One-Billion-Dollar Office Buildings Lose 70% of Market Value

Takeaways

• The market value of a suburban office park in Los Angeles was estimated at almost a billion dollars in 2019.
• Given changes in the market brought on by the COVID-19 pandemic, the property is struggling.
• When the lender attempted to sell the loan in 2023, it revealed dramatic price dislocation.

Last week, a lending syndicate led by Morgan Stanley attempted to sell one of its distressed loans, but things did not go as planned. The loan in question is collateralized by an office property that’s located in the Los Angeles market. Known as PCT, it’s a three-building, suburban office park with some 1.6 million square feet of rentable area. The borrower, an ownership entity representing Starwood Capital and Artisan Realty, purchased the property in 2017 for a little over $611 million, which was roughly the equivalent of $382/SF.

A Value-Add Play

It was an older property, built in the early 1980s. After completing upgrades to the elevators and other mechanical systems, renovating the common areas of the buildings and campus, and generally modernizing the feel of the property, the pair of owners refinanced it in 2019. Morgan Stanley originated a senior mortgage of about $500 million itself and syndicated another $125 million or so to other lenders. In total, that put the loan at about $625 million. It’s also believed that it was an interest-only loan, meaning that that the principal hasn’t been paid down at all over the subsequent years.

Since the loan was not associated with a sale, we don’t know the lender’s precise estimate of market value at that time. However, assuming a maximum loan-to-value ratio of 65%, which would have been fairly standard for a suburban office property in Los Angeles in 2019, the parties to the transaction may have thought it was worth as much as $960 million, or $600/SF.

Timing Is Everything

As you’ve probably already guessed, things took a turn for the worse during the COVID-19 pandemic and the subsequent shift to remote and hybrid work policies. By early 2023, the property was operating at only about a 50% occupancy rate, suggesting that it wasn’t generating enough income to adequately service the loan and its market value had significantly decreased.

According to Green Street, a research and advisory firm that focuses on the commercial real estate industry, Morgan Stanley began actively negotiating a resolution with the borrower in March of this year. Soon thereafter, they decided that the best course of action was to sell the debt and hired Eastdil Secured, a commercial real estate investment bank, to market the $625 million loan for sale. At that time, it was expected to attract bids around $400 million, again, as reported by Green Street.

What Happens When You Buy a Loan?

Let’s pause here to flesh things out a bit from a prospective buyer’s perspective. If you purchased a $625 million loan for $400 million, what exactly would you be getting for your money? Basically, you’re buying a lien. Even though it was someone else who loaned the borrower $625 million, the lien that you just purchased gives you the right to collect that $625 million in accordance with the terms of the existing loan.

In a situation like this, things would most likely play out in one of two different ways.

• Scenario 1 – The borrower continues to pay as agreed. In other words, they continue to make the monthly interest payments until the loan comes to maturity, at which point they would repay the principal in its entirety. To reiterate my earlier point, if it’s an interest-only loan, the balance at maturity would be the same amount as the balance at origination. The term for an interest-only loan on commercial real estate typically falls somewhere between three and seven years.
• Scenario 2 – The borrower defaults. If that were to happen, you would be within your rights to foreclose on the property. That said, depending on whether or not your relationship with the borrower is continuous, it might not be necessary to foreclose. If they’re willing to hand over the keys, so to speak, title to the property might be transferred by a so-called deed in lieu of foreclosure. Regardless, you take ownership of the property, having effectively purchased it for the amount you paid for the loan.

Things Did Not Go as Planned

Okay, let’s get back to the subject property, a suburban office park in the Los Angeles market. Eastdill Secured took the $625 million loan to market for Morgan Stanley, reportedly with the expectation of selling it for about $400 million. As I mentioned, however, things did not go as planned. The highest bid received for the loan was $275 million. Let that sink in for a moment.

Given the bids, it seems safe to assume that none of the prospective buyers expects the loan to be repaid. Instead, their objective is to take ownership of the property and their bids suggest that the market now estimates a value of $275 million for this particular property, or $172/SF. Never mind that it was valued at almost a billion dollars less than five years ago.

Waiting for Sellers to Sell

As of right now, Morgan Stanley hasn’t announced if they’re going to follow through with the sale. You better believe, however, that turn of events like this are getting the attention of market participants. It’s definitely informing their decisions. In a recent survey of investors, conducted by Bloomberg, an overwhelming majority of the respondents expect sale prices, particularly the sale prices of office properties, to continue decreasing through at least the second half of 2024. What we’re waiting for is confirmation from sellers that they’ve come around to the same realization.