Lenders in San Francisco’s struggling commercial real estate market are facing billions of dollars in default after owners of the city’s largest mall and largest hotel defaulted on loan payments and returned the keys to what was once the city’s most prized property.
This week, Westfield and Brookfield Properties announced they have stopped paying on a $558 million loan secured against the sprawling downtown San Francisco mall they have owned since 2002 they will hand over the premises to their lenders.
Days earlier, New York Stock Exchange-listed Park Hotels & Resorts said it expects to hand over ownership of two of its top San Francisco hotels — the Hilton Union Square and Parc 55 — after it finishes paying off a loan in San Francisco amount of 725 million US dollars. When the loan was issued in 2016, the hotels were valued at more than $1.5 billion, suggesting owners believe their value has more than halved.
The big defaults were the latest in a series of distress signals from San Francisco office, hotel, apartment building and retail landlords. The city has been grappling with a sharp decline in tourism and business travel, downsizing by tech companies, an exodus of residents and international control over crime, drug use and homelessness since the coronavirus pandemic.
Park Hotels CEO Thomas Baltimore said, “San Francisco’s path to recovery remains marred and prolonged by major challenges,” including “concerns about road conditions.”
The Westfield mall was half-empty after brands like Nordstrom left the mall, in part due to “running criminal activity” and because downtown foot traffic has not recovered from the pandemic. Westfield said its sales fell sharply between December 2019 and 2022, compared to an average sales increase at its other U.S. malls.
The defaults could trigger a fire sale of commercial real estate in the city as lenders rush to dump assets at deep discounts to reduce risk and protect bondholders. In many cases, major commercial real estate lenders in San Francisco, including JPMorgan, Deutsche Bank, Wells Fargo and Bank of America, have syndicated real estate debt through commercial mortgage-backed securities. Bondholders could take a hit as falling house prices have meant some of the loans have come under pressure – meaning the asset is worth less than the value of the loan, economists said.
This revaluation could trigger a domino effect, making it harder for homeowners to refinance their debt as banks become even more cautious about lending. Some US banks have reduced exposure to the commercial real estate market following the recent turmoil in the region’s banking sector – and the downside risk is particularly high in San Francisco.
“We’ve reached a tipping point where we’ve seen a lot of that [broader economy] Headlines come in the San Francisco market,” said Lonnie Hendry, director of commercial real estate at Trepp, a data provider. “The dominoes fell much quicker in San Francisco than anywhere else.”
Park Hotels & Resorts anticipates delivery of ownership of the Hilton Union Square. . .
and the Parc 55 Hotel © Justin Sullivan/Getty Images
In San Francisco’s Financial District, a number of office towers have changed hands in recent months for a quarter of the price they were marketed at three years ago. WeWork defaulted on a $240 million loan for its tower at 600 California Street in April. Elsewhere downtown, Elon Musk’s Twitter company stopped paying his rent in November, forcing his landlord to default on a $400 million loan.
As the economic situation in San Francisco remains uncertain, the re-rating could take even longer. “Even if you can buy a building today for 50 cents on the dollar relative to the loan balance, that doesn’t mean it’s a home purchase,” Hendry said. “We don’t know the ground yet.”
According to the filing, Wells Fargo is one of San Francisco’s largest commercial real estate companies with approximately $34 billion in outstanding loans in California. The state had the largest share of its total outstanding loans of $155 billion at the end of 2022 (the bank doesn’t report figures by city). Almost $14 billion of Bank of America’s total outstanding commercial real estate loans of $73 billion is in California. First Republic, which collapsed in May after a bank crash and was acquired by JPMorgan, has originated about $12 billion of its $35 billion total in commercial real estate loans to the San Francisco Bay Area, 2022 filings show . Deutsche Bank originated the Westfield mall loan in 2016, while Park Hotels’ mortgage is serviced by Wells Fargo and was originally acquired by JPMorgan.
Data from rating agency Moody’s showed that 50 percent of CMBS office loans maturing in 2024 are at risk of default.
“This is a situation where there is, at least temporarily, a loss of confidence in certain assets in the market,” said Thomas LaSalvia, chief economist at Moody’s. “There will be a hit across the board,” he said of commercial real estate lenders.
Just outside of San Francisco in the wider Bay Area, tech giants like Google and Meta have offered parts of their massive offices for sublease. An executive at a firm that services defaulted CMBS loans said this created an “awkward situation” for landlords and lenders whose loans are secured against the campus. “If they don’t use the space, it’s logical to conclude that they won’t renew the lease and you have a big problem being on track, but there’s nothing you can do until the lease expires.” said the person.
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The city is facing a decline in technology and the shift to teleworking, leading to lower demand for office space.
A senior executive at a major global real estate lender said the San Francisco office market would be harder hit than other parts of the commercial real estate market. He said there will be “challenges in refinancing” as loans for vacant offices come due.
“It is clear that the assets will not be worth more than the debt even if they deposit more cash [landlords will] Ask yourself: Is it better if I just return the asset to the lender?”
Office vacancies in San Francisco have risen to 30 percent, the highest of any major US city. Hotels in San Francisco were particularly hard hit. The city has an average daily room rate of $207, which is below 2019 levels — one of only two major U.S. cities where rates have not increased. Hotel bookings in San Francisco were prone to a drop in travelers from China and security concerns prompted a shift in business meetings.
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Club Quarters, a business hotel owned by the Blackstone Group, has defaulted on a $274 million loan since 2020. The Huntington Hotel, a historic luxury hotel in Nob Hill, defaulted on a $56 million loan from Deutsche Bank last year and later defaulted again in a foreclosure sale for about half the loan amount.
According to real estate data provider CoStar, more than 20 other San Francisco hotels have CMBS loans maturing in the next two years. 15 of these are on their lender’s “watch list,” meaning they have missed repayments or are likely to miss future payments.
The rising number of defaults in several real estate asset classes has raised concerns about a drop in city tax revenues that could trigger a “spiral of bad luck” – an irreversible economic and social spiral. Large office buildings trading at greatly discounted prices would quickly erode a crucial portion of the city’s tax base. San Francisco projects a budget deficit of $780 million over the next two years, which will affect its ability to provide public services or incentivize businesses that help revitalize the downtown area.
Owners of some of San Francisco’s iconic buildings, like the Transamerica Pyramid and Uber’s Mission Bay headquarters, have petitioned the city to lower their tax burden as the value of their real estate has plummeted.
“San Francisco fears it’s losing critical mass,” said Moody’s LaSalvia. He said there is a “snowball effect” where the move of retailers and tech companies causes an even greater drop in foot traffic, increasing the risk for remaining tenants and owners who are then more likely to default on their payments.
“When you get below the point where the vibrancy that attracts tourists, workers and shoppers is gone, it’s really hard to come back from that,” he said.