TenantSee Weekly: The Artificial Floor
Currently, there’s a lot of downward pressure on rental rates in the San Francisco office market. This is caused by a massive uptick in available space (4% to over 30+%), the proliferation of subleases in which the sublandlord is motivated to mitigate cost, not achieve target NOI, and the presence of owners having a materially lower cost basis, either through a long-term hold strategy, or a recent acquisition at steeply discounted pricing, both of whom can compete at much lower rental economics. Indeed, the economics being offered by these parties stands in stark contrast to those offered by landlords who bought or refinanced in the years running up to the pandemic. This latter category, by the way, encompasses a large swath of the market. These investors are struggling against a confluence of factors, including rising interest rates, maturing debt, rising insurance costs, decreased demand, lack of capital, and valuation outcomes that put equity and debt underwater.
TenantSee Weekly: Meet WALT
WALT, or weighted average lease term, is an essential metric in the valuation of office buildings as it forecasts the stability of future cash flow. WALT was less important back when office markets like San Francisco were seeing aggressive year over year rent growth. Back then vacancy was worth more than leased space, the theory being a buyer could take advantage of vacant space to capture higher rent (necessary to justify inflated pricing which baked in aggressive rent growth assumptions). However, in the broader historical context of valuation, the idea that vacancy is worth more than occupancy is antithetical to defining value. Indeed, the more prevalent (and logical) approach to value hinges on the quality and duration of the net operating income. Of course, this approach is less sexy as it disables a seller’s capacity to “sell the dream”. The buyer is buying stability and yield, both of which are measurable going in.
