Defaults sound the alarm on the sustainability of San Francisco’s commercial property

Lenders to San Francisco’s troubled commercial real estate market defaulted on billions of dollars in debt after the owners of the city’s biggest shopping mall and largest hotel stopped loan payments and handed back the keys to what was once the city’s most valuable asset. are ready for.

This week, Westfield and Brookfield Properties announced they have stopped making payments on a $558 million loan secured by San Francisco’s sprawling downtown mall, which they have owned since 2002, and will turn the complex over to their lenders .

A few days ago, New York-listed Park Hotels & Resorts said it expected to hand over ownership of two of its flagship San Francisco hotels – the Hilton Union Square and Park 55 – after it stopped making payments on a $725 million loan. Had done it. The hotels were valued at more than $1.5 billion in 2016 when the loan was issued, suggesting that its owners believe their value has more than halved.

The major omission was the latest in several distress signals by landlords of offices, hotels, apartment blocks and retailers in San Francisco. The city has been battling a sharp drop in tourism and business travel since the coronavirus pandemic, downsizing by technology companies, an exodus of residents, and international scrutiny over crime, drug use and homelessness.

Thomas Baltimore, chief executive officer of Park Hotels, said: “San Francisco’s path to recovery is unclear and beset by major challenges”, including “concerns over road conditions”.

Westfield Mall is half empty after brands such as Nordstrom left, partly due to “rampant criminal activity” and pedestrian traffic in the city has not recovered after the pandemic. Westfield said its sales declined sharply between December 2019 and 2022, while its other US malls posted average sales growth.

The defaults could trigger a fire sale of commercial property in the city, as lenders rushed to sell assets at significant discounts to reduce their exposure and protect bondholders. In many cases, large commercial real estate lenders in San Francisco, including JPMorgan, Deutsche Bank, Wells Fargo and Bank of America, syndicated property loans through commercial mortgage-backed securities. Bondholders could take a hit because the collapse in property prices has left some loans underwater — meaning the property is worth less than the loan is worth — according to economists.

This revaluation can trigger a knock-on effect that makes it harder for property owners to refinance their loans as banks become even more cautious about lending. Some US banks are reducing their exposure to the commercial real estate market after recent turmoil in the regional banking industry – and the potential for loss is especially acute in San Francisco.

“We’ve hit a juncture where we’ve seen a lot of (broadeconomy) headwinds in the San Francisco market,” said Lonnie Hendry, head of commercial real estate at data provider Trapp. “The dominoes have fallen more quickly in San Francisco than elsewhere.”

In San Francisco’s financial district, some office towers have changed hands in recent months for a quarter of what they were at market price three years ago. WeWork defaulted on a $240mn loan for its tower at 600 California Street in April. Elsewhere downtown, Elon Musk’s Twitter stopped paying its rent in November, forcing its landlord to default on a $400 million loan.

As San Francisco’s economic situation remains uncertain, the reevaluation may have to go further. Hendry said, “Even if you can buy a building today at 50 cents on the dollar relative to the loan balance, that doesn’t mean it’s buying a home run.” “We don’t know the destination yet.”

Wells Fargo has the largest exposure to San Francisco commercial real estate, with approximately $34 billion in outstanding loans in California, according to the filing. The state made up the largest portion of its total $155bn of outstanding loans at the end of 2022 (the bank does not report figures by city). About $14bn of Bank of America’s total $73bn of outstanding commercial property loans are in California. At First Republic, which collapsed in May after a bank run and was acquired by JPMorgan, about $12bn of its total $35bn commercial real estate loans were made in the San Francisco Bay Area, according to a 2022 filing . Deutsche Bank made the loan for Westfield Mall in 2016, while the Park Hotels’ mortgage is serviced by Wells Fargo and was originally underwritten by JP Morgan.

Data from ratings agency, Moody’s, shows that 50 percent of CMBS office loans maturing in 2024 are at risk of default.

“This is a situation where it really is a loss of confidence, at least temporarily, of some assets in the market,” said Thomas Lasalvia, senior economist at Moody’s. About commercial property lenders, he said, “There is going to be a hit across the board.”

Just outside San Francisco in the wider Bay Area, tech giants including Google and Meta have put their massive offices out for sublease. An executive of a firm that services defaulted on CMBS loans has created an “uncomfortable situation” for landlords and lenders who have loans secured against the premises. “If they’re not using the space, it’s logical to assume they won’t renew the lease and so you’ve got a bigger problem getting on track, but there’s nothing you can do until the lease expires,” said the person.

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The city is moving towards a slowdown in technology and remote working, reducing the demand for office space.

San Francisco’s office market will experience more distress than other parts of the commercial real estate market, said a senior executive at a large global real estate lender. He said there would be “refinancing challenges” as debt matured on the vacant offices.

“It is clear that the property will not be worth more than the loan balance even if they put in more cash, so[the landlord]will ask themselves, am I better off handing the property back to the lender?”

Office vacancies in San Francisco have soared 30 percent, the most of any major US city. Hotels in San Francisco have also been particularly hard hit. The city’s average daily room rate is $207, down from 2019 levels – one of only two large US cities where rates haven’t increased. Hotel bookings in San Francisco have been susceptible to a drop in travelers from China and security concerns have prompted trade conventions to relocate.

Club Quarters, a commercial hotel owned by the Blackstone Group, owes $274mn in debt since 2020. The Huntington Hotel, a historic luxury hotel in Nob Hill, last year defaulted on a $56mn loan originated by Deutsche Bank and was subsequently sold at foreclosure auction for almost half the size of the loan.

More than 20 other San Francisco hotels have CMBS loans maturing in the next two years, according to property data provider CoStar; Of these, 15 are on the “watchlist” of their lenders, meaning they have defaulted on repayments or are likely to miss future payments.

The rising number of defaults in several property asset classes has raised concerns about a drop in city tax revenue that could fuel a “doom loop” – an economic and social spiral that becomes impossible to reverse. Large office buildings trading at heavily discounted prices would quickly erode a significant portion of the city’s tax base. San Francisco has projected a budget deficit of $780 million over the next two years, which would affect its ability to provide public services or provide incentives to businesses to help revitalize the city.

Owners of some of San Francisco’s iconic buildings such as the Transamerica Pyramid and Uber’s Mission Bay headquarters have petitioned the city to reduce their tax burdens as the value of their properties plummeted.

“The concern for San Francisco is that it loses its critical mass,” said La Salvia at Moody’s. He said there was a “snowball effect” in which leaving out retailers and tech companies leads to an even greater decrease in foot traffic, increasing the risk to the remaining tenants and owners, who are then more likely to default.

“When you get below that point where the vibrancy that attracts tourists, workers and shoppers is gone, it’s really hard to come back from there,” he said.

Lenders to San Francisco’s troubled commercial real estate market defaulted on billions of dollars in debt after the owners of the city’s biggest shopping mall and largest hotel stopped loan payments and handed back the keys to what was once the city’s most valuable asset. are ready for.

This week, Westfield and Brookfield Properties announced they have stopped making payments on a $558 million loan secured by San Francisco’s sprawling downtown mall, which they have owned since 2002, and will turn the complex over to their lenders .

A few days ago, New York-listed Park Hotels & Resorts said it expected to hand over ownership of two of its flagship San Francisco hotels – the Hilton Union Square and Park 55 – after it stopped making payments on a $725 million loan. Had done it. The hotels were valued at more than $1.5 billion in 2016 when the loan was issued, suggesting that its owners believe their value has more than halved.

The major omission was the latest in several distress signals by landlords of offices, hotels, apartment blocks and retailers in San Francisco. The city has been battling a sharp drop in tourism and business travel since the coronavirus pandemic, downsizing by technology companies, an exodus of residents, and international scrutiny over crime, drug use and homelessness.

Thomas Baltimore, chief executive officer of Park Hotels, said: “San Francisco’s path to recovery is unclear and beset by major challenges”, including “concerns over road conditions”.

Westfield Mall is half empty after brands such as Nordstrom left, partly due to “rampant criminal activity” and pedestrian traffic in the city has not recovered after the pandemic. Westfield said its sales declined sharply between December 2019 and 2022, while its other US malls posted average sales growth.

The defaults could trigger a fire sale of commercial property in the city, as lenders rushed to sell assets at significant discounts to reduce their exposure and protect bondholders. In many cases, large commercial real estate lenders in San Francisco, including JPMorgan, Deutsche Bank, Wells Fargo and Bank of America, syndicated property loans through commercial mortgage-backed securities. Bondholders could take a hit because the collapse in property prices has left some loans underwater — meaning the property is worth less than the loan is worth — according to economists.

This revaluation can trigger a knock-on effect that makes it harder for property owners to refinance their loans as banks become even more cautious about lending. Some US banks are reducing their exposure to the commercial real estate market after recent turmoil in the regional banking industry – and the potential for loss is especially acute in San Francisco.

“We’ve hit a juncture where we’ve seen a lot of (broadeconomy) headwinds in the San Francisco market,” said Lonnie Hendry, head of commercial real estate at data provider Trapp. “The dominoes have fallen more quickly in San Francisco than elsewhere.”

In San Francisco’s financial district, some office towers have changed hands in recent months for a quarter of what they were at market price three years ago. WeWork defaulted on a $240mn loan for its tower at 600 California Street in April. Elsewhere downtown, Elon Musk’s Twitter stopped paying its rent in November, forcing its landlord to default on a $400 million loan.

As San Francisco’s economic situation remains uncertain, the reevaluation may have to go further. Hendry said, “Even if you can buy a building today at 50 cents on the dollar relative to the loan balance, that doesn’t mean it’s buying a home run.” “We don’t know the destination yet.”

Wells Fargo has the largest exposure to San Francisco commercial real estate, with approximately $34 billion in outstanding loans in California, according to the filing. The state made up the largest portion of its total $155bn of outstanding loans at the end of 2022 (the bank does not report figures by city). About $14bn of Bank of America’s total $73bn of outstanding commercial property loans are in California. At First Republic, which collapsed in May after a bank run and was acquired by JPMorgan, about $12bn of its total $35bn commercial real estate loans were made in the San Francisco Bay Area, according to a 2022 filing . Deutsche Bank made the loan for Westfield Mall in 2016, while the Park Hotels’ mortgage is serviced by Wells Fargo and was originally underwritten by JP Morgan.

Data from ratings agency, Moody’s, shows that 50 percent of CMBS office loans maturing in 2024 are at risk of default.

“This is a situation where it really is a loss of confidence, at least temporarily, of some assets in the market,” said Thomas Lasalvia, senior economist at Moody’s. About commercial property lenders, he said, “There is going to be a hit across the board.”

Just outside San Francisco in the wider Bay Area, tech giants including Google and Meta have put their massive offices out for sublease. An executive of a firm that services defaulted on CMBS loans has created an “uncomfortable situation” for landlords and lenders who have loans secured against the premises. “If they’re not using the space, it’s logical to assume they won’t renew the lease and so you’ve got a bigger problem getting on track, but there’s nothing you can do until the lease expires,” said the person.

You are viewing a snapshot of an interactive graphic. This is probably due to being offline or JavaScript is disabled in your browser.

The city is moving towards a slowdown in technology and remote working, reducing the demand for office space.

San Francisco’s office market will experience more distress than other parts of the commercial real estate market, said a senior executive at a large global real estate lender. He said there would be “refinancing challenges” as debt matured on the vacant offices.

“It is clear that the property will not be worth more than the loan balance even if they put in more cash, so[the landlord]will ask themselves, am I better off handing the property back to the lender?”

Office vacancies in San Francisco have soared 30 percent, the most of any major US city. Hotels in San Francisco have also been particularly hard hit. The city’s average daily room rate is $207, down from 2019 levels – one of only two large US cities where rates haven’t increased. Hotel bookings in San Francisco have been susceptible to a drop in travelers from China and security concerns have prompted trade conventions to relocate.

Club Quarters, a commercial hotel owned by the Blackstone Group, owes $274mn in debt since 2020. The Huntington Hotel, a historic luxury hotel in Nob Hill, last year defaulted on a $56mn loan originated by Deutsche Bank and was subsequently sold at foreclosure auction for almost half the size of the loan.

More than 20 other San Francisco hotels have CMBS loans maturing in the next two years, according to property data provider CoStar; Of these, 15 are on the “watchlist” of their lenders, meaning they have defaulted on repayments or are likely to miss future payments.

The rising number of defaults in several property asset classes has raised concerns about a drop in city tax revenue that could fuel a “doom loop” – an economic and social spiral that becomes impossible to reverse. Large office buildings trading at heavily discounted prices would quickly erode a significant portion of the city’s tax base. San Francisco has projected a budget deficit of $780 million over the next two years, which would affect its ability to provide public services or provide incentives to businesses to help revitalize the city.

Owners of some of San Francisco’s iconic buildings such as the Transamerica Pyramid and Uber’s Mission Bay headquarters have petitioned the city to reduce their tax burdens as the value of their properties plummeted.

“The concern for San Francisco is that it loses its critical mass,” said La Salvia at Moody’s. He said there was a “snowball effect” in which leaving out retailers and tech companies leads to an even greater decrease in foot traffic, increasing the risk to the remaining tenants and owners, who are then more likely to default.

“When you get below that point where the vibrancy that attracts tourists, workers and shoppers is gone, it’s really hard to come back from there,” he said.