San Francisco Faces Economic Headwinds, Credit Outlook Downgraded

San Francisco's Debt Dilemma: Credit Outlook Dips Amid Economic Struggles

San Francisco’s economic stability is on shaky ground, with S&P Global Ratings recently modifying the city’s debt outlook to “negative.”

What happened: The city reported an unprecedented office vacancy rate of 22%, substantially exceeding the national average of 13% and a drastic climb from its pre-pandemic low of 7%. In the tourism front, hotel occupancy has plummeted to 63% from a robust pre-COVID figure of over 80%, indicating a severe slowdown in one of the city’s key economic drivers.

Fiscal Challenges: Forecasts reveal a daunting financial future for San Francisco with an estimated $245 million budget deficit this year, escalating to $555 million next year. Projections suggest this could balloon to over $1 billion by 2027 if current trends persist. The city’s financial documents reveal that rising personnel costs, notably salaries and benefits, are the primary contributors to these fiscal challenges.

Adding to the problem: The shift towards remote work over the past four years has played a significant role in the downturn of downtown San Francisco. This shift, compounded by ongoing quality of life and safety concerns since the pandemic began, has stifled growth in property and business tax revenues, further complicating the city’s economic recovery.

➥ THE TAKEAWAY

What they are saying: S&P has expressed concerns over San Francisco’s ability to implement necessary budget cuts to regain financial equilibrium within the current outlook horizon. Without significant adjustments, there’s potential for further rating pressures, especially if the city’s general fund reserves begin to deplete rapidly. Despite this, S&P has maintained a AAA long-term rating on the city's outstanding general obligation debt, highlighting the strength of the city's reserves but also the need for substantial revenue recovery or corrective fiscal action to prevent a weaker credit profile.

US Hotels Report First Decline in Revenue per Available Room of the Post-Pandemic Era

In March, the U.S. hotel industry reported its first YoY decline in revenue per available room (RevPAR) since the end of the pandemic, dropping by 2.2%.

A cooling trend: The U.S. has seen a year-long decline in hotel occupancy rates, dropping 2.5% from March 2023, with weekend travel tapering off first, followed by weekday stays. Although ADRs initially helped offset these declines, their growth slowed to just 0.4% over the past year.

Diverging markets: The industry's downturn is felt unevenly across different classes and markets. Luxury to upscale segments saw some weekday occupancy growth, contrasting with more significant losses in economy to midscale classes. Geographically, the top 25 U.S. markets fared better, benefiting from stronger corporate and group travel demand, while smaller markets struggled.

Zoom in: Notably, the top 25 U.S. hotel markets showed resilience, growing across all performance metrics with a robust 8.4% RevPAR increase in 2023. However, the smaller 147 markets struggled, with a modest 2.3% RevPAR increase and continued declines in occupancy. The success in top markets is largely attributed to stronger corporate and group travel demand, which smaller markets failed to capture.

➥ THE TAKEAWAY

Pricing challenges: As 2024 progresses, the increasing economic burden on consumers, evidenced by rising credit card debt and delinquency rates, is making travelers more selective and price-sensitive. This shift is impacting lower-tier hotels and smaller markets more significantly, challenging hoteliers to maintain pricing power amidst softening demand.

Over the past decade, the number of completed build-to-rent (BTR) units has gone up exponentially. With relatively little growth from 2014 to 2019, the pandemic and post-pandemic years saw a rapid rise in completion volumes, from 7,676 units in 2020 to 27,495 units in 2023, or 777.88% growth in 10 years.

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