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San Francisco among most vulnerable cities to plummeting real estate values

Pedestrians walk by a boarded-up building on Sutter Street near Union Square in San Francisco on June 26, 2023. | Source: Isaac Ceja/The Standard

San Francisco is a ways off from the bottom when it comes to shrinking office values, according to new reports. 

According to a July report from McKinsey Global Institute, San Francisco is a “superstar” city, given its disproportionate share of global gross domestic product. The bad news is that it’s exactly these superstar cities that are most vulnerable to plummeting real estate values.

The report from the research arm of the management consulting firm McKinsey and Company adds to a growing body of research attempting to quantify the negative impact of remote work on San Francisco and other major business centers.

A study released this month by economic research firm Capital Economics found that San Francisco "still has the poorest outlook" among peer cities across the United States when it comes to declining commercial real estate values. The research firm forecasted that San Francisco properties will decline in value by 40-45% between 2023 and 2025, edging out Seattle as the hardest-hit city in the study.

Capital’s research builds upon the results of a 2022 paper entitled “Work From Home and the Office Real Estate Apocalypse,” best known for helping to coin the idea of the urban doom loop. That paper estimated $32.7 billion in lost value for San Francisco properties between 2019 and 2022. 

According to Capital’s forecast, demand for San Francisco office space will continue to slide for at least the next three years. 

McKinsey similarly projected falling demand for office and retail spaces, laying out a 20% drop in demand between 2019 and 2030 in a “moderate scenario.” In a more severe scenario, demand could fall as much as 42% in the San Francisco metro. That compares with a projected 13% drop globally in a moderate scenario.

McKinsey reported that between 2019 and 2022, transaction volume fell by 79%, sale prices were down 24% and asking rents were 28% lower than 2019 numbers. That has led to the negotiation of shorter leases, which negatively impact property values and make financing more difficult for landlords.

San Francisco’s tech-dominant economy and office-dense Downtown have been barriers to recovery, the report notes. 

According to real estate firm CBRE, the office-vacancy rate in San Francisco currently sits at a record-breaking 31.6% and is expected to continue to rise. A string of major retailers have also left their Downtown flagship locations or have decided to downsize their spaces, including Nordstrom and Old Navy.

San Francisco officials have tried to fill the vacancies that line Downtown and other commercial corridors through programs like Vacant to Vibrant, which offers space to pop-up tenants and grants to help entrepreneurs defray leasing costs for bricks-and-mortar locations. Officials are also implementing a vision to add housing, entertainment and other uses to vacant Downtown office buildings and potentially changing the tax code to make the city more business-friendly. 

McKinsey’s report echoed some of those efforts, suggesting creating more mixed-use neighborhoods and flexible, “neutral-use” buildings that can be easily modified to serve different uses.

Office-to-residential conversions, however, are likely to be only a small part of the solution. McKinsey reported that if all excess office space was converted into residences by 2030, San Francisco’s housing stock would only increase by 1.5%.

“It is not hard to imagine more ‘hybrid floors’ in which offices, residences, and stores exist side by side. For floors—as for buildings and neighborhoods—turning empty spaces into hybrid places may not simply be a way to counter the damage wrought by the pandemic,” the report states. “It could be a way to transform superstar cities and prepare them for a dynamic, prosperous future.”

Kevin Truong can be reached at kevin@sfstandard.com