Doomsday for Downtown LA’s office market

Landlords are reckoning with offices losing over half their value

(Photo-illustration by Steven Dilakian/The Real Deal; images via Istock)
(Photo-illustration by Steven Dilakian/The Real Deal; images via Istock)

The building was an office buyer’s dream. 

In 2010, Union Bank Plaza, next to the 110 freeway on the edge of Downtown Los Angeles’ financial district, had “all the characteristics investors want,” JLL broker David Doupe said at the time. “A strong rent roll, high credit tenancy and long-term leases in a market with high barriers to entry.” 

How things have changed. The tower is now about 40 percent vacant. This past March, New York-based investor Joel Schreiber’s Waterbridge Capital picked up Union Bank Plaza for $110 million — about half what seller KBS bought it for in 2010.  

The qualities that once made top-tier office buildings in Downtown L.A. like Union Bank Plaza attractive to investors have been lost. About a third of the submarket’s office space is vacant, and more tenants are becoming commitment-phobes, averse to signing long-term leases. Meanwhile, landlords are struggling with higher debt payments due to rising interest rates.

The area’s top-tier offices comprise about 23 million square feet, spread across 24 buildings, according to data from Savills and the Downtown Center Business Improvement District. Together, those buildings are valued at about $8.4 billion, according to 2022 data from the L.A. County assessor’s office. 

But experts predict that national office values will plummet by about 40 percent over the next three to five years as more leases expire and tenants continue to shrink their footprints.

Downtown L.A.’s prognosis is even more acute, with some, including Boston Consulting Group, estimating losses of up to 55 percent. That equates to a $4.6 billion loss in value for Downtown L.A.’s Class A office space, according to a TRD analysis of L.A. County data.

Map created by Adam Farence

Downtown L.A. has a confluence of factors that are putting downward pressure on values — the competing Century City office market, concerns around homelessness and crime, the lack of a Fortune 500 company headquartered in the city and a new transfer tax on commercial sales. 

Add that to the fundamentals that are affecting downtowns across the country, and Downtown L.A. is in an isolated, painful position. 

“If you’re in trouble, you’re in big trouble,” said Bert Haboucha of investment manager Atlas Capital Advisors, who advises family offices on restructurings. “If you’re not, you’re trying not to be.”

Appraisers have cut the value of Callahan Capital Property’s PacMutual building at 523 West 6th Street by about 20 percent compared to its 2021 valuation. Bidders are expected to come in on Shorenstein’s Aon Center at a roughly 40 percent haircut from its sale price in 2014.

And Brookfield, once the largest office landlord in Downtown L.A., has already defaulted on $1.1 billion in loans and is choosing to walk away from at least two of its towers. Brookfield CEO Bruce Flatt has dismissed the defaults, calling them “not relevant to the overall business.”

If office values do plummet, it could be an opportunity for new landlords to buy buildings for cheap and spend money to attract new tenants. At lower purchase prices, an owner could also reduce rents in an effort to boost leasing.

But that hasn’t happened yet. 

“It’s going to take a while for the market to stabilize,” said Santiago Ferrer, who runs BCG’s real estate division in North America. “If you can hold [rather than sell], it’s better.” 

The first shoe

Brookfield started the year on shaky ground. 

The investment behemoth had $465 million in CMBS debt tied to its Gas Company Tower coming due in February and knew it “may not be able to successfully refinance the debt obligations when they fall due,” according to a November financial filing. By the end of December, the firm was not reeling in enough rent to cover its debt payments on the tower. 

In February, the firm defaulted on both the Gas Company Tower loans and a further $300 million in loans tied to its nearby 777 Tower. 

The defaults were striking — the largest office landlord in Downtown L.A. had declined a rate cap and an extension, effectively giving up on the buildings. It was the first public admission that leasing was not improving and rising interest rates were causing financially painful debt payments.

Some were unsurprised. 

In January, JLL broker Carl Muhlstein was already watching the stock price of the Brookfield publicly traded entity that owned its Downtown L.A. portfolio. In January 2022, the stock was trading at about $11 a share, down from about $14.50 a year prior. By January of this year, it was trading at $4 a share. 

Brookfield was struggling with leasing across all of its L.A. buildings, filings with the U.S. Securities and Exchange Commission show. 

“If you’re in trouble, you’re in big trouble. If you’re not, you’re trying not to be.”
Bert Haboucha, Atlas Capital Advisors

Occupancy across its portfolio dropped to 79 percent at the end of 2020 from 83 percent in 2019, leading Brookfield to report a drop in annual rent on a year-over-year basis for the first time ever. By the end of 2021, the portfolio was about 77 percent leased.

The defaults kept coming for Brookfield. By the end of May, the firm had defaulted on $1.1 billion in CMBS debt connected to three downtown towers. 

“It’s a building-by-building scenario; there are different loans with different maturities,” said CBRE broker John Zanetos of the distress landlords are seeing in Downtown L.A.. “But it’s harder for the landlord to invest new capital, a harder environment for a landlord to attract new tenants.”

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Brookfield had three options: Hand the property back to lenders, declare bankruptcy on it or place it into receivership. 

“Lenders are not anxious to own these office buildings,” said Marc Young, an attorney at Allen Matkins, who added that he hasn’t seen a flurry of foreclosures or deeds-in-lieu of foreclosure. “They’re not in a hurry to take title to some of these buildings.”

Young said the most probable and least painful outcome is a loan modification or extension — a method often dubbed “extend and pretend.” In some cases, a borrower may be able to score a short-term extension to help weather the pain. 

But that’s only if a lender is willing to refinance. Given that banks have seen an increase in delinquencies on commercial real estate loans — up to 0.76 percent in the first quarter, from 0.69 percent in the prior period — more have pulled back on lending to office owners. 

“Lenders in general — if they’re lending, they’re lending to their best borrowers, the best relationships,” Scott Rechler, CEO of New York-based landlord RXR, said last month.

Whatever the solution, no one wants to book the loss. 

“It becomes a game of chicken,” Joseph Faulkner, the co-CEO of brokerage NAI Capital, said. “Everyone has a shotgun to each other’s heads to see who blinks first.”

Receivership anxiety

For two of its towers in default — the Gas Company Tower and EY Plaza — Brookfield chose the path of receivership, where a court-appointed third party is tasked with recovering as much value for the debt holders as possible. For a building, that means leasing. 

In a receivership, no debt payments have to be made, meaning any funds previously allocated to that can be spent on the building.

But receivers have to convince tenants the building is in good hands. 

“How comfortable are tenants making a long-term commitment with landlord instability?” said JLL’s Jaclyn Ward. “Given the landlord now will surely not be the landlord at the end of their lease. We don’t know.”

Lawson Martin, a Cresa broker in DTLA, noted that tenants may be hesitant to renew at some of Brookfield’s buildings in receivership, like EY Plaza. 

“You don’t know who ultimately the landlord is going to be,” Martin said.

“What happens if you have tenant improvement dollars and then all of a sudden they stop coming?” he asked. “As a broker, what happens if they don’t pay the commission?”

As of last year, Brookfield’s six towers were valued at $3.1 billion, according to data from the L.A. County assessor’s office. Assuming a 55 percent dip in values, that value could shrink to $1.4 billion. 

Sparking a fire sale

KBS first signed a contract to sell Union Bank Plaza in 2017. An affiliate of Pacific Reach agreed to buy the tower for $280 million — about $446 per square foot — but the deal fell through. 

Four years later, KBS put it back on the market but lowered its asking price to $250 million, or about $398 a foot. KBS had purchased it for $208 million, or $332 a square foot, meaning the firm would still be netting cash. 

In March, Schreiber closed on a deal to buy the tower for $110 million — about $175 per square foot. But he had trouble scoring financing, according to two sources familiar with the deal. 

Schreiber had initially struck a deal to buy the property for $155 million — a price tag many lenders were uncomfortable working with. Because Schreiber signed a deal with a nonrefundable deposit, he was locked in as a buyer. However, when interest rates rose, “the value diminished,” one source said, leading Schreiber to start negotiating the price down. 

The sale of Union Bank Plaza set a new mark — $175 per square foot for a Class A office building that was struggling with high vacancy. It’s also the only Class A building in Downtown L.A. to trade hands in the last year.

Other sale attempts have failed. In September, Brookfield put its 52-story Figueroa at Wilshire tower at 601 South Figueroa Street up for sale, according to marketing materials reviewed by TRD. A potential deal fell through because of financing issues. 

The great reset

This year, Shorenstein Properties put its 1.1 million-square-foot tower at 707 Wilshire Boulevard up for sale. It was hoping for bids to come in at about $220 million, or $200 a square foot, according to a source familiar with the matter. 

The top bid, from L&R Group of Companies, was $160 million, or about $145 per square foot, the source added. Shorenstein bought the building for $244 a foot in 2014. 

At a lower buy-in, there’s an opportunity for buyers to be “more aggressive in trying to court tenants,” Kidder Mathews broker George Crawford said. It leaves more wiggle room for tenant improvement costs, renovations and lower rents. 

Right now, brokers say there’s a bit of chicken-or-the-egg at play. Investing capital into office buildings may help attract new tenants, which would boost revenues, but without more income coming in already, the debt payments are too expensive for it to  pencil out.

“It’s just a game of math,” Ward said. “These buyers are not buying buildings as nonprofits.”