Lacking a Common Narrative
Markets are shaped by an ever-changing interplay of influential factors; including, supply, demand, human behavior, data and a collective narrative. In times of relative stability, market participants accept a prevailing collective narrative and the markets perform with a high degree of uniformity. Take, for example, the San Francisco office market of 2019. Characterized by strong tenant demand and limited supply, this market was not difficult to understand. The narrative, while beneficial to landlords and harmful to occupiers, was supported by data and participant behavior.
Over the past 3 decades, it has been my experience that markets generally settle on a narrative fairly quickly following significantly disruptive events. For example, while there was a moment in late 2000/early 2001 when landlords held fast to a false narrative the dotcom crash would not materially impact rental economics, the data quickly shaped a collective narrative of a market in steep decline. Usually, the data is so revealing that it forces collective agreement on the narrative. But here, two years into a global pandemic that has had significant impact on how we work, how we use office space, the San Francisco office market is lacking a collective narrative. The behavior of market participants is all over the map. You can find landlords that promote a confident narrative of a market in recovery, poised for material growth beginning now; and, you can find occupiers who believe the market is on the cusp of a long-term decline in which vacancy remains high and landlords are forced to substantially lower rental expectations to capture demand, which will be reduced from pre-pandemic levels.
The reason we lack agreement on a collective narrative is we lack good data. Specifically, we don’t yet know how the demand side of the equation will perform over the next several years as COVID has a lesser effect on behavior. Will occupiers lease less space, reflecting new workplace strategies that allow some or all of their employees to work remotely? Or, will companies lease more space in order to accommodate different uses that emphasize collaboration and flexible work spaces? Will we experience an interim period of reduced space needs, only to see increased needs as the center of gravity shifts back to the office?
There’s simply a lot we don’t know. The absence of hard data makes this environment uniquely difficult to navigate, causing participants to feel more comfortable with hedged bets, rather than going all in on a particular strategy. How does this look in practice? Messy. Mistakes will be made on both sides of the negotiating table. There will be a large spread between landlord and tenant expectations; and, in many cases, both sides will be able to put forth rationale arguments as to why their thesis is correct. But only time will tell. For the landlord whom creates an overly optimistic narrative, causing it to lose existing tenants because they believe they can achieve better rental economics than the tenant is willing to pay, depending upon the quality of the space and the building, this bet may prove high risk. Similarly, for the occupier whom passes on a great opportunity to restructure its lease expense now because they deem the required term commitment too long, favoring a short-term solution instead, they risk a less favorable future market dynamic, resulting in higher costs.
Over the course of 2022 and 2023, we expect the San Francisco market narrative to become more clear, enabling participants to more confidently place their bets. Meanwhile, we are operating in an environment in which we must be willing to question everything. For occupiers, this means stepping back from traditional thinking to fully assess how office space serves the company and to determine how best to go forward. The strategies will be more independent, less an expression of industry standards. To this end, tenant advisory services must include the provision of insights and data that help individual companies formulate their own market narrative. Those charged with making real estate decisions will do so without the cover of common market practices, requiring thoughtful planning and consideration to support the strategies they ultimately employ.