Blackstone Deal Hammers San Francisco Commercial Real Estate

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Signs of a bust pile up.

Private-Equity firm Blackstone Group is planning to acquire Market Center in San Francisco, a 720,000 square-foot complex that consists of a 21-story tower and a 40-story tower.

The seller, Manulife Financial in Canada, had bought the property in September 2010, near the bottom of the last bust. In its press release at the time, it said that it “identified San Francisco as one of several potential growth areas for our real estate business and we are optimistic about the possibilities.” It raved that the buildings, dating from 1965 and 1975, had been “extensively renovated and modernized with state-of-the-art systems in the last few years….” It paid $265 million, or $344 per square foot.

After a six-year boom in commercial real-estate in San Francisco, and with near-impeccable timing, Manulife put the property on the market in February with an asking price of $750 per square foot – a hoped-for gain of 118%!

Now the excellent Bay Area real estate publication, The Registry, reported that Blackstone Real Estate Partners had agreed to buy it for $489.6 million, or $680 per square foot, “according to sources familiar with the transaction.” The property has been placed under contract, but the deal hasn’t closed yet.

If the deal closes, Manulife would still have a 6-year gain of nearly 100%. But here is a sign, one more in a series, that the phenomenal commercial real estate bubble is deflating: the selling price is 9.3% below asking price!

The property is 92% leased, according to The Registry. Alas, among the largest tenants is Uber, which recently acquired the Sears building in Oakland and is expected to move into its new 330,000 sq-ft digs in a couple of years, which may leave Market Center scrambling for tenants at perhaps the worst possible time.

It’s already getting tough.

Sublease space in San Francisco in the first quarter “has soared to its highest mark since 2010,” according to commercial real estate services firm Savills Studley. Sublease space is the red flag. Companies lease excess office space because they expect to grow and hire and thus eventually fill this space. They warehouse this space for future use because they think there’s an office shortage despite the dizzying construction boom underway. This space sits empty, looming in the shadow inventory. When pressure builds to cut expenses, it hits the market overnight, coming apparently out of nowhere. With other companies doing the same, it creates a glut, and lease rates begin to swoon.

So Manulife might have seen the slowdown coming:

Tech layoffs in the four-county Bay Area doubled for the first four months this year, compared to the same period last year, according to a report by Wells Fargo senior economist Mark Vitner, cited by The Mercury News, “in yet another sign of a slowdown in the booming Bay Area economy.”

Announced layoffs in the counties of San Francisco, Santa Clara, San Mateo, and Alameda jumped to 3,135, from 1,515 in the same period in 2015, and from 1,330 in 2014 — based on the mandatory filings under California’s WARN Act. But…

The number of layoffs in the tech sector is undoubtedly larger, because WARN notices do not include cuts by many smaller companies and startups. In addition, notices of layoffs of fewer than 50 people at larger companies aren’t required by the act.

The filings also don’t take attrition into account – when jobs disappear without layoffs. “There is a lot of that,” Vitner explained. “When businesses begin to clamp down on costs, one of the first things they do is say, ‘Let’s put in a hiring freeze.’ I feel pretty certain that if you had a pickup in layoffs, then hiring slowed ahead of that.”

And hiring has slowed down. According to Vitner’s analysis of state employment data, Bay Area tech firms added only 800 jobs a month in the first quarter – half of the 1,600 a month they’d added in 2015 and less than half of the 1,700 a month in 2014.

“Employment in the tech sector has clearly decelerated over the past three months,” he said. “As job growth slows and the cost of living remains as high as it is, that’s going to put many people in a difficult position.”

It’s going to put commercial real estate into a difficult position as well. During the boom years, the key rationalization for the insane prices and rents has been the rapid growth of tech jobs. Now, the slowdown in hiring and the growth in layoffs come just when the construction boom is coming into full bloom, and as sublease space gets dumped on the market.

Here’s what a real estate investor — at the time co-founder of a company they later sold — told me about real estate during the dotcom bust. All tenants should write this in nail polish on their smartphone screens:

It was funny in 2000 because the rent market was still moving up. We rejected our extension option, hired a broker, and started looking around. As months went on, we kept finding more and more, better and better space while our existing landlord refused to renegotiate a lower renewal. We went from a “B” building to an “A” building at half the rent with hundreds of thousands of dollars of free furniture.

The point is that tenants are normally the last to find out that rents are dropping.

“All it takes is a couple of big tech companies folding and the floodgates open, causing the sublease market to blow up, rents to drop, and new construction to grind to a halt,” Savills Studley mused in its Q1 report on San Francisco. Read…  “Market is on Edge”: US Commercial Real Estate Bubble Pops, San Francisco Braces for Brutal Dive

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  35 comments for “Blackstone Deal Hammers San Francisco Commercial Real Estate

  1. NotSoSure
    May 15, 2016 at 6:31 pm

    One of the unicorns, Lending Club is close to death IMHO, but it’s not strictly a tech company, more like a finance company wanting a tech valuation.

    I wonder which tech companies would trigger the techapocalypse.

  2. polecat
    May 15, 2016 at 6:49 pm

    ooooo0ooooo000oooOOOOO (“POP”) ——————————-oooooo0oo0

  3. Bruce Adlam
    May 15, 2016 at 7:12 pm

    You would think blackstone was smarter than that .

    The more things change the more they stay the same

    • Petunia
      May 16, 2016 at 10:18 am

      You forget that they are wasting spending investor money.

      • Petunia
        May 16, 2016 at 10:21 am

        You forget that they are wasting spending investor money.


        • d'Cynic
          May 16, 2016 at 3:47 pm

          My thought, too. The maddening thing is that this could be a smart hedge against helicopter money.

  4. dave
    May 15, 2016 at 7:36 pm

    what i find very interesting with real estate, as of late is. I am seeing a lot of stories online about celebrity houses, going up for sale. don’t know why but I think they are looking to get out and cash in on sales of their expensive properties. im looking to do the same. sell now rent for a while then buy back for less than I sold.

    question for you wolf, what is the average American spending for health care every month, either on insurance or perscriptions non cover procedures? how much does this eat away from disposable incomes? I am Canadian and don’t have much of these costs. I remember reading something about the high rates of bankruptcy from medical bills. I find if fascinating.

    • frederick
      May 16, 2016 at 2:07 am

      How people can afford homes is beyond me i sold 2 years ago(a bit early) but wouldnt buy back unless i got a 50% discount as İ believe the US standard of living is in for a big correction to the downside and doubt that there will be a very good market for single family moneypits for a long time

  5. Cookie 2
    May 15, 2016 at 9:16 pm

    Wolf will likely be right on real estate, but for the wrong reason. The catalyst for the implosion will not be economy, but a president Trump.

    West Coast commerical as well as residential real estate are being heavily influenced by foreign investment. Once the foreigners realize that they are no longer ‘welcome’ it may hit harder than anyone has forseen.

    Looking forward to moving out of my shipping container.

    • May 15, 2016 at 9:32 pm

      I’ve already heard from a broker (residential RE) here that the Chinese money “has dried up.” No data yet to confirm it. But that’s what he sees.

      Chinese investors buy about 5-7% of total residential RE in SF – so that would be an additional shock.

      • d'Cynic
        May 16, 2016 at 3:33 pm

        The Chinese investor has moved to Vancouver, Canada. Still lower prices, and much softer political environment.

    • frederick
      May 16, 2016 at 2:09 am

      haha but İ doubt Trump will be as onorous as he espouses İ truly believe alot of what he shouts is simple pandering to his angry base

    • Kevin
      May 16, 2016 at 3:05 am

      Foreigners are welcome. Foreign investment is especially welcome. But unless you actually believe that the illegal fence-hoppers streaming across the border are tech engineers headed for Silicon Valley, it’s hard to see what you’re talking about.

  6. Agnes
    May 16, 2016 at 1:02 am

    Perhaps Blackstone can hold the property and wait for the next boom…like McMansion owners are told to do.

    • frederick
      May 16, 2016 at 2:11 am

      By the time the next boom comes if it ever does those McMansions will most likely be stripped bare by the starving marauding zombie crowd Count on it

      • bead
        May 16, 2016 at 10:02 am

        The McMansions will be re-purposed a la Dr Zhivago. Too far away from anything the cultured crowd wants but close by the McJobs.

      • Chicken
        May 16, 2016 at 7:15 pm

        And this explains why the FED cannot raise rates, no? I keep thinking the yield curve is flattening in anticipation of the FED going further out to the long end.

        Bankers are the ultimate Slick Willie, operating in complete stealth and always misleading the crowd.

  7. Agnes
    May 16, 2016 at 1:20 am

    Since 1986 everytime the inventory to sales ratio has gone up the banking system has gotten help from friends in Washington…no doubt Blackstone can expect some free money via their bankers. Where else will they spend it? When the economic numbers are bad the DJIA goes up because “people know” the Fed won’t raise rates.

    • frederick
      May 16, 2016 at 2:13 am

      At some point(I believe in the not too distant future) the market will delegate the rates and they will go alot higher so be careful what you wish for END THE FED

    • bead
      May 16, 2016 at 9:56 am

      Where will they spend it indeed? We need a little scare to shake off the little chumps who are hanging onto their overpriced real estate. Then scarf up the foreclosures and rent them out. Fed stands ready to lend. This is a potentially very profitable opportunity and Congress just does whatever the Fed says, which amounts to keep your nose out of important business where you lack the technological know how.

  8. ERG
    May 16, 2016 at 6:57 am

    Chinese money for RE has dried up? If that’s true, then it says more about the state of the economy in China than any statistic coming out of Beijing.

    • May 16, 2016 at 7:59 am

      The broker thought it had to do with the government crackdown on capital flight.

      • Chicken
        May 16, 2016 at 11:13 am

        Thus Congress needs to get busy and take action to form new pipelines necessary for resuming the capital flight.

        To heck with citizens, if they complain just threaten to raise their property taxes.

        This isn’t ending well for someone……

        • May 17, 2016 at 2:19 am

          Well, generally real estate cycles last 17 – 18 years. I think we’re in the middle of the cycle. We are not there yet. This could play out much longer than we would expect it to – just like the stock market.

      • May 17, 2016 at 2:16 am

        That’s what I read, too. Chinese were funneling money through Macau and that was cut off.

  9. bead
    May 16, 2016 at 8:22 am

    This could be a great opportunity to fine tune the TARP technique. Once the big shot bond holders are holding over-valued stuff it’s time for the Fed to finance some extend-and-pretend. The stock market is relieved and rallies hard, a rip-your-face-off rally that destroys those morally bankrupt skeptics. Pension funds are relieved. Life insurance companies are relieved. The wealth effect leads to wonderful new credit opportunities. I take my anxiety medicine with a nice stiff toot and stop worrying about risk. Just believe in your technocrats.

  10. Ptb
    May 16, 2016 at 9:02 am

    Although prices have gone way up, you can still buy a house in many parts of the Bay Area and have a mortgage that’s close to what you’d pay in rent. Historically low interest rates are still helping the market. Rent parity in tha Bay Area has been almost unheard of from the 1970s on, but available since rates went to 4%.

    • Markar
      May 16, 2016 at 9:21 am

      Even factoring those nosebleed property taxes?

    • Jus7tme
      May 16, 2016 at 9:22 am

      That is just another way of saying that rents have gone way up. But rents depend on jobs, not mortgage interest rates.

      • Chicken
        May 16, 2016 at 11:17 am

        When debt is free, you can pay your employees high wages for producing razor-thin returns Otherwise, you wouldn’t hire them in the 1st place?

  11. Chicken
    May 16, 2016 at 11:00 am

    Hedge accordingly, I guess.

  12. Shawn
    May 16, 2016 at 3:13 pm

    Apple invest a billion in Chinese Uber rival Didi, that is the spark that will crash all the unicorns.

  13. Akam15
    May 16, 2016 at 3:27 pm

    Property taxes in SF are insane. Almost as high as NYC. It makes very little sense to buy a condo in SF when you know prices will decline due to oversupply and every month your property taxes and HOA fees can exceed $5000. I’d rather rent and rent in NY

  14. fedor
    May 16, 2016 at 5:53 pm

    Regarding the Chinese investment in property:
    “…despite a slowdown due to Beijing’s subsequent clampdown on capital outflows, the figure for the second half of this decade is likely to double to $218bn, the study said.”

  15. May 17, 2016 at 1:09 am

    Chinese money seems to have freed the Reno, NV RE market too. For about 4 years homes were being sold before an agent could come put out a yard sign. I’m starting to see signs on the side of the road and properties which had $200k+ comps a year ago are now sitting unclaimed at $150k.

    Our local economy fundamentals are good. We’ve been attracting a lot of new companies and yet… it’s nice to see that home prices are starting to return to where a reasonable person could afford to save up money and buy.

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