A succession of defaults on towers has unfolded as demand for space drops in the downtown Los Angeles office market.
Brookfield Corp., one of the largest office owners in downtown Los Angeles, defaulted on $784 million worth of loans on two towers. According to a Feb. 10 SEC filing, the firm failed to pay a $465 million loan package for the Gas Company Tower at 555 W. 5th St. and $319 million in loans for 777 S. Figueroa St.
The loan on the 52-story Gas Company Tower was comprised of a $350 million mortgage loan, a $65 million mezzanine loan and a $50 million junior mezzanine loan. The 52-story tower at 777 S. Figueroa St. loan was made up of a $269 million mortgage and a $50 million mezzanine loan.
Those aren’t the only ones. In January, Oaktree foreclosed on Coretrust Capital Partners’ 48-story, 914,000-square foot tower 444 S. Flower St.
As reported by the Real Deal, Coretrust had purchased the building, at the time known as Citigroup Center, in 2016 for $336 million. It took out a $230 million loan from the Bank of China that year. Coretrust refinanced the property in 2018, securing a $64.7 million mezzanine loan from Oaktree as well as a $210 million senior loan from AIG. After missing the due date on its loan with Oaktree in 2021, Coretrust and Oaktree reached a forbearance agreement for Coretrust to pay by May 31 last year. When Coretrust missed its payment, Oaktree initiated the foreclosure.
Brookfield and Coretrust did not return the Business Journal’s requests for comment.
And last year, the Broadway Trade Center at 801 S. Broadway was foreclosed upon as an affiliate of Starwood Capital, a lender on the property, acquired the building through a public foreclosure auction.
From an investment and lender perspective, the view of the downtown Los Angeles market is negative, according to Sean Fulp, vice chair and head of office capital markets at Colliers.
“There’s a lot of value deterioration that’s happened,” Fulp said. “What’s happening right now is a bit of a house of cards. You have a portfolio that’s been over-leveraged based upon where property values are today, and you have an interest rate environment that has risen to a level that no one had anticipated.”
The complicated financial structure on these towers has started caving in.
“A lot of these assets are so large, they require multiple layers of financing,” Fulp said. “You have senior mortgages and mezzanine financing on top of those and in Brookfield’s case, you have preferred equity as well. That’s a lot of leverage that’s been layered and the cost of it gets more expensive with every layer.”
In a lot of cases, the debt service for these buildings has more than doubled.
“In Brookfield’s case, they’ve got balance sheet financing that required interest rate caps,” Fulp said.
In the case of 777 S. Figueroa, Brookfield didn’t purchase an interest rate cap.
“That doesn’t mean it will lead to a foreclosure but it is an issue and it needs to be dealt with,” Fulp said. “If they have to buy an interest cap today, which they have to do to get at least one year extension, the interest caps are very, very expensive and cost prohibitive. It comes down to: Is it good money after bad?”
According to an SEC filing, Brookfield has another $763 million in loans due before the year’s end connected to two towers in the Wells Fargo Center at 333 S. Grand Ave.
The tower woes come as demand for office space in downtown Los Angeles has been sinking in the wake of the pandemic’s shift to remote work. According to a Jones Lang LaSalle Inc. report for the fourth quarter of last year, downtown Los Angeles vacancy is hovering at 22.7%, which roughly matches Los Angeles County’s 22.5%. Asking rents in downtown Los Angeles averaged $3.86 per square foot in the quarter, on par with the previous year. Los Angeles County, by comparison, had an asking rent of $4.14 per square foot for the quarter.
Chris Rising, chief executive officer of downtown-based real estate developer Rising Realty Partners, counts 1200 W. 7th St., the Trust building and the Cal Edison building among its downtown assets. He described downtown in the years 2020 through last year as resembling a “dystopian nightmare.”
“Over those two years, the homeless population moved from a more contained area in Skid Row and expanded throughout,” Rising said. “Then you add the crime element. Downtown was desolate. I came to work every day and I can tell you, it didn’t feel safe.”
Rising said the former downtown Los Angeles, which attracted Westsiders to its Art Walks and restaurants, has been “decimated.”
“What’s happened with Brookfield is they have loans coming due at a time when the values here have been destroyed because it hasn’t been a desirable place to be,” Rising said.
“I think 2023 is going to be pretty bloody, there’ll be more defaults and a complete price reset,” Rising added. “But our infrastructure system is getting finished so the regional connector and the connection to the airport is almost done. If people felt safe that they could ride the Metro and walk in their neighborhoods, downtown L.A. could make a screaming comeback.”
Downtown-based Ratkovich Co. sold off its downtown assets long before the pandemic.
Brian Saenger, chief executive of the company, said that the shift from office to work from home during the pandemic had a huge impact on downtown Los Angeles and the office market in general.
“You’ve got decreased demand in the office space,” Saenger said. “Fewer people are coming down to downtown Los Angeles on any given day. Pre-pandemic, the numbers were in the 500,000 range (compared to half that population now). And then you’ve got this rising interest rate market.”
Lending for DTLA
Some lenders are still open to the downtown market, but only if the conditions are right.
“It really depends on the business plan for the project,” said Vishal Vanjani, managing director of Century City-based Dekel Capital. “There’s been a lot of discussion because there’s been so much of an extra supply of office space downtown that what would be the best use of the projects. There’s a lot of discussion of conversion of some of these office buildings into multifamily and other asset class uses.”
Projects converting buildings into creative office space are not immune to the issues.
“Renovations were fairly expensive and costly so the rents they need to make those deals pencil just don’t exist right now in downtown L.A.,” Shlomi Ronen, managing principal and founder of Dekel, said.
Vanjani believes that a central problem for downtown is that it became too developed.
“A lot of this has to do in downtown specifically with the overdevelopment that has happened in the last cycle,” he said. “You have an over-supply of office space that was developed in the past cycle into a market that didn’t have extremely strong metrics to begin with.”
The problems the area is seeing now are largely a result of high interest rates and a change in the market.
“The office environment downtown is not appealing,” Ronen said. “I don’t know of a single company CEO who wakes up in the morning, has a home in Beverly Hills or in the Palisades or Pasadena and says my goal is to go spend my day living and working in downtown.”
Saenger believes downtown will go through more motions before it can course-correct. “When you have lenders taking back properties, you’re going to have a reset in the basis of those properties. And what you may actually see is, whether it’s a decrease of rental rates or a stabilization of rental rates, you may have a readjustment.”
That readjustment may ultimately drive demand, said Saenger, who remains optimistic about the submarket.
“It’s going to take a few years to play out,” Saenger said. “Downtown L.A. and the office market will come back. It’s just going to take a little bit of time to get there.”