Downtown Los Angeles is on a Downward Spiral, Little Can Be Done to Revive It

Los Angeles, CBRE, Colliers, Santa Monica, Corion Enterprises, Oaktree Capital Management, Brookfield, Columbia Property Trust, Pacific Investment Management Co., Silverstein Properties
Photo by Marty O’Neill on Unsplash

By The Registry Staff

The distressed state of property in America’s second-largest city poses a significant threat to landlords, as mounting vacancy rates lead to widespread defaults. Downtown Los Angeles, situated in a sprawling, car-centric region, is experiencing a record-high office vacancy rate of 30 percent, causing a significant decline in property value. The shift to remote work during the pandemic has resulted in vacant storefronts, concerns about crime, and financial strain on transit systems, affecting downtown areas across the United States, according to a recent report in Bloomberg Businessweek. Additionally, rising interest rates combined with falling property values are pressuring building owners with higher debt burdens than equity, prompting warnings of financial instability from bankers, private equity executives, and the Federal Reserve.

The situation is particularly dire for office properties, with top-tier buildings seeing a 25 percent decline in value over the past year, and the broader office market nearly 40 percent below pre-pandemic levels. Cities like San Francisco and New York are also grappling with excess office space, but their histories suggest potential rebound after crises like the dot-com bust and the September 11 attacks. However, the outlook for downtown areas in metropolitan regions with sprawling suburbs and alternative business districts is more uncertain. Downtowns in cities such as Atlanta, Chicago, and Houston are all experiencing high rates of office vacancies.

Among these cities, Los Angeles faces a unique challenge. While it is renowned for its Hollywood studios and celebrity estates, the downtown area, located miles away from where many residents live and work, lacks appeal. Commercial real estate analyst Lea Overby of Barclays Capital describes downtown LA as having the highest number of distressed borrowers in the market due to outdated properties, downsizing tenants, and unattractive surroundings.

Colliers, a commercial real estate brokerage, reports that almost all of downtown LA’s top three dozen office buildings are currently underwater on their loans, with an average debt of over $230 per square foot. In contrast, this year’s major sale, the Union Bank Plaza, had a price of about $154 per square foot. The challenges downtown LA faces extend beyond domestic investors, as foreign pensions and sovereign wealth funds, which once considered the US office real estate a safe investment, are now in the middle of the property crisis.

Many US office owners are choosing to delay building improvements, capitalizing on declining revenues as their properties slowly deteriorate and tenants vacate. Some landlords are even relinquishing their properties to lenders, cutting their losses. In some cases, prices may have to approach the value of raw land to attract new investors. The overall consequence of emptying office towers threatens the vitality of downtown areas and undermines decades-long investments in densely populated urban landscapes.

Fred Cordova, CEO of Corion Enterprises, a commercial real estate brokerage in Santa Monica, likened the situation to a zombie apocalypse, emphasizing the urgent need to address the capital stack to prevent buildings from becoming unprofitable liabilities.

Downtown LA’s real estate challenges are closely tied to its expansive geography. With a population nearing 10 million, Los Angeles County covers an area of 4,750 square miles, often referred to as “72 suburbs in search of a city.” While downtown LA hosts government agencies, legal and accounting firms, and a handful of financial companies, it lacks the presence of S&P 500 companies. The city’s post-World War II economic growth driven by the oil and aerospace industries has long faded, and the entertainment industry is scattered throughout various areas outside the city center.

Before the pandemic, downtown LA was experiencing a renaissance, with early 20th-century buildings repurposed as apartments and trendy hangouts. The population surrounding downtown had grown to 90,000 in 2020, attracting people seeking a Manhattan-like urban living experience in a decentralized city.

In 2014, the Ace Hotel transformed a former oil industry office building in downtown LA, accompanied by a restored movie palace built by Mary Pickford and Charlie Chaplin, now functioning as a concert venue. The following year, a Whole Foods Market opened, while the Rialto Theatre became an Urban Outfitters, and the Tower Theatre was converted into an Apple store.

However, the arrival of the Covid-19 pandemic led to significant fallout in downtown LA, mirroring the impact experienced in cities nationwide. Homeless encampments, previously concentrated in the notorious Skid Row area, spread as health officials argued against forcing the unsheltered indoors due to virus transmission concerns. Following the May 2020 murder of George Floyd in Minneapolis, protests and subsequent looting led to boarded-up stores and restaurants that never reopened.

Jessica Lall, a managing director at CBRE Group Inc. and former head of a downtown business development district, described the circumstances as exceptionally challenging. The reasons behind the decline extend beyond financial issues and encompass concerns related to safety, security, and amenities.

Epic commutes and congested freeways discourage office workers from returning. Rail and bus ridership on the Los Angeles County Metropolitan Transportation Authority has declined by 30 percent since the pandemic. Additionally, Mayor Karen Bass revealed that as of March, 22 people had been found dead on the Metro system, many suspected of drug overdoses. This figure already matches the total for the entirety of 2022.

In response to these challenges, Mayor Bass presented a budget allocating $1.3 billion to rehouse the city’s 42,000 homeless individuals and $1.9 billion for the LA Police Department to hire more officers. The city council also approved a plan to provide housing for an additional 125,000 residents downtown.

Mayor Bass emphasized the importance of downtown’s success for the overall prosperity of the entire city. She stated that thriving commercial districts do not occur by chance and require deliberate action.

Christopher Rising, a second-generation LA developer, still owns four downtown office buildings but has shifted his focus to industrial real estate due to its higher demand. He pointed out that approximately one-third of downtown LA’s workforce, consisting of government employees and professionals like lawyers and accountants, continue to work remotely, contributing to the challenges faced by the real estate market. Rising believes that these issues can be resolved, emphasizing the government’s responsibility to ensure safety and crime prevention.

Troubled situations have emerged in close proximity to one another in downtown LA. The century-old Broadway Trade Center was foreclosed by Starwood Property Trust Inc. last year, while Manulife Financial Corp. devalued a building by 33 percent after its anchor tenant, TCW Group Inc., ended its lease. Oaktree Capital Management took possession of 444 S. Flower St., the tower famously featured as the exterior offices in the television series L.A. Law. Brookfield, another major property owner, may default on Bank of America Plaza, which carries a $400 million mortgage, according to a report by Barclays Plc.

Brookfield, however, stated that its troubled offices represent only a small percentage of its portfolio. The company remains committed to downtown LA and is currently finalizing the Beaudry, a new 785-unit apartment tower. Online pre-leasing began in April, and there has been a recent increase in demand as physical tours commence.

The challenges faced by Brookfield highlight the difficult decisions being made by landlords across the United States, with institutional investors leading the way in cutting losses. Blackstone Inc. has halted payments on offices in Manhattan and Las Vegas, while Columbia Property Trust, owned by Pacific Investment Management Co., has defaulted on $1.7 billion of mortgages tied to properties in New York, Boston, San Francisco, and Washington.

The situation is expected to worsen, with approximately 1.5 billion square feet of office space, nearly a quarter of all US space, at risk of becoming “zombie buildings” with low occupancy and diminishing financial viability. This could result in a potential loss of up to $450 billion in value by 2030, as projected by a recent report from Boston Consulting Group. Office values in cities like San Francisco, LA, New York, Philadelphia, and Washington, DC, are predicted to drop by as much as 60 percent from pre-pandemic levels. Without new investments, more stores, restaurants, and other downtown tenants are likely to close.

Santiago Ferrer, a managing director at BCG and co-author of the report, emphasized the need for cities to take action to prevent a cycle of declining activity. He called for cities to leverage their convening power to address the situation.

Among the key players boosting downtown LA’s real estate is New York-based Silverstein Properties, renowned for its reconstruction of the World Trade Center area after the September 11, 2001 attacks. In 2020, Silverstein purchased LA’s US Bank Tower for $430 million and invested an additional $60 million in its renovation. The revamp included a concierge-staffed conference center on the 54th floor and a ground-floor lobby adorned with a plant wall, blond-wood paneling, and a juice bar. The aim was to create a comfortable hotel-like experience that would attract workers back from their home offices.

During a March ribbon-cutting ceremony, Silverstein CEO Marty Burger drew parallels between downtown LA and lower Manhattan after the terrorist attacks, highlighting his company’s contribution to revitalizing and transforming New York’s Financial District into a vibrant live-work community. Burger expressed confidence in downtown LA’s remarkable history and great potential.

Rudy Medina, US Bank’s Southern California market president, expressed enthusiasm for the new owners, stating that having Silverstein at the base of the building was a source of excitement. Medina noted that the tower’s underground parking lot has been filling up as more people return to their offices following the renovations. He personally drives to work, despite living a few blocks away, due to feeling uncomfortable walking in the area.

The street environment, according to Medina, is currently far from pleasant.