What Could Go Right?

Mass psychology is literally contagious (that’s how it becomes “mass”).  This is especially true in times of change, when a significant event has precipitated such change (e.g., the pandemic).  These events can be positive or negative.  In our current state, the catalyst was negative, and, in many ways, has resulted in a decidedly negative outlook.  When things turn negative, there will always be market casualties (just as a rising tide lifts all boats in the positive context).  For example, the impact to investors in the domestic office sector has been mostly negative.  As change unfolds, it can have knock-on impacts that weren’t necessarily anticipated.  For example, the demise of urban downtowns due to shifts in daily worker population.  Collective sentiment tends to aggregate around a view and stay there until some brave souls dare to take the contrarian view.  As these contrarians see success, it spurs others to jump on board and the collective sentiment begins to shift, once again, in the other direction.
 
The office market is primed for contrarian bets, both from investors and occupiers.  In San Francisco, 2023 has marked the beginning of what is sure to be a substantial wave of office asset sales, with contrarian investors placing bets at values that are 60%+ below pre-pandemic highs.  Event with steep discounts, these investments aren’t a slam dunk.  But in our view, when the real estate is good (bad buildings will remain a problem), investors who buy San Francisco office now will be well positioned to see out-sized returns as the market recovers (and, yes, we believe it will recover). 
 
Similarly, companies looking to lease office space in San Francisco have an opportunity to do so against the backdrop of what is likely the most favorable occupier market dynamic of at least the past 50 years.  Options are plentiful and the cost of space (but for the most premium view spaces) is 30%+ lower than it was pre-pandemic.  Whereas a 10,000-sf space in a decent building would have cost $850,000/year in 2019, today the same space can be leased for $550,000.  Saving $300,000/year on a 5-year lease is real money companies can use to invest in other facets of their business.  Adding to this is the flexibility occupiers can achieve today, and the fact most are leasing ~30% less space than they would have leased pre-pandemic.  For those who continue to believe in the value of the office, this is a generational moment to capture sizable savings.
 
Maybe it’s just us, but we’re starting to feel contrarian.  While the debate over RTO rages on, we’re seeing companies become more thoughtful about why they want to have an office.  While this may yield an office need that is less than it was in 2019, that’s not the point.  The point is more companies are beginning to take a position on the office.  This, alone, will bring more demand and begin to stabilize what has otherwise been a very unsteady market.  Other indicators point toward greater stability, as well, including a recent Cushman & Wakefield analysis of in and out migration in major US cities which showed the patterns have largely returned to the pre-pandemic norms.  To be sure, domestic office markets still face strong headwinds, including reduced tenant demand, dislocated capital stacks and an expensive and limited financing environment.  Yet we’ve entered the contrarian bet phase in which more will ask, “what could go right?”