By Meghan Hall
Like many core and urban markets, San Francisco saw investment activity in 2020 slow down compared to previous years as companies and investors pressed pause. For many, evaluating investment risk has been tricky due to uncertainty in the market, but experts believe that liquidity in the market and high levels of capital allocation will serve as a strong basis for market recovery in 2021. The Registry spoke with Colliers’ San Francisco Capital Markets Team to gauge the city’s investment market in the coming year.
What is your current perception of the San Francisco investment market? Was there anything that surprised you about 2020, and how is 2021 looking from that vantage point?
Our team was anticipating 2020 to be an extremely active year for trading institutional real estate. Going into the new year, investor optimism was peaking across the board. By mid-March, the market had ground to a complete halt, with nearly every institution pausing all acquisitions and dispositions. After this initial pause, the market was incredibly resilient, with investors pivoting quickly to re-enter the market and update business plans. A catalyst driving this expedited reopening of the capital market was the record amount of liquidity on the sidelines that needed to be allocated. The first asset class to see transactional activity was the industrial sector, followed by high-quality credit tenancy office assets. Throughout the year, high-density CBD locations throughout the Bay Area were the most impacted. Investors had renewed interest in quality-of-life locations/suburbs, such as the inner East Bay.
Are you noticing any particular trends that will impact investment in San Francisco—flight to suburbs, departure of companies, ecommerce?
In 2021 we expect to see a continued flight to seasoned technology – markets that had larger concentrations of R&D will be the first to recover since many of these functions cannot be completed from home. Suburban markets will continue to see elevated levels of interest, and we expect the central business districts to recover once a vaccine is widely available and business return to more normal operations.
2020 was a slower year for the real estate industry. However, were there any transactions that you feel were important to make note of? If so, why, and how are they indicative to where the market is heading?
One trend that we noticed was that transactions with an extended WALT and could be financed accretively were among the most sought after from a wide array of investors from the core and core-plus investors to value-added investors. The value-added investors could engineer attractive returns on relatively stable assets due to the accretive debt available. We expect to see sustained interest in flex business parks as traditional office tenants migrate to these spaces since they can more effectively control their own environment.
If you were an investor, what would be your strategy in the coming year? What properties would you seek to acquire, hold or release? On a similar note, what product types do you foresee getting considerable attention in 2018 and beyond and why?
We expect there will be opportunity across the board, with the volume of opportunity being driven by where an investor falls on the risk spectrum. You can expect to see the highest concentration of core and core plus assets trading at the start of the year. While we think there will be value-added opportunities in the market this year, these assets will likely be the last to see stabilized transactional volume. A mix of conservative buyer underwriting, a lack of short-term visibility in the market, and a sizeable bid-ask spread all signal a lower volume for the value-added space this year.
Given that 2020 was a more muted year for investment, how do you think capital allocations will shape up over the next 12 months?
With the core and core-plus spaces expected to see the highest level of opportunities in 2021, we expect capital allocations to follow suit. We know that liquidity is at near-record levels and should drive transactional volume in the core and core-plus space to stabilized levels quickly this year.
Where do you anticipate cap rates going? How will that impact investment in the year to come?
While 2020 overall was a challenging year, the industrial sector was the darling and experienced strong investor interest and cap rate compression. With the debt markets continuing to stabilize throughout 2021, we expect cap rates to stabilize accordingly across all product types, office, industrial, and retail.
Looking ahead into 2021, what metrics and key fundamentals will you be watching most closely? Why?
One critical fundamental that will help shape the office market is the leasing activity, specifically the San Francisco office subleasing market. As we begin to return to normal, investors will be watching how office demand begins to take shape. On the whole, San Francisco has been one of the most impacted CBDs from a sublease perspective, and investors are going to be closely watching the speed and pace at which office demand returns to the market.
Another compelling space is going to the value-added arena. While we do not expect volume to stabilize early this year, there will be some opportunities, and it will be interesting to see if we get into a “basis” environment.
What are you most looking forward to in 2021? Why?
Easy answer there, a vaccine and a return to normalcy.
In seriousness, though, with businesses expecting to return to more normal operations this year, it will be interesting to see how businesses implement plans and adapt to a new office environment. We expect there could be some minor alterations to space planning, but could there be more cost-intensive changes now and into the future; such as square foot allocations per employee, number of employees in the office, and what tenant build-outs will look like in the future. Those are just a couple of the myriad of potential changes we could see in the office space, and it is going to be very interesting to see what changes come about, if any.
Is there anything you would like to add that The Registry did not ask or mention?
While we expect nearly everything to return to normal as the vaccine rollover continues, roots have been planted in more suburban secondary markets such as Sacramento, Reno, Salt Lake City, and Denver. As an educated population permanently migrated to these markets, it will be interesting to see what lasting impacts this has on those markets. It could be a catalyst that drives additional demand in the future.
We also expect the demand and life of the urban CBDs to return to normal, with the caveat, it will take time. These locations still have the infrastructure, accessibility, and population base that are attractive to companies. As the return to office begins to take shape, it will also be compelling to watch how the office CBD markets evolve. Once employees start this return to the office, we expect to see the pace grow exponentially. While employees have likely enjoyed their alternative office locations, as more coworkers return, it could create a snowball effect pressuring more of the workforce to return to the office.
Colliers’ Capital Markets Team Includes:
- Robert Gilley, Executive Vice President
- Kevin Moul, Executive Vice President
- Brad Idleman, Senior Vice President
- Andy Zighelboim, Executive Vice President
- Jeremy Thorton, Executive Vice President
- Andrew Gibson, Senior Vice President