Rising vacancies and higher interest rates are dealing a hammer blow to office towers and retail outlets across the country, sending real estate values plunging from New York to San Francisco. Here’s what the smartest minds in the business are doing about it.
By Giacomo Tognini and Richard J. Chang, Forbes Staff
As millions of Americans stayed home to avoid Covid-19 in 2020, one of the most iconic buildings in the nation’s capital, Union Station, sat virtually empty. The Beaux Arts–style rail terminal with offices and retail space was one of the jewels in the real estate portfolio of billionaire Ben Ashkenazy (net worth: $2.6 billion), who purchased an 84-year lease on the property for $160 million in February 2007.
The lack of passengers quickly took its toll. In May 2020, Ashkenazy defaulted on $430 million in loans on the station that he had refinanced in 2018, according to court records in a foreclosure lawsuit filed against him by the lender, New York–based Rexmark. Seven months later, Ashkenazy lined up a deal with an unnamed sovereign wealth fund to take a 50% stake in the terminal for more than $700 million. But that deal collapsed in 2021—and in another twist, Amtrak moved to take over Union Station for $250 million via eminent domain in April 2022.
Now the landmark is at the heart of a legal battle between the federal government, Ashkenazy and Rexmark, which maintains that it purchased Union Station for $140.5 million at a foreclosure auction last June. One thing is certain: The commuters aren’t coming back. Amtrak’s annual passenger numbers decreased from more than 5 million in 2019 to 1.8 million in 2021, a 66% drop. Ridership on two key routes through Union Station dropped 26% to 9.2 million through 2022.
The plight of Union Station is one of the most visible manifestations of the crisis facing America’s urban cores, which for decades relied on a steady stream of office workers to remain economically vibrant. More than three years after the lockdowns, it’s obvious that those workers are never returning in the same numbers. Daily commuters are down an average of 39% across six markets. As a result, office towers are languishing, losing nearly 20 million square feet of leases in the first quarter of 2023, according to real estate brokerage JLL. A record 962 million square feet of office space is now vacant in the United States—20.2% of the country’s entire stock—with the highest vacancies in New York, Washington, D.C., and Chicago.
In the absence of workers, social problems are proliferating, making downtown spaces even less appealing. Petty crime in New York is up 29% since 2019. Homelessness in the San Francisco Bay Area has surged 35% over the last four years. Last July, Starbucks closed 16 stores around the country, including six in Seattle, two in Portland, Oregon, and one at D.C.’s Union Station, citing safety issues including drug use. Nordstrom recently announced that it was closing its flagship store at the Westfield mall in downtown San Francisco, with the mall’s owner citing “lack of enforcement against rampant criminal activity.”
The plummeting value of commercial real estate means that cities are far less able to address these problems: In New York City, taxes on office buildings and retail spaces account for nearly 40% of its property tax revenues and 12% of its $107 billion budget. In San Francisco—where office buildings make up 18% of the city’s $328 billion total property assessments—the controller recently forecast a loss of up to $200 million in property tax revenue by 2028 due to declining office values, a big cut considering the city pulled in $2.3 billion in property taxes last year.
Soaring interest rates—now as high as 7.5%, up from 4% in 2020—compound the problems. Developers who were highly leveraged before the pandemic now face a set of unappealing choices. They can refinance at much higher rates—if they have enough cash on hand to do so—or hope that lenders will agree to an extension to avoid default. Another option is to sell their properties at a steep discount, but even that is proving difficult: In New York, only $470 million of office transactions took place in the first quarter of 2023, down from $3.1 billion over the same period last year, according to Ariel Property Advisors.
“You’ve got to get rid of the debt,” says Jeff Greene, a 68-year-old real estate billionaire based in Florida who made his fortune from misfortune. During the 2008 financial crisis, Greene bought credit default swaps on subprime mortgage–backed bonds as the housing market crashed, resulting in a windfall of $800 million. “There are these young guys, kind of in that whole Ben Ashkenazy group, spending the big bucks, flying around. They’ve never had to deal with this, they’ve never seen rates go up. So they’re shell-shocked; they don’t know what to do.”
“70% of the office stock in the United States is either obsolete or heading toward obsolescence.”
“Nobody wants to buy their properties,” he adds. “I think you’re going to see a lot of really desperate real estate people pretty soon.”
Ashkenazy wouldn’t comment, but a person close to his company, Ashkenazy Acquisition Corporation, told Forbes that the federal government has taken over Union Station and that troubled properties make up a small part of his overall portfolio. Says Yehuda Sheinfeld, the company’s chief financial officer: “We are disciplined and limit our debt to well below market standards.”
Trophy properties in America’s largest cities, bought for top dollar like Union Station, are among the hardest hit. In February, Canadian real estate firm Brookfield defaulted on $754 million worth of debt on two office skyscrapers in Los Angeles. Last December, Vornado Realty Trust failed to repay a $450 million loan on 697–703 Fifth Avenue—a luxury retail property at the base of the St. Regis Hotel in Midtown Manhattan.
Retail investors want nothing to do with the sector. Large publicly traded office real estate investment trusts (REITs) such as Vornado, SL Green and Boston Properties have seen their stock prices slide by more than 50% over the past year. Privately owned firms are feeling the pain as well. Nationwide, office buildings lost an estimated $506 billion in value between 2019 and 2022, according to a research paper published in May by Columbia and New York University professors Arpit Gupta, Vrinda Mittal and Stijn van Nieuwerburgh. Things have only gotten worse since: “Interest rates have risen more than we anticipated, which has lowered even further the value of offices and other commercial real estate,” Gupta says.
That value destruction will hit city budgets. A 2021 research paper from the nonprofit Institute on Taxation and Economic Policy found that cities like Chicago, New York and San Francisco—which depend on property taxes for more than 20% of their revenue—could see those proceeds decline by more than 5%, potentially costing hundreds of millions of dollars in future tax receipts. That will make it more difficult to fix a range of problems—from crime to homelessness—whose mitigation might keep large companies from fleeing.
“If you’ve ignored things for far too long, and you haven’t fixed your potholes and your transportation systems, and you tax, tax and tax and now you’ve got crime and all the rest, that is not very conducive to businesses, is it?” says John Kilroy, the CEO of publicly traded office REIT Kilroy Realty.
The outlook is especially gloomy for buildings that already looked tired going into the pandemic. Aging, saddled with debt and losing value, they lack the amenities to compete with state-of-the-art developments—raising the specter of acre upon acre of vacant downtown lots. “Seventy percent of the office stock in the United States is either obsolete or heading toward obsolescence,” Kilroy adds.
Greene sees parallels with the late ’80s and early ’90s, when savings-and-loan institutions collapsed and real estate owners were unable to secure loans to refinance their properties, leading to a wave of foreclosures. In 1991, amid that downturn, billionaire investor Sam Zell (who died in May at 81) came up with a mantra: “Stay alive until ’95.”
“Now they’re saying ‘Stay alive till ’25,’ ” Greene says. “It’s going to take a long time to clean this mess up.”
To make it through this crisis, America’s savviest real estate operators are going back to basics. The dreamers had their moment—erecting lavish buildings financed with near-zero-interest loans. But the present belongs to the pragmatists, those who kept their cool and followed age-old wisdom like using little leverage, buying good locations and developing strong banking relationships.
Charles Cohen, a real estate developer who oversees an empire of millions of square feet of office space across the U.S., has been in the business since the late 1970s. In a conference room adorned with framed awards and newspaper clippings at International Plaza, one of his office towers on New York’s Lexington Avenue, the 71-year-old billionaire has a simple answer when asked how he’ll make it through the storm. “You’ve got to be very defensive,” he says.
More than half of his properties have debt with fixed interest rates, temporarily insulating them from the Fed’s rate hikes. Those don’t come due for several years, meaning he doesn’t face an immediate crunch to pay back the loans and should be able to work out a solution with his lenders. “We have lots of fixed-rate debt with years to go,” he says. “It’s not an issue of imminent concern to me.”
The dreamers had their moment, but the present belongs to the cool-headed pragmatists.
Not every developer has been so savvy. Donald Trump, for one, secured a variable rate on his $360 million portion of a $1.2 billion loan on 555 California Street, a trophy office complex in San Francisco that he co-owns with publicly traded Vornado. When he took out the loan, in May 2021, his 2% rate seemed a bargain compared to the 2.26% fixed-rate one secured by Vornado. But Trump’s loan has since ballooned to an estimated 5.93% rate. (He appears to have hedged that variable rate since.)
Still, Cohen isn’t immune to the challenges facing other developers. International Plaza, where he has his main office and which sits opposite Bloomingdale’s in Midtown East, was only 72% occupied at the end of the second quarter of 2022, and the tower’s two loans, totaling $125 million, were more than 30 days delinquent this April. But Cohen believes that working closely with his lenders is key, rather than taking a confrontational approach that could end in default.
“Do we need help from our lenders? Yes, everyone needs flexibility right now,” he says. “We’re keeping lenders apprised of what’s going on, being transparent, explaining why things are the way they are.”
“They are uninvestable. No one wants these buildings at any price.”
It has been difficult for Cohen to replace tenants like Ralph Lauren and law firm Locke Lord, both of which ended their leases before the pandemic—“leasing activity is spotty,” he says—but he is seeing some success by being more flexible with clients who are now more price-conscious. Space that’s ready to move into rather than requiring a lengthy and expensive build-out has become more popular.
“If it’s not good for the tenant, then it’s not good for the landlord,” he says. “My understanding of the bankruptcy code is that the greatest security an owner can have is a year’s rent.”
On the other side of the country in Seattle, Martin Selig has a tried-and-tested method to avoid trouble during real estate downturns. “We have a habit of only putting a loan on a building at 60% of value. That leaves you a lot of room to maneuver,” he says. “I’ve been doing that since day one. You do that from day one specifically for situations like this.”
The 86-year-old billionaire has seen his share of crises: When he was 3, his family fled Nazi Germany, traveling through Poland, Russia, Korea and Japan before arriving in Seattle. His first foray into real estate came in 1958, when he began buying shopping malls. Now Selig is one of the largest office developers in the city, with tenants including Amazon and Cisco.
Another strategy that has proved useful for Selig is to bundle loans of multiple buildings together, so that better-performing ones can cover the debt of underperformers. “We put five buildings together. If one building loses a tenant, the other four will pay what’s due to the bank,” he says. “We’re spreading the risk among the five buildings.”
Many loans on office buildings are packaged into commercial mortgage-backed securities, or CMBS, which banks sell to institutional investors. Most CMBS have fixed interest rates, so developers like Selig—who have loans that were packaged into CMBS—aren’t currently facing higher interest payments and can avoid refinancing at today’s much higher rates.
It’s a different story when it comes to loans to finance the construction of new buildings. Those loans almost always have variable rates, so Selig has halted all new projects. “We have room for four more buildings, and we’re not doing those with this climate,” he says. Cohen is doing the same, putting off construction on a new building in South Florida until next year. “We’re not borrowing money now,” he says. “Rates have to come down.”
Another route is to forgo borrowing altogether, assuming one has the cash to do it. Neil Bluhm, an 85-year-old real estate and casino billionaire, is building a new office tower in Los Angeles that has already signed the talent agency CAA as a future tenant. He’s considering financing it all himself.
“We could do it all with equity, which we’ll do unless we get a loan that makes sense. We’re fortunate that over the years we’ve made enough money so we could just build it ourselves,” he says. “Interest rates are very high, especially if you need a lot of money. Office buildings are almost impossible to get financed.”
Bluhm also points to another way to survive tough times: Focus on the classic real estate maxim of location, location, location. He owns office towers in L.A.’s Century City neighborhood and luxury retail in Chicago’s tony Gold Coast, both of which have been outperforming other areas in those cities. Another office project he’s building in Atlanta, set for completion in the third quarter of this year, will have Intuit subsidiary Mailchimp as an anchor tenant.
On the other hand, Bluhm has jettisoned buildings in which he doesn’t see much potential. Last year, he wrote off his First City Tower in Houston, a 49-story high-rise that was hit hard by falling oil prices in 2019 and 2020.
There’s some evidence that splashy newer developments are faring better. Billionaire Stephen Ross’ Hudson Yards—the $25 billion private development by his Related Companies on Manhattan’s far West Side is the biggest in U.S. history—has been adding leases at a steady clip. Ditto One Vanderbilt, a 93-story skyscraper overlooking Grand Central Terminal developed by publicly traded SL Green, which opened in September 2020. Filled with hotel-style amenities ranging from posh gyms to Michelin-starred restaurants, they’re both more than 90% occupied (One Vanderbilt is at 99%). The perks not only make workers more likely to endure long commutes, but they command premium prices. Tenants at One Vanderbilt are paying upward of $200 per square foot—well above the $80 average in New York. “If we have great amenities, we really feel like we can lease the space at compelling rents,” adds Andrew Mathias, president of SL Green.
Jeff Blau, CEO of Related, points to existing tenants like private equity giant KKR and investment manager BlackRock as examples of firms that have been able to entice employees back to the office thanks to the comforts on offer. “We’re doing a lease right now with [the leader of] a well-known private equity firm in Midtown. He can’t get his people back to work,” Blau says. “He spoke to Larry Fink and Henry Kravis, and they were telling him about Hudson Yards, that [they’re] 100% back in the office because people like being here. He called us up, and they’re taking two floors at over $200 a [square] foot.”
Still, bread and circuses go only so far. Last September, Warner Bros. Discovery put 30% of its space at 30 Hudson Yards—450,000 square feet—up for sublease. At One Vanderbilt, some tenants still receive free rent, a perk that’s keeping the tower occupied but not helping SL Green’s bottom line.
A toxic mix of high interest rates, fewer commuters and fickle tenants have hit some buildings harder than others. Here are five of the biggest in the U.S. to default since the Fed started raising rates last year.
Gas Company Tower | Los Angeles
Loan default: $465 million
Brookfield Properties defaulted on this Downtown L.A. tower, home to Deloitte and WeWork, in February.
697–703 Fifth Avenue | New York
Vornado Realty Trust defaulted on this retail property on Fifth Avenue, home to luxury jeweler Harry Winston, last December.
1740 Broadway | New York
Blackstone handed the keys of this 26-story tower on Manhattan’s Columbus Circle to the lender in March 2022 after L Brands vacated its lease.
777 Tower | Los Angeles
Brookfield also defaulted on this 52-story tower in L.A. in February.
600 California Street | San Francisco
WeWork and its joint venture partners stopped payments on this tower in San Francisco’s financial district in March.
Developers saddled with troubled office towers have few options left. Refinancing is difficult, buyers are scarce and there is no indication that the Fed plans to lower rates anytime soon. Amid the doom and gloom, some have decided on a radically different approach: converting their properties to residential buildings.
In cities across the country, mayors have embraced conversion plans as a Hail Mary that could revitalize their downtowns and add much-needed housing. Cities including San Francisco, Chicago and Washington, D.C., are offering incentives and plans to make it easier to adapt older office towers into residential units. Private investors are also getting into the mix, with New York–based Silverstein Partners announcing a $1.5 billion fund in December to buy older office buildings and convert them into apartments.
The problem with these plans? It’s extremely difficult to convert most office towers into apartments. “These buildings weren’t designed in the first place to be apartments,” Bluhm says. “There’s a huge amount of work to try to restructure them, and they’re not necessarily where people want to live.” Adds Selig: “How often are you going to put toilets on a 20,000-square-foot floor?”
If they can’t be converted, other cities—such as New York—are offering tax incentives for “transformative renovations” that could make these older buildings more attractive to tenants. But not everyone is convinced that’s a good plan. “They’re uninvestable. Nobody wants to be in these buildings at any price,” says Related’s Blau. “Even if you could find a tenant that wanted to lease those buildings, the amount of money that you have to spend to bring them up to par just doesn’t make economic sense.”
Tax incentives are a sweetener, but they won’t help real estate owners who just don’t have the money to renovate or convert their properties. And if they resort to loans, they’ll face the same problems they have with their current debt troubles. “The majority of refinancings over the next year or two will be cash-in. Does every owner have the extra cash to get [them]?” says Bob Knakal, a senior managing director and longtime broker at JLL. “If not, the writing’s on the wall. If they do, why do it if their perception is that the value is going down further?”
According to Jeff Greene, simply waiting in the hope that workers come back to the office and interest rates start to fall isn’t an option. To stay alive until 2025, developers must attract new tenants and lock in leases—even at reduced prices—while trying to restructure their debt and come up with a plan for their worst-performing properties.
Comparing the real estate business to boxing, he adds: “When you’re being battered, put up your fists and defend yourself.”
Additional reporting by Dan Alexander.
Editor’s note, May 30, 2023: Jeff Greene contacted Forbes to say that he misspoke when he mentioned Ben Ashkenazy in his quote in the eighth paragraph of this article. He does not deny saying it, but says he meant to refer to a younger real estate investor.
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