Bring up US offices with Brookfield’s real estate chief Brian Kingston these days and he will share frustrations. The Toronto-based mega-manager has some of the best-regarded prime workspaces on the planet, but Kingston feels gagged talking about them.
“I don’t want to scare everyone and have them think if they invest with us it’s going to be all for offices,” he explains. Kingston says current toxicity surrounding the country’s offices is one reason they are not an emphasis for the firm’s funds business these days, despite Brookfield’s legacy in the asset class.
In June, it emerged the firm was seeking $15 billion from institutional investors for the fifth installment of a global opportunity fund series beginning in 2013 in the aftermath of the global financial crisis. Kingston would not discuss the fund. But the inference here is US offices will be off the menu unless the mood music changes.
That is a notable takeaway from this candid discussion with Kingston, which took place over an hour at the firm’s US headquarters at 250 Vesey Street in June. The tower, in the firm’s Brookfield Place complex in the financial district of Lower Manhattan, is 95 percent leased and among the firm’s best-performing assets. That irony is not lost on Kingston. “We’ve owned it since 1993. It’s never before been 95 percent leased,” he says. “And we’re signing leases at the highest rents we’ve ever achieved here.”
We meet days after Canadian wildfire smoke swept through New York, engulfing Manhattan in an orange hue resembling something from an apocalyptic movie. Looking out the window into New York Harbor, he recounts: “At 10am, everything looked clear. By 11am, the Statue of Liberty disappeared. It was like you were on Mars.” It had been so bad he even wrapped a meeting with a government agency early after noticing smoke on the ceiling in the older building. “Everyone’s eyes were red and their throats were sore,” he recalls.
Such an experience should be a cue to extol the modern attributes of Brookfield’s prime office holdings, just as Kingston did in an interview with PERE only three years ago. Indeed, this building is equipped with state-of-the-art HEPA filters. “If there’s smoke outside, you don’t even smell it in the building,” he states. “You’re not in some dark, low-ceilinged, dingy office.”
Kingston gets into how few offices with such engineering in place exist in the city: “In New York, 13 percent of office space was built after 1994. Even if the overall demand is shrinking for office, if you’re a tenant with a choice between a good and not good building, it’s always going to be a flight to quality. These buildings stay fuller for longer and empty out last.”
Kingston goes into detail on the contemporary appeal of 250 Vesey and Manhattan West, a 7-million-square-foot office-led development spread over 8 acres at Hudson Yards farther uptown; even 660 Fifth Avenue, a classic 1960s office, which Brookfield acquired opportunistically in 2018 and is going through a $400 million redevelopment, has proved popular with tenants.
Works there are not done yet, but the building is already nearly 70 percent occupied. “It looks and leases like a brand-new building and we’ve done more than 1 million square feet of leasing there over the last two years at phenomenal rents,” he says.
But unfortunately for Kingston, general interest in Brookfield’s prime offices, or anyone else’s for that matter, has dwindled. The mainstream tarring of all offices as bad news, amid multiplying accounts of growing vacancy rates across major cities in the wake of covid-19, and as interest rates spike to render most refinancings challenging, means promoting any offices has become difficult.
Indeed, certain groups, including Brookfield’s closest rival Blackstone, are now marketing themselves on how little exposure to the country’s offices they currently have. “The reality is with most real estate investors, they will get back into offices eventually,” Kingston predicts. “They will then go back up in value, make a lot of money and the narrative will change.”
Silence is scolding
In the meantime, Kingston is not looking to swim against the sentimental tide, and so Brookfield has been quieter about its work in offices. As such, the firm did not feel compelled to respond to the negative headlines earlier this year about defaults on some of its office loans. In April, Brookfield defaulted on $161 million of debt covering a dozen properties in the Washington DC area. That added momentum to perceptions of Brookfield’s office empire shaking, following defaults on approximately $1.1 billion of debt against offices in Los Angeles two months before.
The LA portfolio comprises assets from its $4.8 billion acquisition of Trizec Properties in 2006 and its $2 billion purchase of MPG Office Trust in 2013, deals which made Brookfield the biggest office landlord in the city’s Downtown area. The firm placed six of the assets from these deals into a public entity called Brookfield DTLA Fund Office Trust Investor, a vehicle designed to benefit from the area’s residential boom happening at the time. After seeing Lower Manhattan’s residential appeal surging and that leading to parallel demand for modern workspace nearby, Brookfield bet the same phenomena would play out in Downtown LA.
Kingston recognizes that its thesis proved flawed with home-working persisting beyond the pandemic: “The first part was right: there was a lot of population growth in Downtown LA. But it didn’t translate into a lot of leasing activity, at least not in these big, glass towers.”
Indeed, occupancy levels in the LA portfolio dropped from almost 90 percent leased in 2016 to 77 percent at the end of 2021. Even while the assets attracted increased rents, soaring interest rates rendered their original business plans obsolete. This prompted Brookfield to default on the debt behind the buildings over seeking recapitalization capital – alongside certain other managers on their properties. Subsequently, three of the properties – the Gas Company Tower, 777 South Figueroa Street and EY Plaza – went into receivership this February.
Kingston says defaulting is a hard but sometimes necessary call. “We would prefer not to default than to default, to state the obvious,” he says. “We’ve always maintained a very good reputation in the capital markets and it’s important to preserve that if we want to borrow in the future.” But equally he underlines the importance of the firm’s fiduciary duty to its investors. “If we throw good money after bad and we don’t think we’ll get a good return, then we’re not doing a good job for our investors. That’s the push and pull of it.”
Kingston says any reports of the firm handing over the keys to its offices are overstating: “Very rarely does that actually happen.”
He expects the defaults, which are single-asset loans and non-recourse to the broader Brookfield franchise, to trigger negotiations with lenders, particularly with the loans held in CMBS structures. “Special servicers don’t even get appointed without a default, or at least the risk of a default. Otherwise, there’s nobody to talk to,” he says.
Critically, Kingston believes most negotiations will lead to Brookfield retaining management of the properties, albeit on redesigned terms. Notably, too, he expects these processes to take as long as a year to resolve. “It’s not like a default on a house. It’s a much longer process.”
One New York-based office operator, who declined to be named, sympathizes. He says his firm has also grappled with increased scrutiny after a multiple-hundred-million-dollar loan on one of its offices went into special servicing this summer. “It was frustrating to explain to a reporter how this was a nothing-burger. Once you’re having to explain these things, they become a distraction. The headline is a loan going into special servicing [but this] is the only way to have a conversation.”
Another New York-based manager, who also asked to be anonymous, believes Brookfield’s current predicament should be considered par for the course as the market embarks on another cycle and stable negotiations with its lenders should see the firm through. “When it comes to Brookfield and its office [defaults], all sides just need pragmatism.”
Not a canary
Nonetheless, Kingston admits Brookfield could have communicated better around the issue of the firm’s defaults to get ahead of the narrative. He even accepts a certain wariness discussing offices generally, believing mainstream media has unfairly labeled Brookfield as the sector’s ‘canary in the coalmine.’ Interviews like this are an effort to remove such tags. “I almost resist when people call and ask for views on the office market because I don’t want to perpetuate this idea we’re just office guys.”
“We don’t really have US offices in our fund and the offices on our balance sheet are the highest-quality offices one can own”
Kingston recognizes the benefit of getting a grip on the narrative surrounding Brookfield and its current exposure to offices, especially in terms of its well-performing private funds business. Investor reports reveal net IRRs of 19.5 percent from the BSREP series and other opportunistic vehicles since 2006. Kingston wants to underline the fact that little of that performance lately has come from US offices. Brookfield funds are 23 percent exposed to offices, but just 5.6 percent is stateside; the other 17 percent are non-US. Within that 5.6 percent exposure, Los Angeles and Washington – the two markets where the firm has attracted attention for office defaults – account for only 1 percent each.
Net IRR achieved from the BSREP opportunity fund series
“It’s fine to acknowledge we own offices on our balance sheet. But we’re being painted as the office guys and that makes people assume our funds are in trouble,” Kingston explains. “We don’t really have US offices in our fund and the offices on our balance sheet are the highest-quality offices one can own. They are doing fine.”
KPMG exemplifies how well. The professional services firm is going to lease 450,000 square feet at Two Manhattan West, consolidating its presence from three offices in New York. Managing partner Yesenia Scheker-Izquierdo says the space meets “the needs of a modern workforce” and was the result of an “extensive search in Manhattan.” She concurs with Kingston’s assessment of blue-chip occupiers prioritizing quality over cost. “We seized an opportunity to unite our New York City-based workforce in a new, modern space in one of Manhattan’s most exciting locations.”
Kingston also believes the common consensus is wrong about why offices, generally speaking, are repelling capital markets these days.
“The biggest issue with offices – and not everybody is following this – is not work-from-home, it is not the future of offices, or AI taking jobs. It is interest rates.” Kingston says the capital-intensive nature of office buildings, in which every tenant change instigates a “big TI package” of costs for the landlord, has become unaffordable given so many business cases were made on low-interest borrowing terms. “When money is free, that implies a certain value,” he says. “But when it costs 7 percent, you’re putting a lot more capital in. So that disproportionately affects a business like office. That’s the bigger issue which is manifesting in these maturity defaults.” Kingston believes rates settling to a new norm will set the cost of running offices and that will help kickstart the market again.
Regardless, while Kingston has views on the office market, he would like to spend time these days also discussing the firm’s current top-conviction strategies, like residential, which accounts for 22 percent of the fund’s assets, or logistics, which accounts for 15 percent. “Did you know we have more than 40 million square feet of logistics in our opportunity funds?” he asks. “It’s a substantial business for us and has performed very well.”
Indeed, Kingston would rather discuss how the firm’s hotels are enjoying room rates that are “18-19 percent above 2019 levels,” or how its apartment rents “are up 22 percent over pre-pandemic levels.” Even the firm’s retail properties – real estate’s previous pariah asset type – are enjoying rents “up almost 20 percent over pre-pandemic levels.” By Kingston’s reckoning, in the context of the scale of Brookfield’s business – which today has $825 billion of assets under management, of which about $260 billion is real estate – its US office assets do not warrant the attention they have received. “We’re so much more than offices,” he says.
Most importantly, Kingston wants to push the firm’s reputation as being an opportunity-driven investor able to spot market gaps and take share. “We want to be known as a global opportunistic real estate investor and certainly one that does more than just office.” But he recognizes the firm’s need to improve communication in order get that message out there. “We do want people to have a better understanding of our business. We can’t hide in the basement, do deals and expect the performance to speak for itself.”
Keeping the senior
Brookfield has long been a lender in real estate, but has seen little need to play in the senior part of the capital stack, until now
With US office equity plays largely off the table, Kingston sees a bigger, nearer-term opportunity for the firm in senior lending, including to US offices. He sees a chance to engage the country’s credit issues by making Brookfield part of the solution.
Indeed, future fundraisings aimed at allowing the firm to issue senior debt are among the ideas on the drawing board. He says: “We do think there’s an interesting opportunity at the moment because both base rates have gone up and spreads have really widened as well. So as a lender, the economics are pretty attractive right now.”
Brookfield’s funds business started life as a junior lender, and the firm acquired a majority stake in debt specialist Oaktree Capital Management in 2019, too. But the Los Angeles-based manager is most prevalent in higher-yielding mezzanine and distressed debt strategies, so Kingston does not see cannibalization as a problem.
“We used to originate the whole loan and then create senior and junior loans, keep the junior and sell the senior to a bank or insurance company,” Kingston says. “Where spreads are right now, more and more we are looking to hold the whole thing because you can actually make returns there.” He says Brookfield is considering separate vehicles for the senior and junior parts of loans it issues and could raise capital for a vehicle to contain the senior parts.
Brookfield could also tap capital from its growing reinsurance business as the return profile from senior real estate debt is a good match for the liabilities of its premiums.
Such a move is in line with the growing aspirations of other global operator-managers, including Houston-based Hines and New York-based Tishman Speyer, both of which are also thought to be planning debt products to occupy market space abandoned by traditional bank lenders. Their aspirations chime with a white paper published in June by asset management giant PIMCO, which forecasted a “tsunami” of loan maturations that need addressing: “In the near term, we see unprecedented potential in real estate debt. This includes senior origination opportunities as lenders retreat,” the asset management giant wrote.