2024 USA Property Market Observations

23rd May, 2024

I travel to the USA each year to observe the commercial property markets. I’ve been doing this since 1998 when the technology boom first started. I felt strongly then and still do now that American global companies would find Australia attractive somehow even though the tyranny of distance still remains real. Good leasing agents are always prospecting and the USA has the powerhouse pool of tenants with global ambitions. 

This year I took 4 weeks and visited New York - the greatest city in the world, San Francisco - the engine room of technology, Omaha - home to Berkshire Hathaway an investment juggernaut and Jackson, near Yellowstone in Wyoming. It was perhaps a whimsical chance to talk to Kevin Costner about his character in the TV series, Yellowstone and what John Dutton’s views of real estate over family really means. 

I go and learn from the best too. When I’m in New York its, GFP RE’s - Courtney Adham, Flatiron’s - Sunny Atis, Knight Frank’s - Joey Vlasto and Official’s - Richard Jordan. In San Francisco it’s always Newmark’s best - Phil Mahoney (San Jose), Ben Stern (Palo Alto) and this year I spent time with Elizabeth Hart, President of Leasing at Newmark. In terms of research, it’s Newmark’s finest, Andrea Arata, Michael Bublik and Reed Watson. I’m also fortunate to have another colleague and friend, Benjamin Osgood of Recreate who updates me on what tenants are looking for in San Francisco city and Los Angeles.

Omaha is home to the Woodstock for capitalists. It’s an exhibition of Berkshire Hathaway’s 66 owned businesses and an Annual meeting which this year attracted Microsoft’s Bill Gates, Apple’s Tim Cook and countless international fund managers. They all want the same thing, to learn about attracting more clients and to be reminded of the true value of trust in retaining them.

After queueing with 18,800 other shareholders from 5am on a Saturday morning I sat in a key central position near the CNBC camera team and witnessed Guy Spier, Chantal Hackett and William Green of Swiss based fund manager, Aquamarine meet a procession of acolytes before the 8.30am Berkshire AM commenced. I helped them with their water bottles whilst they had photos taken with adoring fans. Later, I had dinner with my friend, Luke Rathborne of Fortitude and Dr Brett Cairns, ex CEO of Magellan as a recap of the whole day of listening and learning from Warren Buffett.

This is what I learned which could shape the commercial markets in Australia:

The USA office market is correcting quickly and with huge pricing adjustments there are now reasons for optimism

The office market is very badly impacted by the change in the way we work today. This looks like a structural shift in thinking about purpose rather than just a cyclical downturn. COVID taught us to work from home and now the journey back isn’t a natural one. Americans are a mobile mob, starting at university age where they move across states to pursue tertiary education. This willingness to move makes the task of returning to a central office even harder as they seem to relish change for any reason from saving money, buying an affordable home, starting a family to accepting a career appointment in another location. It doesn’t stop there either with the super wealthy unafraid to move their home state to seek improved tax relief. Americans are mobile within their country.

Commercial real estate debt of $2 trillion is reported to be maturing between 2024 and 2026 in the USA according to the Wall Street Journal. There is as much pressure on the lender as there is on the borrower with non-recourse style lending facilities. Recent bank failures have shown that several regional banks are over exposed to CRE loans and lack the liquidity to manage their way through. A run on a bank is no longer a queue of people at the door insisting on their savings, it’s an electronic exodus of funds overnight. Signature, First Republic and Silicon Valley banks are testament to the potential for a quick collapse.

Residential accommodation supply is a problem in the USA as it is in Sydney and Melbourne. Scarcity brings inflation so cost of living is high and workers on big salaries struggle to find affordable accommodation. Companies chase workers in a competitive, high employment environment. Supporting regional living is attractive to acquiring talent. The quest for a 5 day return to the office has gone.

The mega drivers of growth, huge profits and space consumption, the FAANGs (Facebook, Amazon, Apple, Netflix and Google) now known as MAMAA (Meta, Amazon, Microsoft, Apple and Alphabet/Google) are shrinking and consolidating space. This had to happen as their businesses matured and growth tapered. New demand from them is weak and this ripple effect runs through the market. Apart from empty office space, there are literally oceans of high quality second hand office furniture in Silicon Valley.

Obsolete/Unwanted office supply trumps Availability Factor (which trumped Vacancy Factor in 2023)

Disturbingly 40% of the existing stock supply is either unwanted or obsolete. Newmark’s Phil Mahoney calls them “Generational Ghost” buildings. Some haven’t been inhabited since after the GFC and won’t be again. Brookfield in its report “The Misunderstood USA Office Market” claims that 90% of all USA office vacancy is contained in the bottom 30% of buildings, characterised by older buildings with limited amenities and reduced functionality. This view of Brookfield’s is consistent with the Australian fund management view that the office market is going through a form of bifurcation. I do agree that this appears to be happening however I’m not sure that this plays out well for trophy building owners only. I believe that everyone is impacted, some more so than others.

The industry accepted lead indicator, Vacancy factor is almost irrelevant, it’s all about what’s available and that’s double the official vacancy factor. If 14 - 20% is the official vacancy factor range then think 30 - 40% as a general guide to availability (space which tenants will vacate) across most USA cities.

Where is my crystal ball?

Tenants are still unclear on the future office environment. What is apparent is that it must be appealing and it must bring people together so they can socialise and collaborate. No one will commute 5 days a week to a workplace unless the reasons are compelling. Attractive reasons are challenges which develop skills base, career path, collaboration and socialisation. Unattractive reasons are all fear related to job loss. At present Tuesday, Wednesday and Thursday are generally considered work at office days. Monday and Friday are home/work days. When I asked Newmark’s Elizabeth Hart if there was room for organisations to share space, especially given that you pay for 7 days and get use for 3, she said “No”. In her words everyone wants the same 3 days. 

Kastle Systems monitor, through their own “Back to Work” barometer the use of office space. They control 2,600 buildings with 41,000 business across 47 USA states. They track access from their daily App, keycards and fob usage. Their data confirms the above mentioned trend with Tuesday dominating at 60% usage.  

In Australia, Parking industry icon, Peter Witts, General Manager of Wilson Parking could see the working trend to 2-3 days years ago with Monday and Friday stay at home days. Wilson Parking’s Book a bay system not only allows for pre booking of parking but collects the important data so that trends are understood and that they are able to adjust pricing when demand is low to become attractive. Wilson Parking’s performance has been outstanding and should be a beacon for government on how to bring people back to cities. 

Surely an opportunity will present itself where Monday and Friday are so financially advantageous that the working week will become more flexible. That said, I still shake my head at commuters driving on congested roads at common peak times but its hard to change the direction of a herd without leadership.

Quality home workplace beats the commute

Many workers have established a better office environment in their homes than their work. This means a larger, more comfortable and well resourced working space. As worker space has shrunk over the decades from 20m2 per person to 10m2 per person for business cost purposes the space has become less attractive to work from. Expect workspace and comfort to increase in the pursuit of bringing workers back. In fact, there are some early signs that companies are expanding their footprint as a means of attracting workers. This makes more sense when rents are falling as few business will knowingly exceed past accommodation budgets.

As a guide to commuting attraction, San Francisco’s Bay Area Rapid Transit (BART) rail system which services the city, airport and Silicon Valley was functioning at 400,000 passengers per day however this has now dropped to just 160,000 per day highlighting how commuting is in decline. Anecdotally this is due to expense, time and other cost of living savings, like expensive child care costs.

Socialisation remains critical but you need a great atmosphere

Co-Working companies are finding it tough to fill their spaces. Members have fled which is especially easy on short term agreements. There are always exceptions especially where the space is interesting and supported by quality amenity and managed by a professional community team.

I witnessed this at Shack 15 in the Ferry Terminal building in San Francisco. The space is exciting and fresh and sits above an artisans market place of food offerings as well as the ferry terminal. The space is friendly and centred around chefs who are busy baking morning tea and afternoon tea surprises for members. If you wanted a stimulating environment to work in this is it.

Overall though the Co-working model has to change. These businesses have a place in the market because they can offer superior community leadership and service on flexible lease terms. Wework and others have shown that the model is doomed as direct tenants on leases at full office rates. I think the industry's future looks to be a management agreement based business model whereby the landlord and the tenant share the business risks. If the direct model survives expect it to be on wholesale or discount rates.

Attractive offerings

Warm shell options are everywhere so in order to differentiate supply landlords are fitting space out so that there are walk in/walk out solutions. This staging of space makes the decision to deal easier as many of the tenant construction, planning and finance risks are absorbed by the landlord and the space is ready to go.

Incentives are becoming more internationally common, as a way of defending hard earned face rents. 40-50% of the deal is no longer outrageous. This is a huge departure from where the market has been as I've know that TI's (Tenant incentives in the USA were always 10% and occasionally 20%).

New construction grinds to a halt

There will be very few reasons to build new office stock in the next few years and when new building starts it will be a different product that we desire. I’d suggest there will be two good reasons for new building, technology and community. Expect to see new technology involving robotics and AI make its way into smart buildings and also expect mixed use towers where office, permanent residential, hotel, retail, health care and fitness, food and beverage, storage, goods received and despatched loading areas, parking, childcare, dog minding and walking, professional building and community management teams all co-exist. This will test town planning as these uses conflict with outdated thinking. That said, this will be a long way off even if the appetite is current.

Every $ counts

Minimising lease security is an important focus of tenants. 6 month bank guarantees are common and additional incentive guarantees less so.

Lease terms are shorter

Depending on tenant confidence I saw deals on short term leases like 2-3 years and also heard of deals above 10 years where confident tenants were looking to take advantage of today’s heavily discounted deal over a long period.

If it can’t be used can it be converted?

Converting office stock is the rage but it is also difficult. Whilst residential is the logical demand you need a whole empty building and lots of capital in a zone which allows the use. In New York the Mayor is willing to review the zoning if it means build to rent supply or in the case of the sale of condominiums there is a portion of supply to suit affordable housing.

Where are the buyers?

As property institutions make their plays public in order to give investors confidence in their future they also limit their appetite. It’s easy to stay away from underperforming sectors but hard to find your way back when you staunchly oppose them. The funds have made their beds. Office and Retail property is off the menu. 

Bankers need liquidity so poor performing investments must be sold, especially if they are bleeding cash and more so if they need capital. Credit is even harder to find so new borrowing is limited. This makes way for the UHNWI, Family Office and the traditional property investor. These are the buyers with 10c - 40c to offer in the $1. They don’t need debt, they buy well with cash and their understanding of holding long term is instinctive. They also don’t need to explain what their plans are. This is their moment in the sun. Arriving when there is blood in the street and when property is unfashionable.

The market is so open in the USA to trade and that’s what Americans do so well, shift stock and sell.

Who is my landlord?

The credit checks run both ways and this time the deal isn’t over until the landlord and their bankers are in agreement. I heard of several deals at Heads of Agreement stage which did not proceed as the landlord’s bankers refused to honour the incentive deals to achieve the new lease. This has other consequences and makes the fitted out space way more attractive as it reduces fit out time and provides product certainty. 

Retail

Retail is in a cyclical decline and unless it is linked to luxury, which is in outperform mode, it is in trouble. Rents have been varied to turnover based as a way of returning the deals to an equitable outcome for landlord and tenant. Retail landlords understand their responsibility to maintaining the retail environment. There is nothing worse than an empty mall or in San Francisco’s case an empty city heartland at Union Square. Retail vacancy send a strong message that city is in trouble.

Industrial

Industrial remains strong and the most desirable commercial real estate. However it is impacted by rising interest rates. Rents have maxed out. Watch this space on “last mile” convenience and on-line retail which moved from high street to warehousing. Industrial will be impacted by the reduction in discretionary spending.

I’ll update you on the city specific markets in my next stories. What I found interesting was that they have ideas and are already trying new solutions. Some are failing but some are showing signs of working. Regardless there is one difference between the American and Australian investing environment. In the States failure is OK, In Australia it’s a game changing disaster so the risk appetite in the US is unquenchable and therefore the mood is always about the next positive step.