A new analysis from Newmark found 26% of LA offices, or 57M SF, are under 70% occupied, potentially jeopardizing their ability to remain economically viable assets.
In the report, Newmark looks at the association between occupancy and operating cash flows and the debt sustainability of an asset, assuming that these assets have loans on them.
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“The idea is that an office building whose occupancy drops that low is liable to struggle to generate positive NOI,” Newmark Executive Managing Director of Global Research David Bitner told Bisnow in an email.
With those numbers, a landlord would likely hesitate to make large investments in the building, which would, in turn, make it less attractive to tenants than it already was, Bitner said. That small doom loop would create a major issue for the property.
Those buildings are most likely obsolete, said Bitner, one of the authors of the report.
Los Angeles isn't alone. The report said that more than one-third of the $1.4T of commercial real estate loans maturing nationwide in the next 2.5 years are "potentially troubled" and zeroed in on cities whose offices are facing a nexus of low occupancy and debt service payments, signaling potential distress areas.
Newmark also found that 41%, or 91M SF, of LA offices that are over 90% occupied are likely to have strong cash flow and a solid debt-service coverage ratio but aren't in the clear, Bitner said.
Many of these buildings still must face the fact that “values have declined [more than 40%],” Bitner said.
“If the building was worth $100M with 65% loan-to-value and now the building is worth $60M, you still have $65M in debt on $60M of building value,” he said. “That’s a problem.”
These higher-occupancy buildings have options, Bitner said. Their owners could seek JV equity partners and put in more equity in exchange for a longer loan term or better interest rate.
“There are many different paths for restructuring an underwater but cash flowing property,” Bitner said.
Bitner said this analysis is more of a “statistical association rather than [a] dynamic that plays out definitively for every specific building.” The LA market's overall vacancy in the second quarter was 21.7%, “flat relative to the previous quarter,” Newmark found.
Erica Finck, a senior director in the capital markets group at Cushman & Wakefield, said while there is trouble ahead for Los Angeles office buildings, she thinks that worst-case scenarios won’t play out every time simply because lenders don't want to own these assets.
“Offices that have continued leasing challenges and growing vacancies are where the pain is being felt, and I don't think that's going to turn around overnight,” Finck said. “That pain is definitely going to lead to some foreclosures and lender-assisted sales, which we've already started to see in the LA market.”
But while those distressed sales are occurring, Finck said, she is also seeing a “significant” number of loan workouts.
“[Lenders] are blending and extending or they may be downsizing the loan, but they're trying to work with the property owner so that the lenders don't have to take these buildings back,” Finck said.
Loan extensions for two years or five years give owners more time to try and lease up their space, improve their net operating income and get healthy cash flow on their buildings, Finck said.
“A lot of these issues are going to get kicked down the road,” she added.
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