Private valuations of distressed SF commercial properties plunge

While some San Francisco buildings have recently sold at fire-sale prices, private valuations of numerous other distressed properties in The City have plunged, according to real estate market experts.

“It gives you a feeling,” said Nigel Hughes, senior Bay Area director of market analytics at the real-estate information-services firm CoStar, “as to how much pressure the owners are under, in that because of the way the economy has moved, the value they have in these buildings has been seriously eroded.”

The distress has been most acute in sectors reliant on traffic in downtown San Francisco, said Hughes, who did a recent survey of strained commercial mortgage-backed security loans where the loan servicer asked for an appraisal and found resulting valuations that had fallen between roughly 20% to 80%.

The City has been among the hardest hit in the nation in terms of having a central business district in a severe slump following the COVID-19 pandemic, with record office and retail vacancies , particularly because of the rise of remote work and companies’ reduced leasing of office space.

The resulting impacts have slammed property owners stretched by burdensome debt obligations and buildings suffering occupancy declines, Hughes said.

Hughes’ observations were echoed by data from KBRA Analytics, which tracks commercial property loans tied to investor securities down to the individual property performance level.

Such debt represents a fraction of all existing commercial loans, but it serves as a proxy for understanding larger commercial real-estate market trends, said Patrick Czupryna, a KBRA managing director.

The San Francisco metropolitan area had the third-highest percentage among major markets of distressed loans tied to commercial mortgage-backed securities, 35% of $21.9 billion, KBRA reported this month. Chicago and Denver had the number one and two positions, said the company, which includes loans in default as well as loans exhibiting other signs of stress.

In dollar terms, Hughes said the largest single decline in appraised value — $930 million since 2016 — was recorded at the downtown mall and office complex now known as the Emporium Centre San Francisco, which was placed into receivership last October after the owners stopped loan paymemts .

The borrowers, international mall operator Unibail-Rodamco-Westfield and Brookfield Asset Management, had a $558 million loan covering 794,521 square feet of retail and office space at the 1.4 million square-foot mall in June of 2023, according to KBRA.

KBRA in July concluded the value of the property covered by the defaulted loan was worth about $221.7 million, down from $1.22 billion in 2016.

In addition to that retail sector pain, it is perhaps not surprising that Hughes said office properties make up most distressed loans, given that the real estate company CBRE reported that The City’s office vacancy rate hit a record high of 36.8% for the second quarter. Hughes said it will likely take years to reach peak loan delinquency.

“I think we’re still in the early stages of this whole process,” he said.

One example in the office sector is One Market Plaza, a 1.6 million square-foot, two-tower complex in the South Financial District that had a relatively high occupancy rate, but where Google has a lease for 22% of the space until April 2025 that the tech giant has indicated it will not renew , according to KBRA.

“A lot of tenants are either vacating their space, or maybe even just minimizing or reducing their space, or they’ll renew for the full space, but they’re looking for some kind of discount in their rent, whether short or long term that is going to have a negative impact on cash flow,” said Mike Brotschol, a KBRA managing director.

A February appraisal showed a 29% drop in value at One Market Plaza since the $975 million loan on the property was initiated, KBRA said. Hughes put that number at $510 million.

The loan was due in February, but owner Paramount Group said in a press release at the time that together with its joint-venture partner it had negotiated a loan modification and extension after paying down the balance by $125 million. The capital injection, which Paramount said showed its commitment to a quality asset, helped make the interest rate “viable,” Hughes said.

Lenders typically do not want to take ownership and management responsibility for properties and will try to find ways to keep borrowers in place, with the hope of one day getting repaid, Hughes said.

One office building that did go into receivership in anticipation of a potential foreclosure action was 600 California St., a 20-story building partly owned and half-leased by WeWork, which suspended lease payments in 2023 and then got a deal to pay less rent, according to KBRA. The firm said a February appraisal showed the building worth 64% less than when a $240 million loan on the property was issued in 2019.

The hospitality sector has also seen major downgrades in appraised values, Hughes said.

The Hilton San Francisco Union Square and the Parc 55 San Francisco are both also in receivership after the owner stopped payments on a $725 million in June of 2023.

KBRA conservatively put the value of the two giant properties, which have nearly 2,945 rooms combined, at $553.1 million. That was 64.5% below the $1.56 billion appraised value in 2016.

Owner Park Hotels & Resorts, a large lodging real-estate investment trust, had estimated the properties needed a combined investment of $200 million over five years to remain competitive, KBRA said. Instead, the company walked away and a court-appointed receiver is now trying to sell the properties.

Average occupancy, which did not recover after COVID-19 caused lengthy closures of both hotels, was 51% for the 12 months ending in May, compared with 93% in 2019, KBRA said.

“There’s a lot less business travel in The City, and it’s been a real struggle for those properties to achieve occupancy rates that they were enjoying pre-pandemic,” said Maverick Force, a KBRA senior director.

Such reductions in property values have an effect on city finances. Last year The City received a deluge of assessment appeals , including for the Emporium and many other commercial properties.

A June report from the city controller’s office said the city budget assumed refunds would eventually be paid for assessment appeals filed in this fiscal year and the following year, totaling $118.9 million and $136.1 million, respectively.

The budget also assumed $2.5 billion of reductions in assessment values in each of the two budget years, which translates to approximately $14 million in annually refunded property-tax revenues.

The current window for making appeals of 2024/2025 assessed property values is open until Sept. 16.