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Comment by idopmstuff | Hacker News Reader

SF commercial real estate genuinely feels like it's a slow-motion trainwreck that nobody can stop. As leases end, there's just no way that owners will be able to re-rent those buildings at anything close to the same price.

That seems like it's going to have two major consequences - when the values on those buildings fall, SF is going to lose a lot if income at a time when the quality of life is already greatly suffering there. On top of that, a lot of those buildings have large loans against them that may well become greater than the value of the buildings. The latter certainly feels like the sort of thing that could ripple through the economy as building owners have to sell off assets to make loan payments.

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It does seem likely there's more to come, and what if anything can be done to mitigate the impact on the city's economy is an interesting question. Reasoning about that probably requires some careful disentangling of the different inputs - housing policy, remote work trends, recession and tech layoffs, etc.

It's too bad this piece just takes the opportunity to launch into a list of generic conservative complaints about SF policy, which were equally applicable when rents were skyrocketing. They seem to have forgotten that it was all supposed to be Chesa Boudin's fault... Bring him back, he was better for the office market!

Going by the StrongTowns archives, what will happen when these properties go underwater is the rent will be held the same and the building will be vacant. Writ across the entire office space of San Francisco, the result will be a disappearance of foot traffic and empty districts.

Reason being the property financing is a function of market rent. Short term balloon mortgages are commonly used. If the rent for the space falls, when it comes time to refinance, you won’t be able to get a loan to cover your previous balloon payment, making you insolvent. Solution: never lower the rent, even if it means leaving the building vacant. Slowly bleeding is better than instantaneous bankruptcy.

Who is making these loans? Do they know something we don't? Or do they just think that they'll be bailed out when it all goes bust?

Last time the banks were selling the loans to other people. Is that happening again this time? This can't-lower-the-rent phenomenon is well documented at this point so I'm just having trouble figuring out why anyone with money is willing to continue taking on the large risk with limited upside (the value of the buildings).

I would honestly bet it'll be good for the economy overall (a reset to healthy prices) not a ripple effect to cause an overall american crash

Correct, it's not the bust that's the problem - it's the boom. The buildings were never really worth that much.

There’s no “truth” to what a property is worth. It’s worth what the market will pay for it.

But regardless of that, whether the values were inflated because of a market flush with cash or not, it doesn’t change the fact that crashes can and do have ripple effects.

If you purchase an investment asset at a certain price with the expectation of earning a specific future cash flow on it, and your cash-flow target misses, you can absolutely say in retrospect that your investment wasn't worth what you paid for it. If you buy an ice cream cone, and it turns out to taste bad, you can say the ice cream cone wasn't worth what you paid for it.

People miscalculate a product's worth all the time. The "It’s worth what the market will pay for it" mantra is quasi-economic nonsense. It isn't true.

Yes, hindsight changes perception of past decisions. But there is no "end" to the economy. It ebbs and flows. Maybe today this is "worth" 75% less, but what if next year at this time it's "worth" 25% more? Now suddenly it was "worth" even more than you originally paid for it. This it the problem with how you're defining worth: it's going to change depending on when you, in the future, decide to ultimately sell it.

But that's not a particularly useful definition of worth. Worth measures a moment in time. We can only price something based on what we know about it today and what we predict about it in the future, and we're not perfect predictors of the future.

I think about "worth" using the only definition of worth that is particularly helpful (to me): the amount you could get for the asset if you were to sell it now. Part of that decision almost certainly a prediction of what you believe an asset will be worth in whatever time horizon you plan to sell it. You may be right or wrong about that prediction. But it doesn't change that in the moment at which your purchased the asset, it was "worth" that to you/the market. The reality is that many, many people were under the perception that the value of these assets would continue to appreciate as they were all collectively willing to pay what we now believe to be high prices for them.

In hindsight, we may all have been wrong. But in that moment, I could absolutely have sold the asset for the price I paid to purchase it. So it certainly was "worth" that when the transaction happened.

> So it certainly was "worth" that when the transaction happened.

Right, but it's also fair to say that in retrospect that the "worth" at the time of the transaction was incorrect since it was based on an estimated prediction of the future (as you said), which ended up being wrong.

>But that's not a particularly useful definition of worth.

It is a more useful definition than the one you made up. The error in your argument here is that you are mistakenly conflating the words "worth" and "price". These have different meanings. Price is an objective measure at a specific moment in time. Worth is not.

If you choose to use your own personal definition of a word, then you can not have a good-faith discussion with other people who are applying that word's common usage. "Worth" is not the same thing as "price", not even in the field of economics. You just made that up.

You're right, I was loose with my words here. Worth does have a specific economic definition, but that definition is not particularly helpful when talking about an asset price like this. It is by definition individual, can only be known once the future happens, and it depends on when the realization of that value ends. This is particularly challenging when the realization of value (rent payments) on the asset (commercial real estate) is inherently volatile itself. In fact, for this very reason, economic value is generally not (usefully) measurable. So in absence of that, buyers will attempt to estimate the future value, and use that as input to the price they're willing to pay.

My point in my original comment, which I believe still holds, is that there is no objective truth to this number. Multiple buyers can arrive at different definitions of worth depending on how they used the asset and when they ultimately sold it. And even if they both arrived at the same value, it can only be known in hindsight. For example, say I purchase a stock solely as a monetary investment for $10 today, in 1 year the price drops to $2, and in two years the price jumps to $50. The answer to whether the stock was "worth" what I paid depends on when I decided to sell it. If I had to sell that stock in a year to buy a house, it certainly was not. If I could hold the asset for 2 years, it was certainly worth it (and then some). Or, going back to your example before, if the cash flow was less than I expected - that's not great. But next year it could be more than I expected. The time horizon is a critical component here, as are the factors unique to the individual buyer.

Your statement that the property was not worth that much can only be said with the benefit of knowing what the market is today. In 6 months, the asset may be worth 25% more than was paid for it. It's likely that's not the case, but clearly many people thought it was likely the asset would generate more money than it did when it was bought and were wrong. We may also be wrong today.

So, when we're talking about the "worth" at the market level we almost have to be talking about willingness to pay. We assume that will price in estimated future value. There's not much else we can usefully measure here.

> “It’s worth what the market will pay for it” Is absolutely true at the time it sells — it was worth that much for the former owner who now has that much cash from it. The bigger question is whether the next owner will get that much value from it. Sometimes there is no bigger sucker.

False. Suppose I possess a fungible asset, and that asset is selling on the market at a particular price. I can choose not to sell at that price, because it's worth more to me personally than the market price. Worth is subjective, price is not.

Where people usually err is saying "this property is worth so much more than what people are willing to pay me for it." Or some variation of that statement.

Commercial Real Estate is valued based on Cashflow/Income (correct me if I am wrong). San Francisco should look at examples like One AT&T in STL, which was once worth 400 million that got sold for 4 million or so a year ago.

https://en.wikipedia.org/wiki/909_Chestnut_Street

4 million?!? That’s like the price of a normal old Victorian in SF if you’re lucky, and the people pooing on your front porch come free with that.

I'm guessing it must've included a lot of back taxes too?

In the same way, any ripple effects are just the natural consequence of a market economy. We chose this, and we’re getting exactly what we ordered.

>There’s no “truth” to what a property is worth. It’s worth what the market will pay for it.

There are historical charts and indexes that compare the price of square foot to inflation, wages, etc. There may be no one single universal truth, but there is a baseline for what real estate should cost (relative to everything else).

My only hope is that because leases aren't all going to come due at once, there won't be a total collapse because everyone's simultaneously selling at fire-sale prices.

SF is going to lose a lot if income at a time when the quality of life is already greatly suffering there

In the boom decades many American city governments have become incredibly, grotesquely inefficient. Voters should now prioritize basic competence over ideological purity so that they can get on a better footing.

SF is particularly tough for this - they've built up so much structural inertia in their government that even if you get someone who's incredibly competent, they're still wildly unlikely to get anything done. I actually think pretty Breed is a pretty good choice for the job, but I have no faith whatsoever in her ability to create meaningful change because of the system she's working in.

It’s bad but ironically prop 13 (which I personally think is a problem) is actually helping SF here because it never had that money to begin with. Of course a smart city would bank all the profit into an emergency fund and so prop 13 would be net negative (I think California generally has done this as a state but not sure about SF).

The statistic I read is about 50% of commercial buildings would have an impact on SF’s budget (ie they would drop below their initial purchase price).

As for the rippling out into the banking sector, it’s plausible because it’s not just SF that’s a problem. All major cities are likely affected by this phenomenon. Cities would have to start regulating employees to go into work but I think that would be politically challenging for any politicians who attempt that.

> It’s bad but ironically prop 13 (which I personally think is a problem) is actually helping SF here because it never had that money to begin with

Its not actually helping, its just changing the route that the impact from the problem takes to hit city revenues. What Prop 13 does to revenues (both the very low nominal rate limit and the assessment increase limit, though people always talk about the second and ignore the first) means that San Francisco relies on other revenue streams than property taxes, such as income abd sales taxes (local and formulaic distribution of state revenues) but these streams respond to the same broad forces (and often with much higher volatility.)

The loans against these buildings are my biggest concern here - these building owners may be about to default en-masse at a time when loan holdings are a big vulnerability to banks. That may have some weird systemic consequences like it did with housing.

The city governments of SF and NY (which seem to have the biggest problems here) have honestly just gotten too big and will need to deal with the pain. The people living in the cities will survive, and honestly may have better quality of life when rent gets cheaper.

A financial YouTube blogger that I watch (hedge fund manager, a university professor and a former investment banker - https://www.youtube.com/@PBoyle/featured ). He seems to have the credentials ( https://www.kcl.ac.uk/people/patrick-boyle ) and his videos are straight forward and accessible and not trying to sell you anything (other than the clearly identified paid sponsorship).

His most recent video is on commercial real estate - https://youtu.be/5QtCC6eUn-k

End CA Prop 13 benefits for businesses or make them pay all the difference in back taxes when they sell the property. That would have the potential to massively help the budget and make things more fair for newer businesses moving in, so they wouldn’t be stuck trying to compete with businesses that enjoy a tax bill that at might be 1/20th of theirs.

San Francisco's problems have a lot more to do with expensive garbage can/bus-stop graft than Prop 13.

https://missionlocal.org/2021/09/san-francisco-garbage-can-d...

Perhaps they can be turned into living spaces instead, which were already at a premium in San Francisco.

They responded to that in the article. If you live in San Francisco you should contact the board of supervisors and give them the quote from within the article that permit fees and other costs put the conversion costs well over what the owner could recover.

With the article's $1000/sqft conversion cost estimate, the developer could provide free catered meals for life instead of adding kitchen space to each unit.

The city should figure out how to reasonably reduce that cost (waive permitting costs, optimize the efficiency of the permitting process, etc)

Some of that cost isn't really waiveable. Commercial spaces aren't residential spaces. For instance, I've heard that commercial buildings generally run the pipes only up the middle of the building, since they can centralize bathrooms and kitchens. Residential space is not generally so amenable. Residential spaces need other heating setups. Residential spaces have different load characteristics based on where the furniture goes. There's a lot of real differences between commercial and residential buildings, and just like with computer code, as you scale up the building minor differences a single-family home owner would ignore become significant differences become vast differences.

In theory you could go all Mad Max and give them permissions to just start throwing up walls, creating spaces with communal bathrooms, and just dealing with it, but the amount of regulatory work to do that is pretty substantial. Even if you could get the agencies to agree to it in principle, a massively uphill battle since you're basically asking them "Hey, will you agree that you and your mission are worthless and irrelevant inside my building and pretty please promise to not worry about whether other people will start asking questions about what exactly it is you do (including the legislative bodies that provide your budget) and why it is they have to conform but I don't?", they'd immediately start putting their fingers back in the pie anyhow.

It really isn't financially feasible. HVAC is different. Electrical loads are different. Plumbing is different. Sewer is different. Requirements for elevators are different. Life safety is different. Huge chunks of the building would be unlivable because they'd be on the interior with no windows.

To meet even the barest of code requirements you'd basically have to gut the building and redo almost all of it. And SF requirements are hilariously strict and complicated.

Of course it can be done, but if you think renting to businesses is hard, try renting at >$75/sq. ft. A 1200 sq. ft. apartment would be $7500/mo. The only people who can afford that are high-paid technology guys, and their job has already left SF for Texas or wherever.

"To meet even the barest of code requirements you'd basically have to gut the building and redo almost all of it. And SF requirements are hilariously strict and complicated"

The guy who turned the DNA Lounge from a Bar into a Bar has a tragicomic blog detailing the journey.

If he weren't a Mozilla multimillionaire it would have been ludicrous to even try.

I followed all of that saga. jwz did an excellent job, both in doing the work and highlighting the insanity and difficulty.

Almost all of the cost isn't waiveable unless they are willing to hand out huge subidies to redo everything about those buildings in addition to going "mad max" as you eloquently put it. That would be politically untenable, since it would be seen as a "subsidy for the rich."

All great points I did not consider.

If I was to nitpick, I would only say that load is unlikely to be a problem: walls are usually configurable in office spaces, and floors should be able to handle stuffing a data centre in the middle as well.

It depends on the building. A three story brick & concrete building may be able to handle a data center on the top floor. As you get into the 80 floor skyscrapers you're getting into buildings where you have to start worrying about exactly how they wave in the wind, something I don't tend to think about at all. Trying to stick a datacenter on the 75th floor there may be a noticeably bad idea. Scale isn't just an issue for programmers.

A lot of people with a lot of power make a lot of money from those costs.

Definitely the right solution in my book, but conversions are going to take a lot of time both from the side of government regulation changing to allow it and just in terms of the physical construction work needed.

>no way that owners will be able to re-rent those buildings at anything close to the same price.

Good! they were gouging for decades.

Also, why has nobody talked about all the tax incentives given to twitter to build their HQ where it is... what happened to all those tax incentives?

"a lot of those buildings have large loans against them that may well become greater than the value of the buildings"

You can drop the "may well". They are, right now, full stop. Massively underwater.

The so-called "Harvard Business School types" always advocate for businesses to take on a lot of debt to get that sweet sweet leverage, and a lot of real estate has been mortgaged for a long time. That's not really new.

But prolonged zero-percent interest rates made it both extremely appealing by making it seem like there was no downside: Don't get enough rents? It's OK, you can always roll over your debt for virtually free and try again later. 0% interest is deceptively close to real money if you get too far into "Harvard Business School" analysis and detach from reality too much... but it isn't real money. Enough people made this analysis that prices pushed up in the commercial space just like residential; in theory, at super low interest rates the value of the buildings would converge on the rents being able to cover only the interest, because someone would bid them higher until they reach that point. Don't have to worry about principal, can always roll that over.

But they don't get fixed-rate 30-year-mortgages in that space. Honestly, nobody does except homeowners in the United States. When the interest rates finally go up, you can't even come close to covering the interest on those rents. The cascade of all of that happening to the entire market at once is pretty severe.

So in this scenario, the businesses owning these buildings go bankrupt pretty quickly once rent has to come down at all. But that's not the real problem. Those businesses dissolve, but somebody else acquires the assets generally. The problem is that when they dissolve, they take their mortgage payments with them. Now the mortgage the bank is holding is worthless. They get to repossess a building in a rapidly deflating market. They are not particularly excited about this. As a result, the bonds for this sort of asset get marked down even more.

Fortunately, the American banking system is strong, sound, resilient, and well-capitalized, I am reliably assured. So it's not a problem that the $2.9 trillion in commercial real estate loans the banking system holds as of May 10th [1] are looking at pretty significant haircuts and massive loss of collateral. (Not necessarily as bad as SF, being the biggest bubble it'll see some of the biggest drops, but definitely large double-digit percentage drops are going to be the norm across the board.) The banks are doing strongly and soundly in all their other metrics so they'll be able to handle this just fine.

[1]: https://www.federalreserve.gov/releases/h8/current/ , Table 2, line 15, last column.

The “banking system” is an anachronism. We now have a machinery for securitizing asset backed loans. People and companies that just want somewhere safe to store their cash should not be implicitly investing in commercial real estate.

Banking should be a boring industry that charges a cost of carry for storing and transferring cash. No lending, no fiscal assets.

Those poor landlords shouldn't have made risky investments. Thoughts and prayers.

It also sounds like there's a lot more value saved by not having an office downtown with more money to be spend on QoL improvements than renting office space

The problem isn't the effect on the landlords - it's the effect on everybody else.

> more money to be spend on QoL improvements than renting office space

Who is going to spend money on QoL improvements? The corporations who would've spent it on office space will keep it as profits, not invest it in the city of San Francisco. The city will have much less money to spend on QoL because of greatly diminished tax revenue.

Assuming somehow spending money on rent is a more efficient allocation of resources than profits is absurd. For us without an office we're able to hire several more team members and embrace fully remote with east and west coast staff allowing us to expand our service coverage an additional 3 hours without having to ask team members to work outside of normal hours

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