about the corporate headquarters in his book Trailblazer:
“In January 2018, in the early stages of writing this book, Salesforce Tower officially opened for business in San Francisco. At sixty-one stories, it’s the city’s highest structure and one of the tallest skyscrapers west of the Mississippi. I won’t lie—I was thrilled. I had spent years on this project: finding the right location on Mission Street and then tinkering with design details, from the multicolored furniture in the lobby to the artistic tiles on the walls. I knew its completion marked a significant milestone in the company’s history. I couldn’t have been prouder.”
When I walked up to the building with a cup of Starbucks coffee in my hands, I felt a sense of awe. At 1,070 feet with a grid of metal fins running from the base of the building to the roof, Salesforce Tower was an architectural marvel. At the same time, I could not help but wonder how much of the office space would be utilized that day in the world of remote and hybrid work. The surrounding area felt a tad quiet, albeit it was an early Friday morning. It did not have the buzz that one would expect from that prime end of Mission Street.
Remote Work and E-Commerce: Paradigm Shift
Since Covid-19, San Francisco has been cited as a city in decline. Tourism is a fraction of its former glory, office occupancy continues to drop, hotels are barely breaking even, and retail space struggles with declining foot traffic.
Below are some of the recent headlines shaping the city’s image:
Park Hotels (PK 0.00%↑) materially reduced its portfolio exposure to the city when it ceased making payments toward the $725 million non-recourse CMBS loan secured by its two San Francisco hotels—the 1,921-room Hilton San Francisco Union Square and the 1,024-room Parc 55 San Francisco. I stayed
Jun 29, 2023: The Grim State of Downtown San Francisco, by the Numbers
For the second quarter of 2023, real estate company CBRE ( CBRE 0.00%↑) estimates the office vacancy rate to be 31.8%. CBRE’s data shows net absorption at negative 1.9 million square feet, implying that the vacancy rate can go higher
Retailer owner Westfield and partner Brookfield Properties stopped making payments on the $558 million loan secured by their property, the San Francisco Centre, a 9-story mall featuring over 170 shops & restaurants.
In a statement, Westfield says: "For more than 20 years, Westfield has proudly and successfully operated San Francisco Centre, investing significantly over that time in the vitality of the property. Given the challenging operating conditions in downtown San Francisco, which have led to declines in sales, occupancy, and foot traffic, we have made the difficult decision to begin the process to transfer management of the shopping center to our lender to allow them to appoint a receiver to operate the property going forward."
Real Estate Market: Disrupted
With technology enabling working from home, the office property market is undergoing seismic changes. Even in a gateway city like San Francisco, prime office space struggles to find tenants. Companies—large and small—are rethinking how much office space is really needed with a hybrid (or fully remote) model. Many technology companies, including still-thriving giants like Meta (META 0.00%↑) and Google (GOOG 0.00%↑), have announced massive reductions to their office footprints.
The proliferation of online shopping and rapid improvement in delivery capabilities—as exemplified by Amazon (AMZN 0.00%↑)—is also causing a slow demise of lower-tier shopping centers, which continue to see thinning crowds. Even San Francisco Centre did not stand a chance, although the city’s woes probably added disproportionately to its diminishing prospects.
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Conclusion: Stark Delineation Dividing Various Classes of Properties
Real estate is often regarded as one of the safest asset classes in the world. Apartment blocks, houses, shopping centers, office towers, hotels, warehouses—they are everywhere. We see, touch, smell, shop, and live in real estate. When an asset class is tangible, the human psyche is more assured, akin to how possessing physical gold still appeals to many.
That said, property value stems from actual and anticipated usage in the present and future, not the past. If demand for an office or retail space diminishes over time, it will command less lifetime rental, and valuation will drop. In contrast, a well-appointed single-family home in a good location, for example, will retain or enhance its value, as long as it remains desirable.
Baron Rothschild would not have been a happy man if he had indiscriminately bought any office space or physical retail shop in recent years. All words of wisdom require some qualifications, and when it comes to real estate, Covid-19 has upended multiple sub-sectors of the property market for good. Our relationship with conventional office and retail spaces may never be the same again.
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