Commercial real estate faces new challenges after LA fires

Homes lie destroyed after the Palisades Fire in Pacific Palisades, California.
Bloomberg

In the wildfires that devastated Los Angeles earlier this year, most of the buildings destroyed were homes. But many commercial properties were caught in the flames as well, and the banks that lent against them are just beginning to assess the consequences — both for the short term and for years to come.

Researchers at CoStar Group have estimated that $1.9 billion worth of commercial real estate, mostly apartment buildings and retail properties, was damaged or destroyed by the Palisades and Eaton fires. Moody's has calculated an even higher toll, with commercial buildings in the fires' footprint estimated to be worth $3.29 billion.

"There has been some commercial impact," said Matt Anderson, co-founder of the real estate analytics company RE Metrics. "If they're not properly insured, then ultimately there could be some losses borne by the banks."

How well property owners and lenders bounce back will depend in large part on insurance. If a building is completely destroyed, underinsurance can mean a severe loss for its owner — which could potentially be passed on to the bank after a default. 

On the other hand, if a property is damaged but not destroyed, it can end up in a difficult gray area: The building is no longer generating income, but the destruction isn't severe enough for a full insurance payout.

On top of it all, the fate of commercial real estate is not so easy to separate from residences'. In order for a shopping district to recover, for example, it will need customers who live in homes nearby. And the rebuilding of those homes, too, will depend a great deal on insurance.

"Insurance is really the backbone when it comes to resilience and the economy coming back in that area," said Firas Saleh, director of wildfire models for North America at Moody's.

An already vulnerable market

Even before the fires, the commercial real estate market in L.A. was on shaky ground. High interest rates had put a damper on borrowing, refinancing and construction. And in the wake of the COVID-19 pandemic, vacancy rates at office buildings had soared to historic highs.

"The office sector has been struggling everywhere," Anderson said. "The return to work hasn't been as robust as office investors and owners would like."

Then, in January 2025, the fires struck. To be sure, the fraction of L.A.-area commercial property that was impacted is small: Moody's estimated that only 0.14% of commercial real estate in Southern California was in the fires' footprint. 

But banks in the region still faced some exposure, which some reported on their earnings calls later that month. Banc of California said its portfolio had four commercial properties and three residences that were damaged or destroyed. Pacific Premier Bancorp said four loans totalling $8 million had "sustained some level of damage." East West Bank said 32 of its loans, totaling $26 million, had been impacted, but the list included only one commercial property.

"We assess the needs of each customer, but are fortunate to have only a relatively small number of commercial customers impacted," Doug Krause, vice chairman of East West Bank, told American Banker by email. "In fact, we only have one commercial real estate loan where the property was significantly damaged."

Complete destruction, incomplete insurance

For the least fortunate commercial property owners, only the value of their land remains — along with the hefty costs of clearing it and getting it ready for new construction.

"There's going to be debris on the property," Anderson said. "So you'd be spending money on architectural work and structural engineering, and then permitting and so on. So that's where it starts to get costly and complicated."

If the borrower defaults, Anderson said, the bank would most likely try to sell the property to someone else, most likely a developer with the resources to rebuild. But finding an eager buyer may prove difficult if the area remains depressed.

"I think the pace of recovery would be the number-one thing," Anderson said.

Borrowers may be more likely to default if they have inadequate insurance, which makes rebuilding less feasible.

How likely is real estate to have inadequate insurance? In California, the chances are higher than elsewhere. Because of the increasing frequency of wildfires there, many insurers have withdrawn coverage from the state. Allstate and State Farm stopped issuing new policies in California in 2023.

All of this makes adequate insurance harder to reach, and borrowers don't always know when the policy their insurer recommends isn't enough.

"I think a lot of these properties were underinsured," said James Chang, president of Pasadena Federal Credit Union. "Sometimes you limit your coverage because it's just too much."

LA wildfires
Workers with the U.S. Army Corps of Engineers remove debris from a home destroyed by the Eaton Fire in Altadena, California, on Feb. 11.
Bloomberg

Damaged but not destroyed

Then there's another scenario: The commercial property is damaged enough that it's no longer bringing in revenue, but not damaged enough for the insurer to pay out its full value. This worst-of-both-worlds predicament can leave both borrowers and lenders in a financially tight spot.

"You're in a bit of limbo there," Anderson said. "If [property owners] are caught in between, they may be in a position where they might have to miss a payment or two with their bank."

In that case, Anderson said, the solution is a combination of communication and patience: The bank should talk with the borrower, find out if they're having trouble paying their mortgage and work out a plan, possibly including some forbearance, to get them back on track.

"The first line of defense is always to be proactive and reach out," Anderson said. "It's definitely a red flag if your borrower is unresponsive."

The residential-commercial connection

Another danger to commercial properties comes from the residential side: Offices and retail outlets will have trouble bouncing back if people can't — or are afraid to — live in the area.

"If you're trying to develop commercial real estate … yet there's no easy access to get there from a housing situation … it's probably not going to be successful," said Seth Sprague, director of mortgage banking consulting at the accounting firm Richey May.

Time will tell whether — and how quickly — residents who fled the fires return to their neighborhoods. In Altadena, which was ravaged by the Eaton Fire, many of the houses that are still standing remain unoccupied, months after the flames subsided.

Sprague called the connection between residential and commercial real estate a "chicken and egg" question: Do commercial areas thrive because many people have homes nearby, or do people choose to live in those homes because they're close to the commercial area?

That question is impossible to definitively answer. But it's a reminder to stakeholders that in the L.A. area, commercial and residential real estate will need to recover in tandem.

"I don't think you anticipate that, all of a sudden, there's going to be these deserts within L.A. or any city where there's a natural disaster, where nobody moves back," Sprague said. "So I think it just takes time."

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Commercial banking Real estate Commercial real estate loans City of Los Angeles, CA California
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