Lease non-renewals will continue over the next 4-5 years. TBD on when defaults hit a tipping point or runaway failure, but it doesn't bode well for the particularly-exposed regional banks.
> About 700 office leases are likely to expire in 2023 and another 600 are up in 2024 in the Financial District alone, said Avison Young’s insights and innovation head Dina Gouveia, for a total of about 10 million square feet of office space. In 2025 and 2026, another 10 million-plus square feet are likely to expire.
Not could be, as in the future, but currently is, as in right now.
As long-term leases expire, more tenants are giving notice of non-renewal, because they're not using all the space they have. Many office buildings are facing declining revenues in the near term. Most cannot fulfill their monthly debt service obligations if tenant collections drop below ~80% leased, give or take.
Many regional banks, in particular, are loaded up with loans to office buildings.
Well this isn't the collapse of San Fransisco - but rather the office rental market. Also interesting that people let go of the office space. Companies making a lot of money wouldn't do that they'd keep it for a year or so simply to have the continuity. They are too busy making money to worry about their rent.
But if they are looking to cut back on rent costs it makes me think times are tough. That paying attention to cutting this cost (and the hassle it will cause now and when things return to normal), and taking that attention away from growth means that there is an issue.
Obviously this isn't the permanent collapse of SF but it might be a nail in it's long term coffin. I can't imagine in 50 years time, with globalisation, with global currencies, remote working, VR etc. that you'd need to be tied to a physical location to innovate or get investment.
It's not "becoming" a major risk. It already is a major risk:
* As long-term office leases expire, more tenants are giving notice of non-renewal, because they don't need as much space anymore.
* Many office buildings cannot fulfill their monthly debt service obligations if tenant collections drop below ~80% leased, give or take, at the old $/sqft.
* Many regional banks are loaded up with loans to office buildings likely to default in the near term.
* Downtown restaurants, pharmacies, shops, and other retail operations have lost a lot of foot traffic. Many are on the verge of shutting down.
* City governments depend significantly on downtown economic activity for tax collections. Local governments are likely to see a big hole in their finances.
All of this has been on economists' radar for well over a year:
> I wonder what will happen in SF/NYC when more of the office leases have expired and the corporate property tax base erodes?
Large metropolises will manage potential budget shortfalls how they will.
More importantly, after large commercial leases expire, commercial property owners and their management companies will adjust their commercial rents until companies and institutions find value. While some concerns go remote-only, others will implement hybrid or even full RTO. The price and associated tax revenue on these commercial leases will stabilize and, more than likely, increase as the economy increases.
The expiration of corporate leases will not usher municipal financial apocalypse as many observers seem to speculate. Rental market corrections unavoidably will lag pandemic economic contraction (leases take time to expire) and such contractions hardly signal the end of commercial and corporate interests in renting urban real estate.
Business owners are adapting just fine. Commercial real estate owners are in big trouble.[1] That article says that most office real estate is leased for five years with an option to renew. Many of those renewals are not happening.
“Here’s the big “why not” when it comes to office-to-housing conversions: Gutting a building and rebuilding the inside as housing is expensive, especially in San Francisco and especially while construction costs are high.
Asking rents for downtown commercial leases have dropped around 15% from pre-pandemic peaks, but haven’t dipped further because of the relatively long lease terms signed by commercial tenants, as well as market optimism that the return to office will continue at a gradual pace.
Essentially, the city and the market aren’t convinced that empty offices downtown are here to stay.
“People would need to believe that office uses are going away,” said Louis Cornejo, president and CEO of Urban Group Real Estate. “You talk to 10 people you get 10 different comments. Are we really going to take a chance on our economy based on: ‘Well, it worked for a year or two?’”
tbd. no collapse yet because commercial leases typically last multiple years. Many leases are coming up for renewal in the next year, however. Might very well see a recession in commercial real-estate soon.
At least in NYC, many commercial leases are 20 or 30 years. I imagine WeWork gets similar terms. In highly appreciating markets (London, NYC) towards the end of such a long lease (the last ten years or so), the lessee is paying well under market rate, and the lease becomes an asset rather than a liability. So if office real estate continues an upward trajectory for a decade or so, they can easily weather a downturn if it occurs in the later part of their lease term.
If it happens in the next 3-5 years, it’ll probably be catastrophic for them.
That is not your typical company though. The typical company is leasing pretty cookie cutter office space in an office park or downtown. And many of those companies are not renewing many of their leases as they come up.
"... stuff that got financed five years ago, and probably has pretty decent loan to values given that the property values are in most cases up from where they were 5 years ago."
Yes, that is the hope - and the narrative - but we're not talking about a minor correction here ... like a 10% haircut on building values. I suspect the current market for office space in SF is probably ~40% off and that's for class-A space.
"... but unless rents fell off a cliff, has a bit of runway to play out."
Rents have fallen off a cliff we're just pretending they haven't by refusing to lease the space at the prices the market would actually clear at. Building owners and management, etc., would rather have empty offices than establish new, lower rents by actually renting them.
If they did actually rent the space at the market clearing price they would all get margin calls from their banks because their loan to value (LTV) ratios would blow up and their loans have covenants specifically calling out the LTV.
This cannot last forever.
Eventually someone is going to rent space at the market rates and building owners in SF will either need to show up at their bank with a 5 or 10 million dollar check ... or with the keys to turn in.
Tangentially related: I wonder what will happen in SF/NYC when more of the office leases have expired and the corporate property tax base erodes? How will the cities fund themselves?
Presumably by hiking residential tax rates and converting office space to residential, but the latter could take a long time…
SF commercial real estate genuinely feels like it's a slow-motion trainwreck that nobody can stop. As leases end, there's just no way that owners will be able to re-rent those buildings at anything close to the same price.
That seems like it's going to have two major consequences - when the values on those buildings fall, SF is going to lose a lot if income at a time when the quality of life is already greatly suffering there. On top of that, a lot of those buildings have large loans against them that may well become greater than the value of the buildings. The latter certainly feels like the sort of thing that could ripple through the economy as building owners have to sell off assets to make loan payments.
They are going to be screwed when there’s another recession, given that they don’t actually own the office space they rent out. This is a real gem:
“Substantially all of our leases with our landlords are for terms that are significantly longer than the terms of our membership agreements with our members. The average length of the initial term of our U.S. leases is approximately 15 years, and our future undiscounted minimum lease cost payment obligations under signed operating and finance leases was $47.2 billion as of June 30, 2019.”
Absolutely agree. There are still plenty of companies out there who have the relevant covenants and ability to sign that 3 year lease.
However, as the economy evolves and high growth companies companies become the norm the number of people willing to commit to a 3 year lease will start diminishing. This not just because they are not able to forecast their financials, but they are not able to forecast their staff numbers either.
It's an interesting time for commercial property and it'll be intriguing to see how this plays out.
> About 700 office leases are likely to expire in 2023 and another 600 are up in 2024 in the Financial District alone, said Avison Young’s insights and innovation head Dina Gouveia, for a total of about 10 million square feet of office space. In 2025 and 2026, another 10 million-plus square feet are likely to expire.
https://therealdeal.com/sanfrancisco/2022/10/17/downtown-sf-...
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