[co-author: Kevin Donner]
There hasn’t been much good news for the office sector for several years, but positive sentiment is picking up. While there are a few California markets with a negative outlook, there has been marked improvement in San Francisco, Silicon Valley, and the East Bay. Allen Matkins Partner Spencer B. Kallick spoke with Kevin Donner, executive vice chairman of Newmark, about his take on the current state of the office sector.
Spencer B. Kallick
What are the trends in office right now? Is it conversion? Is it just buying and holding?
Kevin Donner
In Los Angeles, you have to look at the different markets. Downtown LA is really a basis play. And for the most part, you need good seller financing right now. Because it's expensive. With a basis play, there are more private buyers. In Playa Vista, there are more institutional buyers. Overall, I think sentiment is gradually improving in LA, but we need to clean up Downtown to push things along.
SBK
What is creating such a challenging capital markets environment right now? And how do we address it?
KD
I think you're starting to see people willing to sell their loan pools or certain loans. But this protracted period of elevated interest rates gets back to cost of capital. When you look at an asset, you have to consider the elevated cost of capital, so the required returns have gone up. By virtue of that, you're not seeing any development.
However, unlike during the global financial crisis, now we’re not just going to the big PE funds to buy a loan pool. We’re going to individual investors who underwrite the deal they’re interested in. Either you get paid off or buy at a discount. But that's where a lot of the deals are getting done. If you have a lender who's willing to sell, if they're realizing that it's going to be a longer-term process right now, they can repatriate some capital and the equity value, which makes them feel good about what they're buying.
SBK
What about San Francisco?
KD
San Francisco is a market that I think a lot of institutions are betting on because again, there are tech and, specifically, AI companies that will fill office buildings. You also have the VC dollars backing many of these companies. It was and still is financial services-oriented, but then it became really tech-heavy, and then the bottom fell out. But I think San Francisco is a market that comes back as you talk to investors, and people are making bets there.
Hopefully, something will start to happen in Downtown LA as well. It has to get cleaned up. We are working on a multifamily asset there. The problem is that investors come in and walk the streets at night. It's okay to do it at two o'clock in the afternoon. They walk the streets at night, and they see what it's like, and they hear the stories, and they pull the police reports. It’s tough to argue about safety when they have all the facts about what has happened on a given block. Hopefully that comes back. In the near term, I see the office market heading south, which ties into Venice, but then into El Segundo and even further south. And those are the markets that should do well as the sector recovers.
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