As far as San Francisco's notorious boom-and-bust real estate cycle goes, Greg Flynn has been around the block. After an especially rough time for the city, the real estate veteran is putting roughly $40 million behind his conviction that the city's high-profile bust is poised for its next boom.
The president and CEO of Flynn Holdings, the parent company for both what it calls the world's largest franchise operator as well as a commercial real estate investment firm, said the city's property market has always had ups and downs. And while some analysts say the COVID-19 pandemic has disrupted San Francisco offices more than any other in the country, Flynn sees his recent acquisition of a downtown office property hitting at just the right time.
"You can get everything right in investing in office, but if you get the timing wrong, it will likely derail the whole return," the San Francisco-based CEO told CoStar News. "Conversely, you can get many things wrong with an investment, but if you get the timing right, it's the most important determinant of success. On the raw investment side of this, it was a good time to invest."
Through a joint venture with Ellis Partners, a fellow San Francisco-based investment firm, Flynn Properties paid about $40 million to purchase 631 Howard St., a roughly 108,750-square-foot property that's fully leased and located along a bustling corridor at the end of New Montgomery Street, one of the city's main thoroughfares.
San Francisco faces one of the nation's highest office vacancy rates due to pandemic-induced headwinds. Property valuations have plummeted in recent years, largely because San Francisco has been more impacted by the effects of flexible work than any other market in the United States, according to a CoStar analysis.
Rather than shy away from that market pressure, however, a cohort of investors based either locally or elsewhere across the country are echoing Flynn's belief that San Francisco is poised for a comeback, even if it doesn't come quickly.
"The San Francisco market has always been highly cyclical and whipsaws because of the combination of changes in supply and demand," Flynn said. "They lag each other, and that throws up shortages of space and excesses of space that make vacancy and rents move wildly. That has always been the case in this market."
Back From Rock Bottom
Despite the obvious challenges, Flynn's longstanding ties with the city, coupled with his deep-rooted belief in its ultimate recovery, means Flynn sees himself as a long-term owner — even if San Francisco's office market recovery takes longer than other investors have the patience or capital to endure.
For Flynn, the chance to purchase 631 Howard St. came at just the right time and at just the right price.
A partnership between global investment manager Invesco and Oakland, California-based Harvest Properties were the sellers in the deal that closed on an all-cash basis and didn't require a loan, according to Flynn.
It isn't a major, $200 million equity bet, Flynn said, and doesn't come with the pressure of a loan.
He said it's a building "that's finished to the nines and requires very little capital. It's got historic architecture that's beautiful and charming but still has totally modern finishes, which means that if and when we need to take it back to market, it's already market-ready."
The city's fall in both demand and pricing has been especially pronounced given the steep run-up in the years leading up to the pandemic when tenants were aggressively competing for space and investors eagerly paid record-high values to acquire a piece of the tech-concentrated region.
Office pricing, which averaged more than $1,000 per square foot prior to 2020, has now fallen by more than 50%, according to CoStar data. Some lenders, especially those backing high-vacancy properties, have agreed to short sales that have sold for just a fraction of their previous deal prices. Others have taken over buildings through foreclosures or ownership transfers.
Over the past three months, at least half a dozen office sales have closed for prices that represent steep discounts compared to the peak levels paid in the years prior to the pandemic. Fountainhead Development, an Alaskan investment firm, acquired 795 Folsom for $48.3 million late last month to mark its debut purchase in the city. Southern California's LBA Realty took over the building at 255 California St. in July, while Redco, a San Francisco firm, scooped up 300 California St. just down the street at the end of May.
The 'Long Haul'
Flynn Group says it is the largest franchise operator in the world — and the third-largest operator of restaurants in the United States, trailing Starbucks and Chipotle — on the website for its parent company, Flynn Holdings.
The firm's chief executive knows the market still has a long way to get back to its pre-pandemic levels of normalcy, adding that the valuation drop alone is cause for concern.
Through a combination of cost-cutting efforts, dried up demand as a result of flexible work policies or a more dispersed workforce, tenants in the downtown area surrounding Flynn's latest purchase have handed back a total of almost 2 million square feet more than they signed for over the past year, according to CoStar, not accounting for the roughly 3 million square feet of available sublease space that has yet to be filled.
Those givebacks have sent the city's vacancy rate to a historic high of 24%, the highest in the country, according to CoStar.
“Like many major office markets, San Francisco is going through the Great Reset," Derek Daniels, Colliers' regional director of research, told CoStar News. "While vacancy remains at an all-time high, there has been a resetting on pricing, creating significant opportunities for buyers. [Flynn's acquisition] is another example of a local established institutional ownership group committing to the future prospects of the San Francisco office market.”
While leasing activity in San Francisco is beginning to gain a bit of speed, much of which has been bolstered by artificial intelligence firms, the city still has a long way to recover from the record losses it endured as a result of the pandemic. Office attendance in the city is less than half of what it was prior to 2020, according to data tracked by security technology company Kastle Systems.
Even for a seasoned investor such as Flynn, who has seen multiple boom-and-bust cycles, this one hits differently.
"I have never seen values come down" by 70% or more, he said. "Just like the vacancy is extreme, this particular price trough is more extreme. Institutional investors are on the sidelines, banks aren't lending, and it all just feels kind of hopeless. The key is to know that is the environment where it's the best time to invest, provided you have access to the capital and the wherewithal to wait for the recovery."
Yet he said the dynamics of the property, coupled with his own belief in the city's recovery, made the 631 Howard St. deal especially attractive.
"San Francisco is going to come back in a big way for all of the right reasons," Flynn said. "It has gone through a tough time, but that's getting better, and I like the idea of investing behind that belief. There are also some green shoots that I have seen so many times before. We're prepared for it being a long haul just because of the amount of vacancies, but I'm a long-term investor."