Challenges in the commercial real estate office sector continue, with stubbornly high vacancies persisting as remote and hybrid work schedules continue to stifle demand. Owners of struggling properties are feeling the burn, in the form of loss of cash flow and, if faced with loan maturities, an inhospitable financing climate. Investors are not the only players in the office market that are suffering from the bleak market conditions. Brokerage firms are victims of the office sector’s decline as well, and those firms with a strong presence in the most depressed markets are in a special kind of bind. National real estate investment firm Marcus & Millichap maintains offices in 36 states across the country but has a high geographic concentration in California. The firm, which is unique in the commercial real estate services world as its primary business line is representing clients in investments sales transactions, saw its activity in California outpace that in the other 35 states where it has a presence, accounting for 23 percent of its total revenue.
California is home to two of the country’s leading office markets, San Francisco and Los Angeles, where the central business districts are struggling with unique issues in addition to those that plague most of the big-city office markets. As with most top metros in the United States, the Los Angeles and San Francisco office sectors continue to struggle with low occupancies largely due to the remote and hybrid work schedules that have become the new normal in the office-using workplace. Making the office market more challenging, Los Angeles and San Francisco are also beset by safety concerns in the central business districts, where plummeting foot traffic has led to an increase in camps of unhoused individuals and a rise in crime. The total vacancy rate in Downtown Los Angeles and San Francisco’s central business district (which comprises the Financial District, South of Market or SoMa, Union Square, and Civic Center) rose to 35.2 percent and 35.8 percent, respectively, in the second quarter of 2023, according to research from CBRE. Current conditions in the office sector and the lending market have driven down office sales activity at Marcus & Millichap. But that’s not all. “The gap between seller expectations and buyer expectations on pricing is still really wide—that, probably more than anything, is affecting the market,” said Adam Christofferson, senior vice president & division manager, with Marcus & Millichap.
On the surface, it may appear that these are dark times for a company that counts its real estate investment brokerage sales commissions in California as its bread and butter. After all, Marcus & Millichap did see its year-over-year brokerage commissions plummet 52.9 percent to $135 million in the first quarter of 2023. But the sky isn’t falling at the firm. According to Christofferson, Marcus & Millichap is designed to weather such storms, being well positioned in the marketplace courtesy of a very healthy balance sheet. Granted the balance sheet isn’t as robust as it was a year ago, but the company’s total cash, cash equivalents, and restricted cash balance totaled $228 million in the first quarter of the year. Additionally, although brokered sales dropped 58 percent year-over-year, the firm still recorded sales volume totaling $7.1 billion in the first quarter from transactions in the retail, multifamily, office, and other sectors.
Furthermore, the company has cut back on expenses. While expanding its presence through organic growth and the acquisition of existing firms remains part of its long-term growth plan, Marcus & Millichap hasn’t been investing a great deal of funds on expansion of late. At the close of 2022, the company had 1,904 investment sales and financing professionals across the U.S. and Canada, marking a 4.5 percent year-over-year decrease. And by the close of the first quarter of 2023, the company’s team of investment sales and financing professionals had declined to 1,864.
There is another important factor to Marcus & Millichap’s resilience: it has no debt. In fact, the firm has never taken on debt (although the company does have access to a $60 million senior secured revolving credit facility). And while the company’s California team isn’t precisely overwhelmed with closing sales transactions and orchestrating the financing and refinancing of properties, it isn’t sitting idly by either. “During a downturn, in some ways, this is when we do our best work,” Christofferson said. “It’s a great opportunity to strengthen relationships with clients and build relationships with new clients. A company like ours has always come out of a downturn even stronger and taken more market share and succeeded, and I’m extremely confident that will happen again.”
One thing is different with the current real estate downturn. “There is a lot of equity on the sidelines, a lot of institutional capital waiting to pounce when those opportunities arise, or essentially when pricing becomes more realistic,” Christofferson said. He added that the California office sector is beginning to experience more distress and at some point, there will be deep discounts for troubled properties. Right now, Christofferson is seeing the beginnings of some of that capital come to the table and prices are starting to correct themselves as some sellers, especially those faced with upcoming debt maturities, “are finally saying enough is enough.”
Despite the particularly grueling time for some parts of the California office market, Marcus & Millichap, based in Calabasas, California, remains keen on the state, as do many others in the real estate world. Ultimately, the commercial real estate market corrects itself and when it does this time around, in places like San Francisco and Los Angeles, the central business districts may begin to look a little different. Many investors waiting to plunk down cash on office properties in these metros will do so with creative reuse or conversion plans in mind. Some ill-fated office buildings will become multifamily communities or be converted into another property type that will help transform these areas into successful live-work-play destinations. In the meantime, Marcus & Millichap continues to support its clients, guiding them with advice and research, and laying the groundwork for a rebound–albeit with revenue from office sales, like everyone else.