New Distress In The LA Market Grows To $4.7B, Led By Office Troubles
The volume of distressed loans tied to property in Los Angeles grew 15% to $4.7B in the third quarter compared to the quarter before and is likely to grow further as the office market stumbles in 2024.
Potential distress, which “is indicative of financial stress that, if not reconciled, has the potential to become full-blown financial trouble,” according to MSCI, totaled nearly $8.7B in Q3, an increase of 18% over the previous quarter’s $7.3B.
About two-thirds of the distress is linked to office properties, MSCI Research Vice President Alexis Maltin said. That isn't out of line with the overall national market, where distress is largely being driven by office trouble.
For the first three quarters of this year, the Los Angeles market saw net positive distress. In other words, the value of new distress was greater than the value of distress that was resolved through a loan workout or the sale of a building.
Net distress has declined each quarter this year, from about $841.5M in the first quarter to $407.9M in the third. But it is still too soon to say what those declines might mean for the market, Maltin said, adding that the data is “quite volatile.”
Buyers and sellers still struggle to find common ground on what they think properties are worth in the uneven market.
MSCI estimates that the gap between what office sellers want to get for their properties and what buyers are willing to pay for them is about 12.5%. MSCI Executive Director of Research Jim Costello said the number implies that big pricing changes are needed to get deals to close and deal volume to rise.
Costello said it would take a change in income expectations for some of these properties or a drop in interest rates to move the needle one way or the other. It will also depend on how long property owners can wait to sell.
Current owners who have cash-flowing properties and can make payments and meet terms of their loans don’t have much motivation to sell right now and are in a wait-and-see position, Costello said.
“Maybe if they're not cash-flowing anymore — if something happens, an event at the property like they lose a big tenant and they can't replace them — or if there's a debt-type of event where they have a big refinancing coming up, they can't get the same kind of credit as before and the numbers don't work for them to refinance the property, then they might be willing to capitulate,” Costello said.
Research from Newmark suggests the amount of office space that could be in danger from an occupancy perspective is growing.
Looking at the office market in terms of occupancy offers another way to see where trouble might be brewing. Newmark’s third-quarter report found that 63M SF of Los Angeles office space is less than 70% occupied, a threshold Newmark uses to designate “economically unviable/obsolete” office space. This number rose from 57M SF quarter-over-quarter.
With occupancy below 70%, Newmark's calculations suggest ownership will likely struggle to generate positive net operating income, which allows an owner to support existing debts with a building’s revenue.
This data was compiled before the news of WeWork’s bankruptcy, which could initially put about 200K SF of office space back on the market from Orange County to LA, with the expectation that more lease rejections could follow as the company’s restructuring unfolds.
By submarket in LA, West Los Angeles has the greatest volume of space with less than 70% occupancy at about 41%.
Newmark Head of Southwest Research Dain Fedora said there is quite a bit of industry concentration on the Westside, which has a number of submarkets that are or were favored by tech and media companies. The industry has contracted its footprint and its workforce since the pandemic.
“There has been an increase [in unviable space],” Fedora said. “It's not massive — these things do take time to play out — but it's definitely on the rise.”
