Wind the clock back four years and commercial property in San Francisco, the highly priced city at the very epicentre of the global ICT industry, was hot, hot, hot.
Office space was at a premium and shopping precincts were bustling, busy places. In the absence of an irrecoverable act of God, it was easy for investors to assume the status quo was immutable.
Oh, what a difference a global pandemic makes. It’s now more than three years since Covid-19 turned economies and societies around the world upside down and, just like that, transformed remote working from a niche activity into something everyone had to start doing, stat.
Today, Covid has devolved into a background issue but the disruption it engendered continues to cause operational challenges for businesses and organisations. Many are struggling to strike a balance between home and office-based working that’s compatible with their organisational objectives and keeps their employees sweet.
Out of office means out of luck for investors
It’s possible the ‘all together, all the time’ office-based model may regain its shine in a few years. But in the meantime, office blocks in key commercial centres like San Fran are significantly underoccupied. A-grade assets are still looking solid, as they always do and likely always will, but the Bs and Cs? Their values are heading south, at an unseemly speed.
Write-downs of between 40 and 50 per cent have become far from unusual and those drastically diminished valuations are giving rise to another issue: financing.
Carrying a degree of debt on commercial properties is usual and desirable – 40 to 60 per cent is the norm – but office towers that have seen their values halve aren’t assets banks are interested in backing.
As they roll off fixed term financing arrangements, owners face an uphill slog securing funds. And if they fail to secure them, selling at a loss becomes their only option.
For their part, lending institutions are in a bind: loath to tank the market that makes a material contribution to their profitability but unable to continue lending to owners and investors on their old credentials.
Misery is catching
Under-occupied, devalued office buildings aren’t only a problem in and of themselves. Too many of them in one location can have a deflationary effect on nearby properties – the shops and shopping centres that can no longer attract enough foot traffic to remain viable, the local restaurants, cafes and takeaway joints ditto.
In a worst case scenario, once thriving commercial neighbourhoods can degenerate into zombie zones. San Franciscans are watching this play out now in sections of their beautiful city and it’s not pretty; not for remaining tenants and residents, and decidedly not for the owners of the ever more unsalable buildings in which they live and work.
Coming soon to a city near you?
Will we see the same trends play out Down Under, as CBD and near city office spaces come up for refinancing? Perhaps our experience won’t be as dramatic as that of our American cousins but it’s difficult to see a reason for us to remain immune to the phenomenon.
Our major cities certainly have their share of vacant buildings. Overall CBD vacancy rates in Sydney and Melbourne were sitting at 11.3 per cent and 14 per cent respectively, in Q1 2023, according to Tenant CS’s most recent Office Snapshot. B grade vacancy rates in the two cities looked decidedly less healthy at 12.6 per cent in Sydney and 20.8 per cent in Melbourne.
The ostrich style behaviour that’s prevailed in recent times can’t continue forever. In some optimistic owners’ minds, buildings that haven’t been formally valued are still worth the same as they were pre-Covid.
Financing conditions are predicated on current market values and, as current funding facilities begin coming up for renewal, reality may start to bite and hard.
At Forbury, tracking the trajectory of those values is our stock in trade. Over the coming months, we’ll be watching with interest to see how far and fast they move.
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