Don't Break Out The Bubbly Yet, San Francisco. More Rate Cuts Needed To Kick-Start Local Loans

Around the country, office investment sales brokers broke out their party hats after the Federal Reserve lowered the federal funds rate by half a percentage point. But San Francisco brokers may want to keep their Champagne on ice until the new year — or even until next summer — as most lenders refuse to take a chance on financing any properties that aren’t fully occupied Class-A assets.

The 50-basis-point drop brought the federal funds rate to 4.75% to 5%, and the Fed says it is likely to make two more cuts this year and four in 2025. While rate cuts might free up some liquidity for San Francisco office investors next year, property values and transaction activity won’t feel much of an immediate impact. 

“The recent rate cut is unlikely to have a material impact on San Francisco office prices through the end of the year,” Ryan Miller, an analyst at Green Street, told Bisnow. “Many office buyers are still paying cash, getting seller financing or assuming an existing loan. Banks that have a substantial concentration in the office sector are unlikely to turn the lending spigot back on again until they work through a good chunk of underwater assets.”

The “deliberate” perception created by the Fed is that the U.S. economy is in an easing environment, which holds true for San Francisco property owners, Trepp Senior Debt Analyst Thomas Taylor said.

Much to the chagrin of local brokers, San Francisco remains one of the worst office markets in the country. More than four years after the pandemic began, downtown San Francisco is particularly struggling to get back on its feet in a new hybrid work world.

Today, San Francisco landlords face vacancy rates in the 35% range and are often expected to offer high concessions to lure tenants.

In a March research report, Green Street analyst Dylan Burzinski estimated it would take nine years for San Francisco office occupancy to rise to prepandemic levels. He forecast that it would take five years for the broader U.S. office market to do the same.

The rate cut hasn’t changed that, at least not so far.

“I don't think one cut will ameliorate all of the problems that have caused folks to be sitting on the sidelines,” Taylor said. “But 200 basis points of cuts would. So by next summer, I would definitely suspect activity to pick up.” 

Cushman & Wakefield senior economist and Head of Investor Insights Abby Corbett agreed.

“The floodgates aren’t just going to open,” she said of the local lending market. “It will be a phased approach as we see the soft landing narrative continue.”  

Soft leasing fundamentals and the subsequent drop in prices for Bay Area offices have fueled some sales over the past nine months, however.

According to Green Street, transaction volume in the San Francisco market was around $485M for the year to August, a 135% increase compared to the same period last year. But the data and analytics firm categorizes many of these sales as distressed.

San Francisco’s investment sales market last year showed a more than 90% decline from prepandemic figures, according to fourth-quarter research by Kidder Mathews.

Mid-Market is among the neighborhoods with a high inventory of distressed office assets, including 1455 Market St., where one of 2024’s biggest transactions closed. Los Angeles-based REIT Hudson Pacific Properties acquired its partner’s stake in the building for $95 per SF, an 80% discount from when the property sold in 2015, according to CBRE.

Trepp reported that San Francisco office has shown some glimmers of hope. 

The analytics firm points to a large debt financing package collateralized by a new 321K SF building fully occupied by Visa Global at 300 Toni Stone Crossing in Mission Rock along the waterfront.

Bank of America fronted $223M in senior mortgage debt, and the Canada Pension Plan Investment Board provided $72M in mezzanine financing with a coupon of 8.25% for the 13-story asset.

The Tishman Speyer and San Francisco Giants-owned property, part of the 303-acre Mission Rock complex that will include apartments, offices and other commercial space, is one of the few newly constructed Class-A office buildings in San Francisco. 

But Visa signed its lease in 2019, before the bottom dropped out of the office market. 

Nonetheless, the Fed’s latest interest rate cut has spurred some optimism moving forward for Class-A assets, although it remains measured, Corbett said.

“I think that liquidity will increase in San Francisco,” Taylor said. “Lending transactions and the volume of transactions will increase because a lot of activity on that front has been pent up for the past several months.

“Lots of people still see opportunity in a great and storied city like San Francisco that has a lot of gems.” 

It has been a tougher market for Class-B and C properties, Taylor said, but he believes the Class-A office market will perform better. 

As for next year?

“The story will change in 2025,” Corbett said. “As we get into 2025, we will get much closer to the neutral rate. We will have more price recovery as office market fundamentals improve.”