Now there’s a new wave of investor-funded tenants in town that are swimming in cash: AI companies.
By Wolf Richter for WOLF STREET.
What’s an older office tower in San Francisco worth? 75% less than in 2019, per the latest transaction in San Francisco, once the hottest and most overpriced office market in the US. And there have been quite a few of those kinds of transactions over the past two years. Everyone knows the drill.
Back in June 2019, at about the peak of San Francisco’s office market, e-cigarette startup super-unicorn Juul Labs, on the eve of its collapse, purchased the entire 29-floor 360,000-square-foot office tower at 123 Mission St., in San Francisco, for $397 million, for its future headquarters and planned to grow into it over time. The tower was built in 1987. Square Mile Capital Management, which is now Affinius Capital, provided a $220 million loan to fund the purchase.
At the time, Juul was swimming in money and had a sky-high valuation because it was going to change the way people smoked and expand the number of people who smoked: A few months earlier, Altria Group, the cigarette maker, had plowed $12.8 billion into the startup for a 35% equity stake in a round of funding that totaled $13.6 billion and gave the startup a valuation of $38 billion.
Then Juul got tangled up in all kinds of legal problems, and its business collapsed, and its valuation collapsed. Altria ended up writing off most of its investment. What was left of Juul departed San Francisco in a huff. The office tower began to empty out and today is 87% vacant. And Juul has been trying to sell it, but couldn’t, and likely stopped making payments on the loan.
Now New York-based Madison Capital and PGIM, the investment arm of Prudential Financial, reached a deal with the lender to purchase the debt on the building, according to the San Francisco Chronicle, citing sources. Holding the debt will allow them to take possession of the building via a foreclosure or a deed in lieu of foreclosure.
The price of the debt, and thereby the building, was in the “low $90 million” range, according to the Chronicle, citing Madison’s head of acquisitions.
That price represents a discount of about 75% from the transaction price that Juul had paid in 2019.
Even as these kinds of transactions at discounts of 60% to 80% continue to occur in San Francisco, there is a fresh wave of office-tower tenants in town, despite all the talk about tech layoffs: AI companies, which are not swimming but drowning in money.
In January, Anthropic leased the entire 25-floor, 420,000-square-foot tower at 300 Howard St. and plans to move into it in 2027 and grow into it over the long term. So let’s keep the circular AI dollars spinning for as long as possible, in the hope that some of these largely empty office towers can find some investor-funded tenants?
In case you missed it: Construction Spending on Data Centers, Factories, Powerplants, and Office Buildings: Boom, Bust, and in Between
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I just keep wondering about the collapse of the tax base. Does SF have a viable plan?
Based on my experience, CA’s state and cities (maybe mostly the cities) seem to not see their policies as failures. The only failure is their policies weren’t done enough.
It’s why they always ask for more money when they fail to meet obligations with previous allocated monies.
Luckily, they are a beautiful coastal town with a global port and amazing surroundings, and that can recover much better than some rust belt city
There is a huge ugly deficit (of nearly $1 billion over two years) in the gigantic ugly ever-ballooning budget. The mayor ordered some staff cuts that wouldn’t be nearly enough to eliminate the deficit. But everyone else seems to be resisting any cuts. Long-term, the City is encouraging the conversion of some office properties into residential, and has made a variety of changes to make that easier, but conversions are hard and take years. The problem with the budget is that SF has always had way too much money. it just sloshes around everywhere. That breeds decades of budgetary excesses into City Hall that no one can stop.
Why not turn them into ICE detention centers? You wouldn’t have to put in all the amenities required by housing codes. Just knock all the walls down and put wall to wall cots with a few showers and rest rooms.
Because it’s still, even after the correction, the most expensive real estate in the U.S.
Enlightened libertarian,
Nope.
That shipped sailed.
But SF is Wolfs hometown. He would know for sure.
Petaluma is offering Wolf refugee status. Will he join me in Petaluma?
Only time will tell.
More importantly, did the ENTIRE Clown Altria senior management and Board of Directors get the boot from wasting $12.8 Billion on Juul and ultimately writing off the investment? Probably not! That has to be one of the largest VC type investment failures in Silicon Valley history. Juul must have had some great salesmen to dupe Altria. Did investors file a lawsuit against Altria management as I don’t recall hearing anything about that disasterous investment? Altria management should be ashamed….
Something like 70% of mergers fail to achieve their objectives.
Well, except for justifying higher executive compensation that is!
Shareholders typically flee, driving down stock prices.
EMPTY OFFICE BUILDING…
So much for Safe, Dependable, Positive Cash Flow (Dividends), REITS…
And to think I had it all figured out…
Back to the drawing board.
At first I thought this story was another Greek tragedy, but then I researched what Juul is….
Now I know it’s a happy story where the villain gets what’s coming to it.
Then again, I don’t smoke cancer sticks.
There seems to be a number of companies operating that seem like they would not have been allowed 20 years ago. Smoking and gambling companies are making a fierce comeback in the disguise of mobile convenience and get brownie points for market share “disruption”. Although that is a moral issue for a different site.
The SF market does seem to be hiding its CRE implosion relatively well. You would never know that the CRE market is churning based on the foot traffic.
“75% off!! Come and get it!” Now if we can only repeat this same scenario with ALL of the MASSIVELY OVERPRICED homes with FANTASY valuations.
a sweet condo in jack london waterfront hood in oakland i sold in 2019 is cheaper than what i payed for it in 2015. might have to buy it back in a few more years.
I stayed in the Bay Area about a month ago and the AI euphoria is everywhere. Companies are flush with cash. There’s this sense that the good times will never come to an end. People are buying housing while it’s still better to rent in many cases. What could go wrong?
Yes, this euphoria and amounts of dollars involved are scary. This is going to get rough. I think the Dotcom Bubble was tame compared to what is happening now.
What do you think the catalyst will be that brings it all down? Im thinking the Open AI IPO. When their numbers become public I believe it will be shocking to say the least.
> When their numbers become public I believe it will be shocking to say the least.
Disagree, tech companies with hyper growth have regularly been given a pass by financial markets as long as the growth story is in tact.
> catalyst will be that brings it all down
1) Energy crisis in East Asia if the Middle East situation doesn’t get resolved soon (not looking likely)
2) Pull back in non-AI corporate spending on AI initiatives due to a lack of ROI on projects.
Either one would send the markets down, combined it will be something one must patiently wait for years for.
My guess, not all tech companies are going to win the AI war, it may be a winner take all scenario, or maybe one or 2 out of the 8 or so will win and the computer assets they are buying may be near obsolete in a 2 year time period.
Either that or they might find that they can’t monetize it fast enough for what they invested into it. They aren’t just paying out of cash flows, they are taking loans, selling stock, taking 3rd party investor money to fund these datacenter. If they don’t get significant returns from investment in a short amount of time, they will have missed their window.
there is gonna be some wonderful cap rates to be had after we get through this recent umpleasantness. operation epstein fury is gonna make the 1965 to 1981 sixteen year stagflation look like child’s play. By all metrics from currency, to infrastructure, to debt and culture we are gonna bust up into 50 state solution next few years. Crumbling empire 101. Time to embrace it like the spanish empire did in 1898
This isn’t zero hedge
Speaking of ZH, what ever happens to these people who invest based on political rhetoric and biased panic media?
You’d think they’d just go broke and disappear into the low-wage elderly workforce.
My guess is ZH is populated by social security beneficiaries who take a portion of each check and day trade it. Then gripe on ZH when most trades lose money. The goldbugs however, have been having a great time lately, provided they stayed in gold after the last election negated the need for it in their minds.
WTF are you typing about kid. actually, don’t answer. don’t give a hoot. peace
The most important observation is just how delusional valuation measurements can be at any given point in time.
CRE is likely somewhat more vulnerable to these valuation delusions (b/c it is moderately harder to model current/likely future cash flows supporting the valuations) but essentially every asset class is vulnerable – too many people (including alleged investment pros) seemingly can *not* endure having liquid funds burn a hole in their pocket – so they gamble on some hard-to-justify asset valuation.
The worst is over-valuation in the equity markets (which can jump around very, very quickly) – overvaluation there has been at the 2x-3x level since 2015 or so.
It is fairly amazing that in this day and age, when valuation model structure info is widely and easily available via the internet, that millions more-or-less blindly pump their retirement savings into 401k auto-destructs.
In the end, I suppose it is a relative lack of semi-safe, widely-available investment alternatives.
Agreed! Imagine if treasuries and savings accounts, or even checking accounts, paid reasonable interest? How different a world this would be.
I’m (not so blindly) “pouring” into a 401k. As B4B says basically TINA!
I have a “high yield” savings account that yielded over 4% when I opened it, less than a year ago and it’s been dropping ever since!
I moved half my 401k into a “bond fund,” that nobody actually knows what’s in it! It’s a system of funds-of-funds for guaranteed management fees.
The alternative? Save nothing, negate the small tax “advantages” that are offered, pray for a big inheritance?!?
I’m Struggling too….
The financialization of the American economy has corrupted every corner of society. Sociopaths reign supreme throughout. The ability to “make” excessive and grotesque levels of wealth has destroyed much of what made the country great in the first place.
All true, but we voted based on the price of eggs, remember?
I also remember: My “vote” Matters!?
I’m surprised one of those Juul’s batteries didn’t catch fire and burn it down.
I love the articles for a couple reasons:
~In this case a villainous company lost its shirt.
~Reading about these loses makes my heart smile- it’s a reminder that consequences for bad decisions do exist.
This isn’t totally malicious, it’s an important lesson for investors to be reminded that unicorns and fairies don’t exist, investors beware.
Good — Commercial real estate sector needs an enema, “Mallpocalypse” style.
Ok, call me confused, but Anthropic is going to “grow into” their 420k-sf offices over time? But, but….I thought AI was supposed to eliminate jobs and the need to hire real people and we were all going to become redundant?
/s
Steve…
I was kinda thinking along the same lines.
It does seem counterintuitive…..
I would think that AI companies especially, would need fewer employees over time, as a direct result of their own technology that they are developing. Yet they are investing in space with plans to grow and add more employees not less ?
Maybe we are missing something.
“grow into”
That’s exactly what every company (from now, back to the beginning of time) has said/thought about every marginal/dubious/way-too-aggressive “investment” in *anything* (although CRE tends to be on the uglier end of the spectrum since minimum investment “buy-in” tends to be huge).
See, also, especially – hundreds of billions in near term data centers for AI whose actual revenue models are so far, well, marginal.
It is like these “pros” simply *cannot* tolerate phased-in, test-the-waters, ramp-up – if there is money burning a hole in corporate pockets – it simply *must* be spent, in some enormous, bad-burrito, one-off dump of epic proportions.
Even more concerning, if these folks are so high-tech, how have they not figured out how to work from home? Do they not have Microsoft Teams?
Was wondering myself. Maybe they themselves know that the capabilities of their models are somewhat overhyped pre IPO. Maybe it’s like that time Amazon hired a bunch of people in India to watch Americans shop so that they could check out “automatically” 😆. Or maybe the big office tower in a major city is just the corporate version of “trophy wife in a convertible”
@Steve2wryt – I thought AI was supposed to eliminate jobs –
AI isn’t a thing or a noun.
AI isn’t THE business, it is the engine that drives MANY TYPES of businesses – including companies who are in the AI space.
To make an AI related business actually useful (and profitable), you still need the same fundamentals as any real business: PEOPLE, PLACES, AND STUFF.
Especially in real-world or regulated environments, AI doesn’t just “plug in and run.” It takes tuning, supervision, and constant iteration.
AI amplifies good businesses. It doesn’t replace them and businesses need space.
….I guess you missed the /s for sarcasm….
@Steve2wryt – I guess you missed the sarcasm
Hmm, apparently so did Huck, cas 127, Chris B and Seba based on their comments to your post.
Or maybe your little /s social media tone marker is out of place here. Jump back on X or IG and /s away.
They should outlaw Juul. It targets kids and the concept of one time use devices is a human-scale tragedy.
@ Skier – human-scale tragedy
Just like all social media – especially for kids.
@Wolf etc.,
Does anyone have any insight into why these proto-companies (i.e., young) are buying these buildings as opposed to leasing them?
Do they have some reit etc., arm within the companies or they are just infected with RE/MBA folks in upper management.
I mean, regardless of how much cash is swirling about, there are certainly some adults in these companies.
It is important to keep in mind that even in good times an empty office building will typically sell for “about half off” since there is zero cash comming in and there will be a lot of cash going out to pay leasing comissions and to cover the cost of TIs to fill the building.
If there is a loan to be lent, rest assured in the US a lender will be there everytime! It’s the ‘American’ way. What a system! Party on!
Now can you see why gold has gone up 18x in the last 25 years?
@Yappymutt – Pary On!
Indeed –
Gold went up because more money got pumped into the system.
That same money also blew up stocks, businesses, and real estate way more than 18x.
You seem to mock risk takers and lenders who move the economy but are fine owning an asset that only makes money if someone else is willing to overpay you later when you want to dump it.
Leverage isn’t about greed — it’s about speed.
The goal is simple: Use other people’s money to control assets that grow faster than the cost of borrowing and keep your capital working elsewhere.
It’s how you stop waiting and actually start moving.