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When studying office fundamentals, the picture is clear: As occupiers continue to adopt hybrid work policies, demand for office space is softening, resulting in higher vacancy rates and higher volumes of sublease space. The aggregate effect of this trend has placed downward pressure on effective rents and has extended the time to lease vacant space on the market. Within the post-pandemic office landscape, these trends are notably evident in older, Class B office properties.
Dan Brandt, a panelist on the webcast and an Ernst & Young LLP managing director in EY-Parthenon’s Restructuring & Turnaround practice, said, “In office, there is an element of a supply imbalance. There is office property today that will need to be converted to some alternate use [due to lack of demand in its current form].” It should be noted that, with the economy slowing, the “office occupancy pendulum” may shift away from employees’ preference to work from home to the employer, who may demand a physical return to working together. However, across the board, softening fundamentals suggest that even the highest quality tenants are adopting smaller real estate footprints in the current environment.
Discussed on the webcast, a reported trade of an office property in San Francisco may be a leading indicator of the current state of the “B” office market. According to EY research, the asking price for 350 California Street in downtown San Francisco approached $300 million when it was taken to market pre-COVID-19 pandemic. Since then, the anchor tenant vacated the building, leaving the approximately 300,000-square-foot office tower with high vacancy. It reportedly traded in second-quarter 2023 for just 20% of the initial asking price in 2020. Webcast panelists agree that while this is one incident, it reflects broader challenges in the office market: migration out of gateway cities, the struggle of Class B product to attract credit tenants and the heightened risk appetite of investors.