THE "ZOMBIE BUILDINGS" AT THE HEART OF THE OFFICE MELTDOWN / THE WALL STREET JOURNAL

The ‘Zombie Buildings’ at the Heart of the Office Meltdown

Private-equity owners abandon souring office deals, leaving bondholders fighting and neighborhoods hurting

By Matt Wirz

Workers in downtown Chicago say foot traffic, especially on a Friday morning, is noticeably lighter than before the pandemic.

One of the biggest office towers in Chicago’s River North district occupies some 1.7 million square feet. 

These days, too much of that space is empty—and the whole neighborhood is paying the price.

A messy restructuring with creditors left the building struggling to attract tenants after its owner, private-equity giant Blackstone, walked away from the office complex two years ago. 

Lenders including Pimco and Oaktree Capital spent about a year battling each other for control of the property, according to people familiar with the matter and documents reviewed by The Wall Street Journal. 

Efforts to sell the building while it is in financial limbo have failed, and tenants are fleeing.

Five years after the start of the Covid-19 pandemic, U.S. cities are still struggling to avoid commercial real-estate doom loops that have claimed areas such as downtown St. Louis. 

Fights like the one involving the River North building’s creditors are making it much harder for communities to rebound.

Private-equity firms that snapped up large office buildings—using money borrowed by issuing bonds called commercial mortgage-backed securities—are often writing off properties in ailing business districts. 

That is leaving the buildings in the hands of bondholders, who sometimes duke it out to recover as much money as possible.

Mary Gabriel, owner of the Shamrock Club in the River North neighborhood, says sales are still below where they were before the pandemic.

All of this is repelling potential tenants. 

Buildings in foreclosure are the least popular because creditors are only temporary landlords and are less likely to pay for the refurbishments that renters demand. 

“The zombie buildings that are out there are going to cast a pall across the entire office market for years to come because it will take time to reposition the properties in a way that meets tenants expectations,” said Lea Overby, head of commercial mortgage bond research at Barclays.

Debt investors considered bonds issued to purchase major office buildings safe, because they carried triple-A credit ratings and involved brand-name firms such as Blackstone and Brookfield. 

That didn’t turn out to be the case with the River North building, where investors have taken paper losses exceeding $200 million. 

Office occupancy fell sharply across the country after 2020, as many employers adopted hybrid or fully remote work schedules to cut costs and to cater to employee preferences. 

Some companies are bringing employees back in, but demand for space remains low. 

Companies are gravitating to new buildings in a few hot neighborhoods—like Park Avenue in Manhattan or Chicago’s West Loop. 

The River North office complex that Blackstone abandoned to creditors almost two years ago, after tenant occupancy plummeted.

In less-popular neighborhoods like River North, a three-square-mile patch nestled in a bend of the Chicago River, even buildings with stable finances are struggling to keep existing tenants. 

Inside the office tower Blackstone abandoned, a handful of office workers rode escalators built for thousands on a recent Thursday afternoon. 

A handmade Italian espresso machine in the lobby’s coffee bar sat idle. 

Surrounding businesses that previously relied on the building’s throngs of workers are losing out. 

For-lease signs plaster building fronts. Car and pedestrian traffic in the neighborhood is sparser. 

Clerks in empty stores while away the afternoon hours staring into their smartphones. 

“Prior to Covid, on a typical Friday, we had a line out the door for lunch, but nobody wanted to come back to work,” said Mary Gabriel, the 71-year-old owner of Shamrock Club, a bar-and-grill around the corner from the building. 

Sales at the Shamrock are 10% lower today than prepandemic levels, and the upper floors that she rented out to beauticians before Covid are now vacant.

Office utilization in River North is about 48% of its 2019 level, according to commercial real-estate company Avison Young. 

That compares with an average of 55% in Chicago’s central business district and 62% nationally.

Dylan Jackowiak, one of the last bike messengers in River North, has noticed a lot of dark windows in the area's office buildings.

Anthony Stefani closed Bar Cargo, his family’s Roman-style pizzeria, in December after years of struggling to adapt. 

“We had to stop the bleeding,” he said. 

Stefani had cut his staff to about 20 from a peak of 50 but was unable to cover his rent.

Dylan Jackowiak, one of the last bicycle messengers left working in River North, said when the weather is nice he takes a break in a parking garage that overlooks the once-bustling office buildings. 

“I can see that a lot of the windows are dark, or it’s just empty desks where you’d expect to see someone working at a computer,” he said.

Buildings purchased by issuing commercial mortgage-backed securities are sometimes clustered together, which can worsen the economic blight when things go wrong. 

Three buildings financed with such bonds are currently in financial distress along a two-mile stretch of Market Street in Philadelphia’s Center City.

One potential fix is to convert office buildings into apartments, and Chicago has subsidized such projects in some neighborhoods. 

But giant properties, like the one in River North, are too large to profitably repurpose.

Blackstone bought the River North office complex in 2015 when it was full of tenants like advertising giant Ogilvy. 

The owner refinanced in 2018 with about $300 million of bonds and a $60 million loan from Teachers Insurance and Annuity Association of America. 

By 2023, the building was 30% vacant and Blackstone defaulted, triggering terms in the bond contract that transferred stewardship to Wells Fargo as “special servicer.”

A tug of war ensued over whom Wells should take orders from: junior bondholders represented by Oaktree, or Pimco and other owners of the safest bonds. 

The senior bondholders peppered Wells with requests for information that went unanswered for months, according to electronic messages reviewed by the Journal. 

Teachers booked a total loss on the deal, according to its 2023 financial statement.

Blackstone has “worked collaboratively with the lenders on a sales process in an effort to reach a resolution,” a spokesman for the firm said.

Pimco didn’t get control of the building until June, a year after the default. 

Now, it must unload a building with a high vacancy rate. 

Some tenants have mostly remote workforces but have been unable to break their leases, leaving their offices mostly empty.

“This building is effectively offline,” said Matt Weinstein, co-chief investment officer at Axonic Capital, a buyer of distressed real estate who looked at the office tower in River North and passed on it. 

“That means the building and buildings like this across the country will continue to lose tenants.”