What It Will Take To Revitalize U.S. Commercial Real Estate (CRE) In 2023
As summer slides into fall this year and children can still be chastened by the prospect of going back to school, the parallel tradition of going back to the office is more different now, for more people, than ever before.
In the arena of commercial real estate (CRE), those who understood and embraced the desired workplace trends that existed prior to the start of COVID-19, and have since greatly accelerated due to the pandemic, will be the ones who position themselves – and their stakeholders – ahead of the curve.
To many, the landscape looks bleak – According to a recent report from Capital Economics, commercial real estate values have cratered by up to 40 percent in some cities. The tech office hubs that have benefited from the greatest value run-ups over the last decade have seen value decreases certainly in excess of 40%.
While many point to the pandemic-induced lockdowns that led to massive increases in ‘working from home’ as the root cause and main impetus behind urban office downsizing, plenty of other factors are at play.
Among the negatives are the increasing costs and logistical challenges of raising a family, the alleged ‘ease of doing business’ in the era of the Internet of Things (IoT), the breakdown of law and order in urban landscapes, and very importantly, the sterility of traditional office and retail store environments; think partitions, terminals, little natural light, and no view. The post-pandemic rise in interest rates and escalating inflation only add to the difficulties of keeping downtown work an attractive option.
And let’s face it – At first glance, San Francisco could be seen as a poster child for CRE disillusionment in America.
Let’s look at, for example, the significant downtick in the city’s travel and tourism space – An announcement was recently published by a major hotel operator suggesting that it was ceasing payments on a $725 million loan on two of its downtown hotels. There are further reports that a commodity downtown office building that was valued in the mid $700 /square foot (sf) 24 months ago has traded hands at values of $150-250/sf.
But San Francisco is hardly the only U.S. city facing massive declines in the value of downtown office space. One only has to look at the public sector office REIT values, which are down 47% since year-end 2021. The REIT sector is now trading at an implied cap rate of 9.2%. Private market values are a bit more opaque than the public sector, but the two trend surprisingly close during periods of rapid transition.
When borrowing costs triple over a 12 month period, one should expect to see a dislocated CRE market across all asset types – this is precisely the case today.
Just last month, The Atlantic reported that U.S. office vacancy had topped 20 percent for the first time in decades during the first quarter of 2023. Vacancy rates were as high as 25 percent in San Francisco, Dallas, and Houston. The actual availability rates are much higher when sublease space is factored into the stats.
Worse, actual office use was still below 50 percent of pre-COVID levels in the nation’s ten largest business districts, with white-collar workers spending an estimated 28 percent of their workdays at home.
And with a third of all office leases expiring by 2026, things could quickly get much worse for city budgets, banks, and pensioners.
Yet while many espouse ‘doom and gloom’ in the industry, the intrepid have always found opportunity – Amid turmoil, our innovative, Western US-based commercial real estate platform sees a clearly defined silver lining.
Drawing on four decades of capitalizing on bearish, even hyper-bearish commercial real estate (CRE) markets, we envision one of the most favorable CRE buying opportunities over the next 18 months and beyond, not seen since the RTC days of the early 90’s.
SteelWave has always focused on Western US markets with a heavy orientation in tech industries. In fact, our market footprint includes headquarters for 15 of the 20 largest tech companies in the world, and 6 of the top 6. Our markets house the innovation workforce that is the backbone of traditional tech, media tech, biotech, defense tech and creative tech.
Today’s tech companies are driven by fully integrated teams, with engineers and marketing experts collaborating side by side. The challenge, however, lies in luring home-bound workers back to the “hive” – It is no coincidence that analysts are seeing long-term work-from-home solutions as link to a significant dip in productivity, when measured against the pre-COVID productivity trend line.
In many businesses, there is a clarion call for change in the workplace. Our experience tells us that bringing workers back to a shared workplace requires changing the environment to meet the new reality and collaborative work-best practices of 2023.
The best way to accomplish this is to create a collaborative, creative, and joyful work environment, with all the modern amenities at hand – more like a high-end hotel. The best workplaces are in buildings that have ‘good bones’ – soaring ceilings and open spaces that can be transformed into livable environments.
Our stakeholders view commercial real estate as a strategic asset that they can brand around, as opposed to a cost center. The secret sauce blends hospitality and residential design elements to deliver a work environment that promotes innovation and creativity, as opposed to drudgery and boredom.
To accommodate for these changes, SteelWave has integrated elements of hospitality and residential design into our properties, including next-generation amenities such as fitness and wellness centers, curated food and beverage options that speak to the culture of the surrounding neighborhoods, tenant community indoor/outdoor spaces and state of the art conference facilities. All these enhancements serve to lure quality workers out of their home offices, and into the creative hubs that provide social and professional collaboration and energy.
It may take a few election cycles for cities to fully respond to some of the self-inflicted social challenges, negative perceptions, and the resulting loss of revenues from downtown real estate that no longer serves the needs or wants of modern-day high-tech and other innovative industries; however, we see green sprouts that the trend line is moving in the right direction.
True urban downtown renewal, though, will require the will to recreate safe spaces within which innovative real estate developers can encourage employers and housing providers to capitalize on the lowered property values to redesign facilities today, to meet tomorrow’s needs.
CRE isn’t the only asset class that is undergoing a rapid transition – The world of digital securities is transitioning at an equally frenetic pace from the standpoint of regulatory oversight, custodial infrastructure and most importantly, market adoption. All of this is ushering in a brave new world of fractional asset ownership – the democratization of all sorts of asset classes, not just CRE.
Think in terms of a convergence of blockchain-enabled ownership solutions and institutional asset ownership. SteelWave saw an opportunity to take a leadership position in this convergence.
SteelWave has created an investment vehicle that allows institutional investors the option to convert their traditional LP interest into digital securities at a future date when the digital ecosystem has matured to a level where it can provide the potential of seamless secondary liquidity.
As one of the leaders in this space, we have had to work through a great deal of regulatory, compliance and tax related complexities relating to both the GP and our institutional investors. This vehicle has been embraced primarily by foreign investors, those who want to invest in US institutional RE and those who have a bit more progressive view on tomorrow’s world of capital markets.
The U.S. regulatory environment is at least five years behind the curve in creating a conducive playing field for digital security offerings – who can and can’t own them, who can and can’t sell them, and who can and can’t provide custodial services. This lethargy is partly because multiple industries heavily invested in our current system are not welcoming competitors whose instruments require far less paperwork, and can move money across multiple investments in a far shorter timeframe.
But make no mistake – with a necessary and common sense realignment, the potential for American urban reinvestment in CRE, both physical and digital, is boundless.
SteelWave believes that the time is right to marry the current opportunity to acquire transformative CRE in a dislocated market to the digital universe that is rapidly maturing into an institutional force.