Banks are issuing fewer CMBS loans. Office deals are falling through. Cap rates on multifamily properties are rising. None of it seems to be scaring Los Angeles studio developers, a group that is so far undeterred by rising rates as streaming services compete to churn out content.
“We’re not putting any plans on hold,” said David Simon, founder of studio developer Bardas Investment Group.
Though developers are pushing forward, few studio spaces have been acquired in the last six months as the cost of obtaining a loan has jumped. One exception was East End Capital’s $240 million purchase of 15 acres to build soundstages in L.A.’s Arts District; the buyer scored its acquisition loan before the Federal Reserve’s June interest rate hike. No large studio complex in L.A. has traded since Brookfield bought a DreamWorks studio in Glendale last November.
But investors still see demand for studio real estate in the long term, as streaming giants like Netflix, Disney, Hulu, Apple and Amazon sign longer leases and have driven up prices in recent years. It’s more difficult to discern the short-term impact interest rates will have on pricing, given that it’s a relatively new asset class at the institutional level.
“It’s undeniable that an increase in interest rates has an impact on valuations,” said Jesse Goepel, head of acquisitions at Square Mile Capital. “But the question is which force is stronger — the demand for studios or the rise in rates?”
The true cost
About a year ago, Blackstone and Hudson Pacific Properties bagged a $1.1 billion loan to refinance their portfolio of studio and office properties in Hollywood. Provided by a consortium of lenders including Barclays, Bank of America, Societe Generale and Wells Fargo, the two-year, floating-rate loan was cheap — at least compared to those today — bearing interest at Libor plus 1.25 percent, according to reports from DBRS Morningstar.
When the duo signed the deal, Libor was less than 1 percent, meaning Blackstone and Hudson Pacific would have paid about $26 million in monthly interest.
By late July, Libor stood at 2.17 percent, hiking Blackstone and Hudson Pacific’s monthly payments 52 percent to about $39.6 million. The partners recently negotiated a 3.5 percent rate cap, meaning their monthly payments will max out at $40.6 million.
Blackstone and Hudson Pacific were lucky, scoring the deal before rates started to rise. Few CMBS loans have been issued since the Fed’s initial rate hikes in the spring, but the terms of any floating-rate loan granted today are guaranteed to be higher than Libor plus 1.25 percent.
It’s unclear what the firms plan to do in 2023, when their debt is due to mature. On July 27, the Fed raised interest rates by a further 0.75 percent, pushing Blackstone and Hudson Pacific’s interest rate to its cap.
Some investors say they aren’t deterred by the higher cost of capital.
“If the capital is more expensive, so be it,” Goepel said, though Square Mile hasn’t bought any more studio properties this year.
When East End bought its site in the Arts District to build studios, it scored a $160 million loan from Oxford Properties Group — just before the Fed hiked interest rates for the third time, in June. Though its payments on the loan will increase, the firm isn’t concerned with rising costs. East End is financing its acquisitions through a partnership with investment firm King Street, Canadian pension fund Alberta Investment Management Corporation and an unnamed sovereign wealth fund.
“We have very deep-pocketed partners and we will finance at a level that we’re paying a fair price, but if we do have to put more equity in a deal, that’s not a problem,” said East End co-founder Jonathon Yormak.
Strong demand — for now
Rising interest rates aren’t all bad news for developers. The increases will quell inflation, or so the Fed hopes. Should inflation subside, construction and labor costs will, too.
“We’re starting to see costs settle, commodity prices are coming down,” Simon said. “[Other commercial] projects are getting shelved for contractors, therefore their demand is coming down.”
In March, 1,000 board-feet of lumber cost $1,418. Since then, the price has come down to about $630.
Simon is hopeful that by the time Bardas’ studios are up and running in 2025, inflation will have tapered off and the firm won’t face challenges getting tenants into them. Bardas is currently building five soundstages across L.A. under its Echelon Studios brand, as well as five other commercial developments focused on media and entertainment tenants.
Lease-up will not be a problem, provided Netflix and other streaming services are still aggressively producing content. Netflix’s dramatic subscriber losses — the company bled nearly 1 million subscribers in the second quarter — have sent its shares plunging and forced it to trim its staff and look for cost savings in other areas, including real estate.
“I don’t think we viewed the Netflix news necessarily as a negative for studio production,” Goepel said. “There will be winners and losers in the industry, there could be consolidation, but at the end of the day, as folks compete for subscribers and streaming service, most important that the content is good and don’t cut costs there.”
Another challenge could be competition from tenants themselves. Apple is moving forward with its own plans to build a 500,000-square-foot mixed-use campus including studio space in Culver City. If others follow in Apple’s footsteps, developers may face the threat of being sidestepped.
Neither Netflix nor any other streaming service has announced plans to cut back on studio space. Still the largest service in terms of paying subscribers, Netflix plans to spend about $17 billion a year for the next several years on content, the company said in its most recent earnings report. All of that production will require ample real estate.
“I would be absolutely surprised” if Netflix put some of its soundstage space up for sublease, Simon said. “That’s their manufacturing facility for their product, and they need to manufacture product.”