The Lingering Fog of a Bull Market
The Lingering Fog of a Bull Market.
Advisors on the right side of a bull market end up looking good, no matter what they do. This was certainly the case for landlord advisors in the San Francisco office market for the ~10 years leading up to the pandemic, a time when you could win for losing, as the deal you failed to make was often (quickly) replaced by a new deal at better rental economics due to rapidly appreciating rents. Today, both landlord advisors and the investors they advise are, in some cases, suffering from the lingering effects of the bull market.
The landlord advisor’s work has become significantly more challenging with less margin for error. The best advice can be hard to deliver, as the new version of “success” looks dramatically different than it did in 2019, and in many cases requires landlords to do things they don’t want (or can’t afford) to do. For example, take the landlord struggling against a challenging capital stack in which equity is lost and the loan is both under water and coming due. This reality may play out at the very time when the asset requires a significant capital spend and decrease in target rental economics to ensure its relevance. It’s understandable that investors will try to preserve as much of their original value thesis as possible. Occasionally, instead of taking sound guidance, they seek advisors who support their false narrative. But this is not a market in which magical thinking wins.
Indeed, the role of the landlord advisor today is to align outcomes with data, to show the investor client where its asset sits in the vast sea of available supply, and how best to position if for success; including clarification of what success will look like. In many cases, the best guidance will aid investors in making tough decisions, existential decisions about the viability of their investment. When the client is unable to meet the market where it’s at, there is nothing to be done. This is the point in time when the asset must trade at a discount, the moment when a new investor can enter with a new thesis that is better aligned to the current and projected market. These “resets” are beginning to play out in San Francisco.
Of course, old habits, especially those borne of a bull market, die hard. It can be difficult for owners and their advisors to adjust to being on the wrong side of leverage. This is the fog of a bull market. Here, they react in shock when asked about the financial health of the asset. The idea of funding all or a large portion of the cost to build new space seems wildly unreasonable. The practice of competing for a tenant against the backdrop of multiple rounds of negotiation in which competitive landlords are seemingly willing to do more than they should to secure the deal is frustrating, at best. This often results in the common phenomenon in which a landlord will “chase the market down”, being unwilling to accept current market realities, only to succumb to worse conditions downstream. During the fog of a bull market phase, one common “solution” to under performance is to fire the advisor. This is the easiest way to redirect blame away from the asset management team and/or the acquisition team. Yes, the market is challenging, but fundamentally the under-performance has been the result of bad advisory. A fresh start with a new broker is what is needed. In some cases, aspiring landlord advisors, seeking to aggregate a portfolio of assets to lease will take on opportunities in which the investor client has unrealistic expectations, hoping the client will “get religion” in short order, allowing them to be successful. But there’s no role quite so lonely as that of advisor to a broken capital stack (investor/lender) that can’t/won’t accept reality and adjust its expectations, accordingly.
No, this is not a time when landlord advisors will gain from telling the client what they want to hear. It’s a time when sober, credible, data-backed analysis and strategy wins. The San Francisco office market is not going to rebound quickly. We’re living through a structural shift in where and how people do white collar work, resulting in reductions in the amount of office space being leased. Even if it turns out employer and employee decide they want to revert to pre-pandemic norms (I doubt it), the time it will take to lease our way back to a healthy market, and the rental values associated with such leasing will be a bridge too far for many landlords. The most successful investor advisors of the next decade will be those who can cut through the fog of the long bull market to focus clients on the new normal.