Newport Beach-based KBS Realty Advisors has seen firsthand how social and economic issues, along with changing post-pandemic workplace trends, have negatively impacted building valuations in three of the West Coast’s most troubled downtown office markets.
The commercial real estate investor, which buys buildings through a variety of non-traded real estate investment trusts and other funds and investment vehicles, this August said in regulatory filings that it may give back an 18-story office tower in San Francisco’s financial district to its lender, given the property’s steep drop in valuation over the past year.
Such a deal, for the company’s 201 Spear Street office, would follow the foreclosure sale of a historic office it previously owned in Portland, Ore., and the sale of a skyscraper in downtown Los Angeles at a steep loss earlier this year.
“Historically high interest rates have impacted everyone from not only investors in real estate but also consumers,” KBS CEO Marc DeLuca told the Business Journal via email. “In San Francisco, increases in crime and homelessness have caused many stores and companies to close or relocate.”
Additionally, “the city’s slow repopulation of the workplace has diminished office space demand for us and every other property owner in the region.”
KBS currently owns some 19 million square feet of office space; the company made a name for itself over the past decade as one of the county’s biggest office investors, among other property types.
$125M Loan
The company’s KBS Real Estate Investment Trust III paid $121 million for 201 Spear Street in 2013. The deal worked out to a price of about $475 per square foot for the office located a few blocks from the Embarcadero Center, in the heart of the city’s financial district.
In 2018, it refinanced the tower with a $125 million loan that’s due to mature in January 2024.
At the end of 2019, the building was about 97% leased, and the value of the REIT’s assets were worth well more than what the company initially paid for them, according to regulatory filings.
Fortunes have changed since the onset of the pandemic.
As of this June, the Spear Street building was 68% occupied, down from 85% last December. The REIT currently values the building at around $70 million, having taken a $45.5 million impairment charge in the first six months of the year, filings indicate.
Given 201 Spear Street’s current value is “substantially less” than the fund’s outstanding mortgage debt of $125 million, “we may determine that it is not in our stockholders’ best interest to make significant paydowns on the loan and invest additional funds into this asset,” the REIT said in regulatory filings.
There “is a high likelihood that we may ultimately relinquish ownership of the property to the lender in a foreclosure transaction or other alternative to foreclosure in satisfaction of the mortgage,” the REIT said.
WeWork Hit
Occupancy rates at the San Francisco tower will shrink further in the coming months, following consolidations from its main tenants, WeWork Inc. and Google.
Google is set to vacate the office next month, while the future footprint remains murky for the New York-based coworking firm (NYSE: WE).
WeWork, which went public in 2021 via a SPAC reverse merger, this month reported in its second-quarter results that “substantial doubt exists” about the company’s ability to stay in business.
The firm has been in the process of notable space givebacks across the nation—including multiple spots in Orange County this year—amid those struggles.
KBS is concerned over WeWork’s ability to fulfill its lease at the property.
“If WeWork were to exit, our leasing rate would decline to around 30%, exacerbating the already high vacancy rates in the market,” KBS said in regulatory filings.
Crime’s Impact
Office towers in San Francisco, particularly in the city’s financial district, have been hit especially hard in the wake of the pandemic, as the city struggles with a shrinking base of workers and an increase in crime and homelessness, prompting vacancy rates in the city to reach a new high of 31.6% during the second quarter, according to CBRE.
KBS attributes the rising vacancy rates in San Francisco offices to “a local political environment that has allowed crime and safety concerns to escalate and remain uncontrolled,” filings indicate.
It’s not the first time the company has cited rising societal problems as a key problem in markets where it owned properties.
KBS Growth & Income REIT Inc., another one of the firm’s non-traded REITs, bought Portland’s Commonwealth Building in June 2016 for $69 million, or about $308 per square foot; two years later, it refinanced the historic 14-story property with a $51.4 million loan from Metropolitan Life Insurance Co., which was due to be paid off this year.
KBS saw the building foreclosed upon earlier this year.
The tower, which was about half vacant at the end of 2022, is not far from where many of the city’s long-running and sizeable protests over the murder of George Floyd by police took place.
The area “is experiencing record high office vacancies due to the impact of the disruptions caused by protests and demonstrations and increased crime in the downtown area,” the REIT said earlier this year.
Office vacancy rates in that city have been on the rise due to slow return to office and increases in crime rates over the past three consecutive years, local reports indicate.
The Commonwealth Building was reportedly sold at a public auction last month to an affiliate of MetLife in a foreclosure sale, for just $15 million.
LA Losses
Closer to home, the company’s KBS Real Estate Investment Trust II in April sold the 675,945-square-foot Union Bank Plaza tower in downtown Los Angeles for about $110 million, well off the $208 million and $308 per square foot it bought the building for in 2010.
The office tower, built in 1967, was LA’s first skyscraper to be recognized as a city-historical cultural monument.
New York’s Waterbridge Capital bought the tower.
The 40-story tower was 57% leased at the end of 2022.
Declining demand for LA office space is the result of prevailing work-from-home policies. “The property represents an opportunity for the buyer to be part of an eventual post-pandemic recovery in downtown Los Angeles,” KBS officials said at the time of the sale.
Local Market
KBS invests in offices, industrial buildings, apartments and other property types. The commercial real estate investor was founded in 1992 by Chuck Schreiber, the late Don Koll and the late Peter Bren, brother of Irvine Co.’s Donald Bren. The first letters of each co-founder’s surname comprise the company’s name.
Despite recent uncertainty, the company maintains it is still bullish on the sector in more favorable markets, including Southern California.
OC “is among the top 25 markets in the country that we will continue to monitor for acquisitions,” CEO DeLuca said.
Office vacancy rates in OC are less severe than those in LA, San Francisco and Portland.
OC buildings with increasing vacancies are “dated commodity offices,” according to a report by JLL.
Buildings developed after 2010, however, are experiencing much higher occupancy rates due to tenants’ preference for newer product, the report said.
OC’s office vacancy rates are currently hovering around 14%, according to CBRE.
