Pimco is saddled with a $1.7 billion default in office-market meltdown

FILE PHOTO: A U.S. dollar note is seen in front of a stock graph in this November 7, 2016 picture illustration. Picture taken November 7. REUTERS/Dado Ruvic/Illustration/File Photo (REUTERS)
FILE PHOTO: A U.S. dollar note is seen in front of a stock graph in this November 7, 2016 picture illustration. Picture taken November 7. REUTERS/Dado Ruvic/Illustration/File Photo (REUTERS)

Summary

  • Columbia Property Trust feels the fallout of rising interest rates

In 2021, the asset-management firm known as Pimco banked on an office-market comeback. Interest rates were near historic lows, and the economy was humming. Cities were expecting a surge in newly vaccinated workers returning to the office.

In September that year, Pacific Investment Management Co. said it was acquiring Columbia Property Trust Inc., which owned 19 office buildings in New York, San Francisco, Washington, D.C., and other cities. The deal valued Columbia at $3.9 billion.

“We continue to believe that high-quality office buildings in major U.S. cities offer long-term value," John Murray, Pimco’s global head of private commercial real estate, said at the time.

Columbia has now defaulted on more than $1.7 billion of debt backed by seven of its buildings, according to people familiar with the matter, which makes it one of the biggest office defaults during the pandemic period.

The company suffered from the rise in borrowing costs and plateauing return-to-office rates in big cities, issues that are hammering many office owners. But Columbia also faced unusual circumstances, such as when Twitter Inc. stopped making rent payments in New York and San Francisco, say people familiar with the matter.

The default marks the latest sign that a meltdown is unfolding in the office market as more high-profile landlords default on debt or engage lenders in restructuring discussions.

High interest rates and the glut of vacant space aggravated by remote and hybrid-work strategies are threatening to send shock waves through the economy while upending one of the mainstay investments of the commercial property world.

“We, like most office owners, are addressing the unique and unprecedented challenges currently facing our asset class and customer base. We have engaged with our lenders on a restructuring of our loan on seven properties within our larger national portfolio," said a Columbia spokeswoman.

Many other office investors have largely steered clear of recent acquisitions. About $113 billion worth of U.S. office buildings sold in 2022, the lowest level since 2013 excluding 2020, when most property investment was frozen during the early months of the pandemic, according to data firm MSCI. Some of the most prominent office developers in the U.S. have also started buying or building real estate that isn’t office.

Pimco, a unit of German insurer Allianz SE, was one of the most active buyers of commercial real estate during the pandemic. The firm, which had $1.74 trillion of assets under management as of Dec. 31, was buying office, hotels and other property types that offered higher yields than investment grade corporate bonds.

The Columbia sale coincided with signs of a rebound. Government stimulus checks, low interest rates and hiring by technology companies stoked the economy. In the summer of 2021, when the deal was negotiated, companies were telling employees who had been working at home since the pandemic hit to return to offices after Labor Day.

“There was a lot of optimism," said John Kim, analyst at BMO Capital Markets Group.

But by the time the acquisition was complete, the Delta variant of the Covid-19 virus had dashed hopes of a robust post-Labor Day return to office. Still, some investors remained bullish about top-quality office buildings partly because of the axiom that job growth boosted demand for office space.

Not this time. Even with the job growth of the last two years, vacancy has soared as businesses have adopted hybrid and remote workplace strategies. “That relationship between job growth and demand for space completely fractured," said Kevin Thorpe, chief economist of real-estate-services firm Cushman & Wakefield.

Pimco’s acquisition of Columbia also turned out to be a bad call on interest rates. Instead of taking out a fixed-rate mortgage, the company in December 2021 took out a roughly $1.7 billion floating-rate loan backed by seven of the office buildings. Floating-rate loans tend to be cheaper and make it easier to sell property, brokers say, but come with the risk of a sudden rise in debt payments.

On top of the senior debt, Columbia put a $125 million mezzanine loan on the seven buildings, according to bond documents. The total $1.842 billion of debt on the portfolio was equal to about 81% of the buildings’ appraised value, the documents said, a steep loan-to-value ratio compared with other office building deals in recent years.

At the time, the risk didn’t look unreasonable. Most investors expected rates to remain low, and the yield on 10-year Treasury notes hovered around 1.5%. The floating interest rate on the debt was around 3% at the time of the deal.

The seven buildings were 87% leased to blue-chip tenants including Verizon Communications Inc., Snap Inc. and Twitter, according to people familiar with the matter.

In 2022, interest rates started rising amid persistent inflation, pushing up the portfolio’s debt cost to around 6% today. At that interest rate, annual debt payments are higher than the buildings’ most recent annual cash flow at the time the loan was issued, according to the documents. And the interest rate could rise even higher at the end of 2023, when a derivative contract Columbia bought to cap the rate at around 6% expires, according to the documents.

The occupancy rate of the portfolio, meanwhile, dropped to 84% as of Dec. 31, according to people familiar with the matter. Columbia also started having trouble with the biggest tenant in the portfolio: Twitter, which leases most of one of the company’s Manhattan buildings and a small space in a San Francisco building. In late December, an affiliate of Columbia sued Twitter for $136,260 in unpaid rent at the San Francisco office, according to court records.

Twitter didn’t respond to requests for comment.

With the debt in default, Pimco’s choices include giving up the buildings to creditors or reaching a deal with creditors to restructure the debt.

Relief might also come if the office market strengthens greatly or interest rates fall. But neither seems likely in the next few months. The Federal Reserve’s preferred inflation gauge—the personal-consumption expenditures price index—rose 5.4% in January, which could prompt the Fed to raise rates further.

The U.S. return-to-office rate has increased slightly this year, but remains at about 50% of what it was before the pandemic started.

“It has been three years, and a lot of employees just don’t want to come back," Mr. Kim said.

Write to Peter Grant at peter.grant@wsj.com and Konrad Putzier at konrad.putzier@wsj.com

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