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Office ­­Sector in Flux: Steep Discounts for Hi-Rise Buildings

Amid alarms, some see green shoots

The owners of the Lakeshore Towers mixed-use campus near John Wayne Airport have put tens of millions of dollars into the 902,000-square-foot property in recent years, bringing in a new slate of hip restaurants, landing a new, upscale Life Time gym that recently opened, and adding architectural flourishes to just about every aspect of the campus, including its art-cloaked, seven-story parking structure, in a bid to boost occupancy at its office buildings.

The work’s created its share of buzz, and traffic to its retail buildings along Von Karman Avenue and the San Diego (405) Freeway, but hasn’t resulted in office leases: brokerage data puts occupancy rates for the three-office portion of Lakeshore, running some 750,000 square feet, at around 40%.

That appears to be having a big impact on the valuation of the campus, which real estate sources indicate is up for sale at a price around $200 million, or roughly $220 a square foot.

In a frothier market, Lakeshore would likely generate interest at a price approaching $400 million.

Debt Downgraded

The campus’ lender, Starwood Property Trust Inc. (NYSE: STWD), recently referred to the Irvine campus’ listing during a recent earnings call.

Regulatory filings indicate Starwood downgraded its $197 million loan on the property. The prospective sellers have received bids “above and near our debt basis,” Starwood President Jeff DiModica said during a May 4 earnings call.

The campus counts “$160 million of sponsor equity,” and there’s a near-term maturity for the property’s loan, which is the reason behind the sale, Starwood officials told analysts.

San Diego-based office owner Sentre partnered with GE Asset Management in 2008 to oversee Lakeshore. Sentre’s marketing materials say it has invested some $40 million in Gensler-designed improvements to the campus, and says it has entitlements for a 600-unit mid-rise hotel or apartment project.

It’s not the first time the Lakeshore campus has faced financial troubles; a prior ownership group filed for bankruptcy in the mid-1990s after being unable to meet loan payments.

A potential sale of the high-profile property this year would add to a slew of discounts seen in recent months for the region’s office inventory.

“With office occupancy going down and interest rates going up, it’s fairly clear what brought us to where we are today,” Paul Jones, executive managing director of brokerage Newmark, told the Business Journal.

Office Headwinds

Work-from-home trends that started in March 2020 have “lasted longer than many of us in the industry expected,” notes Jeff Cole, executive vice chairman for the capital markets team of Cushman & Wakefield. That in turn has prompted many employers to downsize their physical operations.

Cushman & Wakefield estimates about 80% of companies that renewed their leases in 2022 downsized their real estate footprints by an average of 25%.

Physical occupancy rates for the region are currently around 55%, while recorded vacancy rates for Class A office properties were around 19% at the end of the first quarter, up from around 13% in early 2020.

Lease downsizing has been exacerbated by ongoing interest rate hikes over the past year, making it challenging for investors to secure funds for new deals or for their existing portfolios.

What’s more, the banking industry turmoil seen of late has prompted lenders to take a cautious stance on loans, with many banks declining to finance office transactions due to ongoing uncertainty (see story, page 1).

“Lenders are essentially redlining the office sector,” Kingsbarn Realty Capital CEO Jeff Pori told the Business Journal.

Local Buyers

Las Vegas-based Kingsbarn was behind last month’s acquisition of Griffin Towers, a two-tower office complex in the South Coast Metro area of Santa Ana. Together with LA-based Barker Pacific Group, Kingsbarn paid $82 million, or roughly $141 per square foot, for the 560,000-square-foot project.

That represented a nearly 57% price drop from Griffin Towers’ last sale to EQ Office, a unit of New York-based private equity giant Blackstone, in 2014.

Kingsbarn financed the deal in part through a loan provided by Western Alliance Bank, which was among various financial institutions on a watch list from Fitch Ratings.

“Despite that, they did everything they said they would do and were there through the closing,” Kingsbarn’s Pori said.

That wasn’t the case for a recent office deal Kingsbarn had in the works in Hollywood, when a key bank “failed me at the closing table,” Pori said.

“They reduced the proceeds by tens of millions of dollars and inflated the interest rate at the closing table,” Pori said.

Despite the local valuation declines, Orange County remains a more attractive office market to investors like Kingsbarn when compared with larger metro areas like Los Angeles and San Francisco.

“Downtown markets are struggling throughout the country, and there’s been a shift toward suburban office markets,” Pori said, adding Kingsbarn counts a suburban office portfolio topping 2 million square feet in Southern California, and that portfolio is over 90% occupied.

A growing portion of that portfolio is in OC; Kingsbarn has made a series of local deals totaling more than $250 million in the past two years, for offices in cities including Fullerton, Laguna Hills and Lake Forest.

Lender Sale

Orange County has yet to see major foreclosures occur as a result of the market dynamics, though a lender-facilitated sale is in the works for one of North County’s more notable offices: One Pacific Plaza, a roughly 400,000-square-foot office campus along the 405 freeway in Huntington Beach.

Irvine-based Pendulum Property Partners acquired the four-office property that’s home to the headquarters of BJ’s Restaurants (Nasdaq: BJRI) in 2018 for $124.5 million, or nearly $173 per square foot. It financed the deal with a $97 million loan from SunTrust Bank, property records indicate.

Pendulum is working with SunTrust to sell the asset and recoup property losses suffered in the wake of the pandemic, sources tell the Business Journal.

“The deal is the first sizable institutional office to come on the market in a lender facilitated deal,” Jones said.

BJ’s Restaurants recently renewed its lease for the campus, taking 56,000 square feet of space, according to data from CoStar Group Inc.

Another large office property that last traded hands for north of $100 million is expected to hit the market soon, brokers tell the Business Journal. AEW Capital Management is scouting a new owner for 2050 Main St., a 314,074-square-foot office in the Irvine Concourse campus, which sits on the other side of the 405 freeway as Lakeshore. AEW paid $108.5 million for the property in 2011.

Discounted Deals

Other local offices complexes on the market include Canvas in Costa Mesa, Sandpointe in Santa Ana—which is being marketed as a residential conversion project—and 3 Hutton Centre.

Cushman & Wakefield is representing the seller of 3 Hutton Centre, Cypress Office Properties, which paid $50.5 million, or nearly $253 per square foot, for the South Coast Metro building in 2016.

The 199,834-square-foot office is seeking a price of $39.9 million, or around $200 per square foot, sources indicate, which would mark a 27% price drop.

Another office at that complex, 4 Hutton Centre, sold earlier this year for $25 million, less than half its last sales price in 2019.

Joe Wen, the founder of multinational conglomerate Formosa Ltd. and an OC resident, paid about $115 per square foot for the 10-story office.

Opportunistic Buys

Some of the discounted deals are driven by sellers looking to trade their assets above debt levels as loans mature, while other discounts are driven by opportunistic buyers looking for a value-add play.

“Buildings that used to trade for up to $400 per square foot are now trading for $100 to $200 per square foot,” Cole said.

Last year, offices sold for around $318 per square foot, local brokerage data indicates.

Buyers are making transactions based on a price-per-square-foot discount to replacement cost, notes Bill Shopoff, CEO of Irvine-based real estate investor and developer Shopoff Realty Investments.

Deals based on cap rates, though fluctuating, are being done at 100 to 300 basis points more than a year ago, Shopoff said.

Brokers are split on whether Orange County offices have seen the worst of it on the pricing front, with Cushman & Wakefield’s Cole pointing to a surge in all-cash buyers as a bright spot that may “keep a floor on pricing.”

Shopoff predicts there will be more transactions at these new lower values.

“The main activity we see is from groups focused on distressed acquisitions,” Shopoff said. “There is abundant capital sitting on the sidelines, looking for quality opportunities.”

Supply and Demand

Kingsbarn is one such buyer betting on the rebound of the office market; its plans for its just-bought Griffin Towers complex include lowering rents and getting the property to about 90% leased.

“We are writing a few leases now, with one for two entire floors,” Kingsbarn’s CEO Pori said.
Part of his bullishness stems from a prediction of a supply and demand imbalance in the coming years, driven by a hesitancy to build new offices and a surge in conversion projects across the county to demolish offices to make way for apartments or industrial buildings (see story, page 20).

“When the economy picks up, a lot more people will be going into the office, and when that demand picks back up, it will be years before developers can deliver the square footage needed,” Pori said. That imbalance will lead to a surge in occupancy and asking rents, he added.

Kingsbarn is bullish on both sides of the coin—it is working through the entitlements process with the city of Laguna Hills to convert the five-building HERE office campus into 1,000 apartment units.

Leasing Trends

Though Cushman’s Cole notes the office market “is dire in a lot of ways,” there are notable “green shoots” in the sector, such as the influx of new companies planting their headquarters in Orange County, like Virgin Galactic Holdings Inc. (NYSE: SPCE) and 99 Cents Only Stores.

Both those firms chose Tustin’s Flight campus, one of the newer creative office projects, for their new base.

The market has “separated into the haves and the have nots,” notes Shopoff, with “the top-quality buildings in higher demand.”

“Businesses are more focused on a high quality, amenity rich environment to attract their employees back to the office,” Shopoff said.

A return-to-office report from JLL shows some progress on that front, with foot traffic at selected office campuses in the John Wayne Airport area showing slow but steady gains since 2021, accelerating during the first quarter as more companies mandate on-site working.

Creative offices with more open spaces and better amenities are standing out from their counterparts, such as Spectrum Terrace, Intersect and The Boardwalk, according to the JLL report.

The latter campus, along Jamboree Road and few blocks away from Lakeshore, showed a 240% jump in its return-to-office rate this year when compared the same period in 2019.

“The need for office space is not going away,” Pori said.

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