San Francisco’s commercial real estate market, once a beacon of prosperity, is grappling with unprecedented challenges.
At the recent IMN Distressed CRE West Forum held in the city, industry experts highlighted a striking trend: approximately one in three distressed borrowers are voluntarily surrendering their properties to lenders through deeds-in-lieu of foreclosure.
This phenomenon, driven by a combination of economic pressures, shifting work patterns, and high vacancy rates, signals a deepening crisis in the Bay Area’s commercial property sector.
However, it also presents unique opportunities for patient investors with the capital to weather the storm.
Today we are diving into the causes, implications, and potential pathways forward for San Francisco’s distressed real estate market, offering a comprehensive analysis of the current landscape.
The Rise of Deeds-in-Lieu: A Sign of Capitulation
The IMN Distressed CRE West Forum, held for the second consecutive year in San Francisco, drew around 220 attendees, many from outside the region, to discuss the growing distress in commercial real estate (CRE).
Dan Duarte, director of the special assets department at Chico-based Tri-Counties Bank, moderated a panel on “Forced Owner Exit Strategies” and noted that about one-third of distressed borrowers are opting for deeds-in-lieu.
This legal mechanism allows borrowers to transfer property ownership to lenders without the lengthy and costly foreclosure process.
Duarte remarked that he hadn’t seen such a high volume of borrowers willing to “walk away” in years, often leaving lenders with not just the property but also unpaid taxes and other liabilities.
This trend reflects a broader capitulation among property owners who see little hope of recovering their investments in the current market.
Office vacancy rates in San Francisco have soared to a record 37%, driven by the tech industry’s shift to remote work and a sluggish return-to-office movement.
The city’s downtown, once bustling with workers, now struggles with empty office towers and declining foot traffic, exacerbating financial pressures on landlords.
For many, handing over “‘the keys”’ is a pragmatic choice to avoid further losses on properties that no longer generate sufficient revenue to cover loans, taxes, or maintenance costs.
Why San Francisco? A Perfect Storm of Challenges
San Francisco’s real estate distress is not an isolated phenomenon but the result of a confluence of factors.
The city’s office market has been hit hard by the work-from-home trend, with only recent improvements lifting it from the bottom of national return-to-office rankings.
High-profile defaults, such as Paramount Group’s surrender of three office buildings after writing down their value to zero, underscore the severity of the crisis.
Similarly, the San Francisco Centre mall, now in receivership after its owners defaulted on a $558 million loan, has lost 76% of its value since 2016.
The distress extends beyond offices to other sectors like hospitality.
Hotels like the Club Quarters in the North Financial District have seen valuations plummet by 25% in less than a year, while others, like the Hilton San Francisco Financial District, are negotiating loan extensions to avoid foreclosure.
Rising interest rates have compounded the problem, making it nearly impossible for borrowers to refinance loans at affordable rates.
For instance, the Hilton Garden Inn Cupertino’s owners face challenges refinancing a $32 million loan at current 7% rates, compared to the 4% rate at which it was underwritten.
The transition from local banks like Silicon Valley Bank and First Republic to larger national institutions like JPMorgan has further strained borrower-lender relationships.
Riaz Taplin, CEO of Oakland-based Riaz Capital, described this shift as “one of the most unenjoyable experiences in the history of mankind,” emphasizing the importance of choosing lenders open to dialogue during tough times.
Without strong relationships, borrowers face rigid terms and little flexibility, pushing more toward surrender.
The Cleanup Conundrum for Lenders
For lenders, accepting a deed-in-lieu is not a straightforward victory.
Panelists at the IMN Forum described the process as “pretty messy,” with properties often coming burdened with past-due taxes, maintenance issues, and other liabilities.
The cleanup can be complex, especially for office buildings with high vacancy rates or retail properties like the San Francisco Centre, which continues to lose tenants.
Lenders must decide whether to invest in stabilizing these assets, sell them at a discount, or hold them until market conditions improve—a risky bet given the uncertainty surrounding San Francisco’s recovery.
The surge in distressed loans is evident in national data.
The rate of delinquent or specially serviced commercial mortgage-backed securities (CMBS) loans rose to 6.8% in August 2023, with San Francisco’s distress rate hitting 13.9%, one of the highest among major markets.
This distress is particularly acute for office properties, where valuations have dropped by 20% to 84% in some cases.
Lenders are thus caught between enforcing personal guarantees to recover losses—often a contentious and costly process—or accepting discounted sales to opportunistic buyers.
Opportunities Amid the Distress
Despite the gloom, the IMN Forum highlighted potential silver linings.
Heather Turner, CEO of Portland-based Tamarack Capital Partners, called San Francisco a “great long-term market” with significant distress-driven opportunities.
Her firm, which has completed over $1.5 billion in hotel deals in the region, sees value in properties that patient investors, such as family offices, can hold until the market rebounds.
Recent transactions reflect this opportunistic mindset.
Local investors like Peninsula Land & Capital and Presidio Bay Ventures have acquired office buildings at steep discounts, such as 550 California Street for $40 million and 60 Spear Street for $41 million, setting new market-clearing prices.
Non-institutional buyers, including owner-users like LendingClub, which purchased a 22-story tower for $74.5 million, are also capitalizing on the market’s downturn.
These deals suggest that local knowledge and confidence in San Francisco’s long-term prospects are driving investment, even as institutional funds remain cautious.
The city’s hospitality sector may also see a boost from upcoming events like the 2025 NBA All-Star Game and the 2026 Super Bowl and FIFA World Cup matches in nearby Santa Clara, which could draw visitors and support hotel recovery.
For investors willing to navigate the current challenges, distressed properties offer a chance to acquire assets at prices unimaginable a few years ago.
The Path Forward: Relationships and Resilience
Panelists at the IMN Forum emphasized the importance of transparency and strong borrower-lender relationships to navigate distress.
Taplin’s advice to choose communicative lenders underscores a key lesson: partnerships built on trust can make the difference between restructuring a loan and losing a property.
Some borrowers, like the owners of the Hilton San Francisco Financial District, are pursuing loan modifications rather than walking away, signaling a willingness to invest additional capital to preserve their assets.
For San Francisco’s commercial real estate market, recovery will depend on multiple factors: a sustained return to office work, stabilization of interest rates, and renewed investor confidence.
While the city’s 37% office vacancy rate and high-profile defaults paint a grim picture, the influx of local and opportunistic buyers suggests that a bottom may be forming.
The distress conference’s choice of San Francisco as its venue for two years running is no coincidence—it reflects both the scale of the crisis and the potential for a comeback.
Why This Matters
San Francisco’s commercial real estate market is at a crossroads.
The trend of one in three distressed borrowers handing back properties highlights the depth of the current crisis, driven by remote work, high interest rates, and strained financial relationships.
Yet, amidst the challenges, opportunities are emerging for investors with the foresight and resources to act.
As the city navigates this turbulent period, the resilience of its real estate community and the allure of its long-term potential will shape its path to recovery.
For now, the keys being handed back are not just a symbol of surrender but a signal of a market in transition, poised for reinvention.
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