Doom loop opportunities? San Francisco real estate investors bet long on city

Good things come to those who wait.

That's the mantra of those currently investing in San Francisco’s struggling commercial real estate market. 

Glenn Gilmore, the founder of the San Francisco-based developer Brick & Timber Collective, largely took a break from work in the city during the pandemic. Instead, mirroring a trend of remote workers, his company took a sojourn out east where it purchased three buildings in Miami’s hip Wynwood neighborhood. 

But now he’s back and in a big way.

Brick & Timber has raised a fund specifically to invest locally, with plans to eventually spend some $500 million to purchase office buildings in San Francisco.  

“I actually think I’m late,” Gilmore said. “I finally got the traction for this fund, but I’m like ‘it should have been a year ago.’ I’ve been saying it for two years like a crazy person, but I think that this is the best real estate buy in America in any class, in any category.”

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Brick & Timber has traditionally focused on rehabbing historic midsized office buildings in and around Jackson Square, but it is setting its sights wider this time around.

The bulk of the company’s tenants are private equity firms or family offices that have largely stuck around. Gilmore said after weathering the uncertainty during the early days of the pandemic, the company’s nine properties in San Francisco are nearly fully occupied. 

Some of the early capital in Brick & Timber’s new fund is coming from investors with higher risk appetites like family offices and tech money, but institutional real estate firms are slated to make up the bulk of its financing. In the current environment, cash is king. 

The real estate market has been hit with a one-two punch of lower demand and rents due to remote work, alongside higher borrowing costs from rising interest rates. There are also daunting local metrics like record-high vacancy rates that recently hit 34% per CBRE and a growing number of building owners defaulting on their debt or giving up their keys to their lenders.

Instead of taking those factors as reasons to stay away, Gilmore said he’s zagging against the negative media narrative. A student of history, Gilmore said San Francisco’s story has rapidly vacillated from boom to bust and back to boom again. This down cycle, in his mind, is no different, though it may take longer to dig out of. Moving fast and having patience then is key. 

“There’s a bright line between those who believe and those who don’t,” Gilmore said. “The investors that see through it and haven’t been too burned have an opportunity to look pretty smart here.”

But the short-to-medium-term will be ugly for many, particularly property owners in undesirable neighborhoods and those who purchased at the peak of the market and are seeing loan payments come due with little hope of refinancing. 

Gilmore added he believes there’s an opening for construction companies that are able to drive their bids down to win jobs in a city where work opportunities are currently in short supply. His firm has brought more construction work in-house because San Francisco building costs are among the highest globally. 

A survey from consulting firm Turner & Townsend ranked San Francisco as the second most expensive city to build in the world at $483 per square foot, just under New York and ahead of Geneva, Zurich and Tokyo.

“We’re getting to a breaking point,” Gilmore said referring to construction costs. “The new deals are going to be lean, they’re going be competitive and they’re going to be creative.”

Uncertainty about where exactly property values have landed has hampered the volume of buildings trading hands. But those data points are starting to get filled in. A handful of recent examples are large downtown office towers selling at bargain bin prices:

The price declines are indications of a broader real estate reset that includes a widespread revaluation of buildings, which is likely to bludgeon city tax revenue. But the lower prices also mean a silver lining for those who are able to pay cash and have the luxury of patience.

“San Francisco is on a fire sale, and that’s largely due to people that aren’t here who are writing us off,” said Cyrus Sanandaji, the CEO of Presidio Bay Ventures. The company bought 60 Spear St., an 11-story office building built in 1967, with the aim of upgrading amenities at the property and renting it out at top-tier prices. 

Sanandaji said the city’s high commercial vacancy rate becomes a bit more palatable when looking specifically at trophy properties Downtown away from no-go zones like Mid-Market, Civic Center and the Tenderloin, which have been struggling under the weight of public safety concerns and the fentanyl crisis. 

“It’s one of those things where it was $200 a foot and I said, ‘I got to buy that thing, there’s no way that won’t work,’” Stein said. “When you’re young, you say things like, ‘it will never come back.’ Never is a pretty long time.”

In some respects, Stein’s strategy is the opposite of Presidio Bay’s tactic. Essentially, the idea is to charge bottom-of-the-barrel rents that can undercut the current market in a bid to nab cost-conscious tenants. 

Recently, there have also been a few examples of what can be termed “boomerang buys” where owners are repurchasing properties, at a discounted price, that they previously sold off for profit. 

North Park SF, an office complex in Jackson Square, was sold by Gaw Capital to Blackstone Group in 2018 for $245 million. Just five years later, sources say Gaw Capital was chosen to repurchase the property for around $90 million—two-thirds less than the previous price. That was even after Blackstone made major investments in the property. 

“We effectively wrote this investment down to zero last year given the well-known headwinds facing U.S. traditional office buildings and the downsizing of the property’s primary tenant in a market with historically high vacancy,” Blackstone said in a statement. 

Alongside the North Park sale, Blackstone also sold a commercial office building at 600 Townsend St. back to LBA Realty. LBA Realty bought back the five-story property for $25.3 million after selling it to Blackstone in 2015 for $50.5 million. 

Blackstone has steadily shed office properties in an effort to rid itself of bad debt and says “traditional U.S. office” space now represents less than 2% of its owned portfolio. LBA Realty, on the other hand, is rumored to be in the market to pick up additional properties. 

Some real estate observers even raised the potential of building owners choosing to give their properties up to lenders before coming back in to repurchase the asset at a lower cost. 

That scenario has not played out just yet, but real estate sources report a number of property owners are in negotiations with lenders to reduce their debt and potentially lower the value—the “basis,” in real-estate speak—of their buildings. One strategy is to quietly float a property for sale and get a general range of what the market will bear before returning back to the lender with a grimace and a shrug. 

Most real estate observers expect that distressed or short sales—sales at prices lower than the debt owed on the property—will make up much of the market for the near future. 

A growing number of landlords are defaulting on debt on their San Francisco properties including Jamestown L.P, Columbia Property Trust and Veritas. But these are merely the initial dominos to fall, some say. 

“More and more owners have come to the conclusion that the market recovery is going to take some time,” said Mark Geisreiter, a commercial real estate broker with Newmark. “A hope and pray strategy has turned into ‘do what I need to do to fight another day.’”

One example of a person shifting his business in line with that new reality is Brad Blake, the co-founder and managing partner of Blake|Griggs Properties. Blake, who has four decades in the industry, is preparing to take advantage of what he predicts is a forthcoming epidemic of loan defaults. 

“A strategy of hope that the office market will get better probably isn’t a very smart one,” Blake said. “People are kind of stuck. So you either give the building back to the bank or if you have some capital and some fortitude, you try to figure out if there’s another alternative for it.”

The lack of financing available means cash buyers are waiting for the “point of capitulation” by building owners before deals are struck, says Blake.

Blake’s company is mainly focused on the development of mixed-use properties, that is, buildings that offer some combination of retail, residential, office, medical and other space. But it also has an advisory arm that is whirring into gear. The firm has extensive experience working as a court-appointed third-party receiver for distressed properties.  

Blake recounted a recent conversation he had with a representative of a major bank who helps run the bank’s division that focuses on foreclosed properties.

“His comment was, ‘I can see a tidal wave forming somewhere out in the Pacific Ocean, but I have no idea how big it will be or when it’s going to hit the shore,’” Blake said.

Blake has seen this movie before. During the Great Financial Crisis of 2008, lenders found themselves overwhelmed and calling firms like his for help. This time, he expects it won’t just be lenders but also building owners looking for advice on potential conversions of office properties to residential uses, industrial space or other types of workplaces. 

Some of the buy-low-and-hold mentality in commercial real estate has also proliferated among savvy investors in the city’s residential real estate market, according to Alexander Fromm Lurie, a luxury residential real estate broker with Compass.

Lurie said some of his clients have been picking up Downtown condos—which have seen prices decline to levels not seen in nearly a decade—with the idea of holding onto the property for five or more years before seeking a return. 

“It is an objective, non-emotional purchase. They’re looking back at historic data and extrapolating what they think the market will do,” Lurie said. “They might buy up various units across various buildings they feel are a really interesting entry point.”  

Just as commercial real estate firms are looking for properties in distress to pick up, Lurie said he has clients who are finding condo owners facing ballooning mortgage payments and offering to take the property off their hands.

“The commonalities are that these are people who have confidence in San Francisco and are bullish on San Francisco real estate,” Lurie said. “There's no shortage of opportunities for opportunistic buyers right now.”