A Blog by Jonathan Low


Dec 13, 2021

Shorting Empire State Bldg: How Warehouses Became More Valuable Than Offices

Given the confusion generated by Covid and its impact on hybrid versus full time versus remote work, no one is really sure how much demand there will be for office space in the near to long term future.

But there is relative predictability about the extraordinary growth in ecommerce delivery and its affect on logistics space demand. That uncertainty has created an arbitrage opportunity based on the  value of competing types of commercial real estate. And industrial is now worth more. JL 

Konrad Putzier, Chip Cutter and Peter Grant report in the Wall Street Journal:

The new owner of Allstate's campus plans to demolish the office buildings and convert the site into 3 million square feet of e-commerce warehouses and logistics facilities. “I didn’t think I would ever live in a world where industrial land is worth more than office land.” For many years, investors saw office space as a safe and predictable place to put their money. The Covid-19 pandemic and the surging popularity of remote work have changed that. The uncertainty has led to a flurry of bets by investors looking to make a fortune by shorting office owners.

Allstate Corp.’s suburban campus outside Chicago, with its interconnected buildings, manicured grounds and acres of parking, represented a new vision for the U.S. office when it opened in 1967. That vision is now dead.

The insurer reached a deal last month to sell most of the campus. The new owner plans to demolish the office buildings and convert the Northbrook, Ill., site into more than 3 million square feet of e-commerce warehouses and other logistics facilities.

“I didn’t think I would ever live in a world where industrial land is worth more than office land,” said Douglas Kiersey Jr., president of Dermody Properties, which is paying $232 million for the 232-acre parcel. “But here we are.”

The workers who once commuted daily to the Allstate campus, meanwhile, will mostly work from home.

The American office building, where millions of white-collar employees have headed to work for more than a century, is in a state of reckoning. Newly built skyscrapers in central business districts are still filling up and charging top rents, even during the pandemic. But thousands of older buildings across the U.S. face an uncertain future. As more companies elect to make remote work or a hybrid model a permanent part of their corporate culture, they are looking to cut costs on real estate. An outdated office makes the decision to end a lease or sell a building easier.


In New York and San Francisco, more than 80% of all office space is more than 30 years old, and Chicago isn’t far behind, according to Phil Ryan, director of U.S. office research at Jones Lang LaSalle Inc. These three cities also have some of the lowest office occupancy rates in the country: Less than 40% of the workforce was back in the office as of early December, according to Kastle Systems, which tracks how many people swipe into buildings.

What happens to these aging edifices across the U.S.—whether they are converted to other uses, torn down or upgraded to suit modern needs—will go a ways toward shaping what work, the modern city, and surrounding suburbs will look like in the decades ahead.

“There’s just not a lot of need for big-floor-plate, white-elephant suburban office buildings,” in and around cities like New York and Chicago, said Steve Poulos, chief executive of industrial real-estate developer Bridge Industrial.

Some of these white elephants will follow the Allstate campus in the service of e-commerce, becoming fulfillment centers for booming online retail. This is especially appealing for offices located in crowded cities where retailers face a scarcity of last-mile warehouses. Bridge, which bid on Allstate’s headquarters, is in contract to buy several office properties in a number of major U.S. cities and convert them to distribution facilities, Mr. Poulos said.

Developers are also looking to turn suburban offices into schools or lab space, said JLL’s Mr. Ryan. In city centers, conversions of office towers into apartments and hotels are also becoming more common. Even before the pandemic, developers in lower Manhattan transformed early 20th century office buildings into apartment towers that became popular with Wall Street traders and helped develop the financial district as a residential neighborhood.


But these conversions can be tricky, and may not offer widely applicable solutions. Urban office buildings built during the mid century or later tend to have larger footprints than those converted to apartments in Manhattan, and these newer buildings often have too much windowless space for apartments. Others may face local zoning issues if an owner tries to change a property’s purpose. Office buildings that have outlived their usefulness and are unsuitable for conversion could simply be abandoned.

Still, some real-estate executives insist that sprawling suburban locations can continue to thrive as offices. Capital Commercial Investments Inc. in November bought the former office campus of retailer J.C. Penney Co. in Plano, Texas, with plans to modernize and lease it as offices. The company previously purchased the former headquarters of American Airlines Group Inc. in Fort Worth, Texas, and other large corporate complexes.

Such projects make sense in markets where there is strong demand for office space and an influx of workers, said Doug Agarwal, founder and president of Capital Commercial. His firm has refreshed large suburban complexes by adding glass, removing ceiling tiles, updating technology, and sprinkling in gyms, pickleball courts and social areas.

“We’re finding ways to make the space more acceptable and actually sought after by large corporations,” Mr. Agarwal said.

Some companies are hanging on to their offices, even as they offer more flexible work options. The accounting and consulting giant PricewaterhouseCoopers LLP this year gave most of its U.S. employees the option to work remotely in the continental U.S. The firm said 40,000 of client-facing employees could work from a location of their choosing. About 20% of employees chose to do so, with the rest still wanting to work on-site with a client or in PwC’s offices multiple days a week. 

The Empire State Building, ESRT -3.68% completed in 1931, has seen 15 recessions. Jonathan Litt thinks the pandemic could be the event that makes a long-term dent in the building’s fortunes.

The hedge-fund manager is shorting the building’s publicly traded owner, Empire State Realty Trust Inc., according to a person familiar with the matter. He is among a small but growing group of investors who believe the Covid-19 pandemic will drastically reduce demand for office space for years to come, and that markets underestimate the risk.

For many years, investors saw office space as a safe and predictable place to put their money. They paid high prices for skyscrapers in Manhattan and San Francisco, in some cases accepting returns as low as 4% a year. That was at times barely higher than the yield on U.S. government bonds. Companies would always want office space in the most desirable cities, the thinking went, so the risk was minimal. The Covid-19 pandemic and the surging popularity of remote work have changed that. Suddenly, no one seems to agree how much office space companies will want in five years.

That uncertainty has led to a flurry of bets by investors looking to make a fortune. Some, like Mr. Litt, an activist investor known for targeting real-estate companies, are shorting office owners. Others are taking the opposite side of the bet. They are buying and developing office buildings at depressed prices today, hoping that the market will recover and that they can get bargains now.


Houston-based Hines, one of the world’s largest office-building developers, is making a big bet on the future of the San Francisco office market by redeveloping the historic headquarters complex of utility giant PG&E Corp. The company bought the six buildings earlier this fall for $800 million.

San Francisco’s office vacancy rate was over 20% in the third quarter, one of the highest in the country and up from less than 5% before the pandemic, partly because the city’s dominant tech industry has been more eager than others to embrace remote work.

Hines executives acknowledge the challenges facing the market, but they also say tenants will continue to be attracted to San Francisco’s natural beauty, historic neighborhoods and parks and other amenities.

The company is betting that demand for office space will bounce back by the time the project is completed in a few years. It also hopes it will face less competition as other developers are put off by the market’s high vacancy rate and strict city approval process. Chances are other developers will hesitate before breaking ground on speculative office projects in the next few years, said Paul Paradis, Hines’s senior managing director responsible for the West Coast. “We want to take advantage of this and deliver as soon as we can.”

Hines hopes to repeat the success of a speculative 1.4 million square foot tower it built with Boston Properties Inc. in San Francisco in the years following the 2008-09 financial crisis. Salesforce.com Inc. signed a lease for the building in 2014, one year after the developers broke ground. “Anyone who knew we were working on a 1.5 million square foot brand new office tower in the depths of the financial crisis would have thought we were crazy,” Mr. Paradis said. “But we knew San Francisco would come back someday and this was a great way to prepare.”

Even the office bears say that new, glass skyscrapers will probably be fine because deep-pocketed companies still want to spend money for modern, well-located buildings. They disagree with developers like Hines on the fate of older properties.

Last year, Mr. Litt’s hedge fund, Land and Buildings Investment Management LLC, took short positions in two New York-focused office REITs, SL Green Realty Corp. and Vornado Realty Trust, in addition to its bet against Empire State, according to the person familiar with the matter. But this person says the fund has since given up those short positions in SL Green and Vornado, which own a number of newer buildings, and is shorting only Empire State, which primarily owns old office buildings in Manhattan, nine in all. Mr. Litt said he believes there will be around 15% fewer people in office buildings after the pandemic is over. That, he said, will lead to less demand for office space and lower rents. He expects rising operating expenses and property taxes to eat into profits. “We believe that, all said and done, the office values are going to bottom down 40% from pre-pandemic levels,” Mr. Litt said.


Empire State’s chief executive, Anthony Malkin, said the company has modernized its buildings and made them more environmentally friendly, and that he expects to attract tenants moving out of older buildings who can’t afford the newest glass skyscrapers.

So far, the office sector has seen little real distress. U.S. vacancies rose to 17.4% in the three months that ended Sept. 30, from 12.6% before the pandemic, surpassing the 2010 peak of 17.3%, according to Cushman & Wakefield, but most office tenants have continued paying rent even as their employees work from home. A mere 1.3% of securitized office mortgages were delinquent in November, compared with 9.5% of hotel mortgages, according to Fitch Ratings.

Polpo Capital founder Daniel McNamara believes the oversupply of office space will worsen as companies’ long-term leases expire.


Daniel McNamara, founder of the hedge fund Polpo Capital LP, believes these numbers hide the extent of the problem. Many companies have already decided to shrink their office space but are still paying rent because they are bound by long-term leases. As more leases expire, more companies are going to shrink their space, gradually pushing vacancies higher and rents down.

Mr. McNamara, a former principal at investment firm MP Securitized Credit Partners, launched Polpo this year to bet on distress in the commercial real-estate market. The fund, which has raised around $100 million to date, is shorting an index of mortgage bonds backed by malls, offices and hotels. Mr. McNamara said he thinks rising vacancies and skittish banks will make it harder for landlords to refinance mortgages coming due next year, leading to more defaults.

“We have an office in Midtown Manhattan. We have less space than we would have taken if everybody was in the office every day,” Mr. McNamara said of his new fund. “But in reality, we’re going to be a hybrid model, and I just think that that’s the way we’re going to work.”


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