A connection between a Hawaiian king from the mid-1800s and a 21st century real estate investor might not be as far-fetched as you’d think.
Hawaii-based Jay Shidler, who has bought some 2,000 properties, manages many of them using an investment strategy that has ruled real estate in his home state for the past 175 years.
The resilience of that strategy has been on full display in Chicago where Shidler, 78, and his affiliates have offloaded three office buildings in recent years while maintaining ownership of the land beneath them.
It helped Shidler, who declined to be interviewed, weather a storm of distress that’s been punishing Chicago offices in a way that few other investors in the city can.
Leasing back land to a building owner can continue to generate income on an asset that may be struggling to keep tenants. And it’s a business model that’s much older than the state Shidler calls home.
In 1848 — more than a century before the collection of islands became an American state — King Kamehameha III divided up all of the islands’ land among members of his family, the government and other high-ranking members of society.
This resulted in generational landowners benefiting from long-term ownership of land by renting it to those who wanted to build on it or use already-existing buildings for housing or commercial purposes.
Since the mid-1970s, Shidler has replicated a modern version of this throughout the U.S. by purchasing properties with the goal of separating the ownership between a land and a building owner and establishing long-term ground leases that typically last 99 years. Bolstered by his success with ground leases, Shidler’s empire extends to a dozen ventures including industrial REIT, First Industrial.
But when the pandemic ravaged the office market, his time-tested business was put to a new test.
Since 2012, Shidler and his affiliates have bought four office buildings in prime locations in Chicago’s core and near O’Hare with the intent of bifurcating them (splitting the land and building assets) and eventually selling off the leasehold interest (the building).
Things didn’t work out quite as planned.
Three of the four buildings have ended up in some state of foreclosure in the aftermath of the pandemic.
Alliance HP, a Shidler affiliate, tried to sell its leasehold interest in 300 West Adams in the loop but later defaulted on its loan along with its loan for Triangle Plaza near the airport. Both buildings were taken over by lenders while other Shidler affiliates maintained ownership of the land.
The Shidler Group, however, was able to sell off its leasehold interest in another office building at 200 South Michigan in 2019.
At Chicago’s historic Burnham Center, Alliance sold its leasehold interest in the office building to Chicago-based firm Golub & Company but later ran into trouble when the firm stopped making ground lease payments. A $42 million foreclosure case against a Shidler affiliate is pending and could jeopardize its ownership of the land along with Golub’s ownership of the building.
While today’s troubled market may impact Shidler’s current bottom line, three out of his four ground leases have stayed intact.
Even when a lender takes back the keys to a leasehold, lease payments go uninterrupted because the bank is typically on the hook.
For Shidler, playing the waiting game could still pay off, no matter how many new investors try and fail to turn a profit on his buildings.
A bargain with a catch
Shidler’s method of splitting ownership through bifurcation made the investment vehicle more widely available to those who haven’t inherited land.
And asking to buy land out from underneath an existing property owner’s building can be tough.
“The best way to create that [ground lease] structure is to just do it yourself,” said NYU real estate professor David Eyzenberg.
It’s an often overlooked way of doing business in real estate, but it has generated an estimated $19 billion over the past five years in the U.S., according to a study from commercial real estate research group IBISWorld.
And like Shidler, Hawaii remains a top player.
In 2022 Trepp found the value of loans with ground leases in Hawaii totaled $1.4 billion, trailing only New York and California.
Over the past decade, investment firms that solely focused on ground leases, like the publicly traded Safehold, have begun to market the assets as low-risk, long-term investments. They tend to lock in leases with fixed ground rent payments that increase at a slow and steady rate for predictable returns.
Family offices and smaller-scale investors, on the other hand, often establish leases that call for rent re-negotiations after say, ten years.
“If you can’t renegotiate your ground lease, oftentimes that’s the killer in the deal because your costs are somewhat static.”
This allows the land owner to raise rents at much higher rates if the demand in the market allows for it. This can also lead to negotiations that end up in court.
Given this, the investment instrument that generates safe returns for land owners can heighten the stakes for building owners.
“If you can’t renegotiate your ground lease, oftentimes that’s the killer in the deal because your costs are somewhat static,” said Chicago real estate investor John Thomas.
Thomas is no stranger to Shidler’s assets. He tried to buy 300 West Adams at auction, but ended up in a legal battle with co-investor Igor Gabal that recently ended in Gabal’s favor.
The building sold for a record-low $17 per square foot and its ground lease factored into the discount. The 99-year ground lease payments started at $1 million per year in 2012 (when Shidler bought the property) and will increase annually by 3 percent until leveling off at $2.5 million per year.
“Once you pay the lease off, there’s very little money left to operate the building,” Thomas said.
Thomas said he even made an offer on the land under 300 West Adams but it was rejected by a Shidler affiliate. With only 50 percent of the building occupied, it would take a very magical pencil to make the numbers work.
Ezyenberg stressed that some office buildings would still struggle with or without a ground lease in place.
“I think that it is probably 80 to 90 percent office issues, and then 10 to 20 percent ground lease issues,” he said.
Even so, Shidler has started to offer new ways to entice buyers to purchase leasehold interests.
In 2021, The Shidler Group inked its first “convertible ground lease” backed by an apartment complex in Houston. Instead of the traditional contract structure that puts the building back in the landowners’ hands at the end of the 99-year lease term, a convertible lease ensures the land ends up in the hands of the building owner.
And like many ground lease investors, Shidler appears to be drifting away from the office market.
“In a perfect world you want a ground lease under a building where you have a diversified tenant roster, where one tenant can’t take you down. So that’s why I love multifamily and self storage,” Eyzenberg said. “If you have a class A office with a lot of tenants, it’s fine. But if … you have one office tenant, you’re screwed.”
Offices, however, aren’t the only properties causing trouble for The Shidler Group. The firm is also headed toward a possible foreclosure after recently defaulting on a $204 million CMBS loan tied to a portfolio of hotels.
Shidler is now setting his sights on a new target, which could be key to cementing the legacy of his nearly 50-year career.
Calling an audible
Hoping for a donation from a prominent alumnus, The University of Hawaii at Manoa Business School’s Dean Vance Roley didn’t know that when he first approached Shidler the two would forge a years-long friendship.
And that relationship transformed the school.
Over the past 18 years, through a combination of cash and ground leases, Shidler has contributed $238 million to the university, Roley said.
Its business school was named after him following his first donation of $25 million in 2006.
And while a wealthy benefactor giving back to his alma mater is hardly a rarity for someone of Shidler’s ilk, Roley said their interactions over the years made it clear that the real estate investor is savvy and thoughtful about every move he makes.
“He’s one of the smartest people I’ve ever met,” Roley said.
He’ll need that pragmatism as he turns his attention toward multifamily investing. Nevertheless, its uncharted, potentially choppy waters could keep his ground-lease empire afloat.
And he did not start small.
Last year, Shidler launched a $250 million preferred equity fund aimed at recapitalizing multifamily properties with high-cost floating-rate debt and approaching maturities. The agreements establish 99-year convertible ground leases at the properties.
According to his firm’s website, transitioning to multifamily ground leases could play a role in the nation’s undersupply of affordable housing because it can lower up-front costs for developers.
A multifamily developer in California recently tested that theory by selling its land to Safehold. The developer will pay rent on the land, but at a likely lower cost than a loan to buy it.
There’s still risk, regardless of the asset class.
Last year, The Shidler Group sold a Fort Lauderdale complex for $84 million after paying $108 million a year prior.
“The folks who sold it originally bought with the intent to sell the property quickly, but as a ground lease deal,” Andrew Gordon, the buyer, said at the time. “As the market began to turn and interest rates went up, that business plan was not able to move forward.”
The Florida deal was far from the only investment the firm has made since its transition to multifamily.
In 2022 alone, The Shidler Group acquired the land under 13 multifamily properties with more than 3,900 units, according to its website.
Ultimately, the performance of those assets and others could signal if Shidler’s new haul of ground leases will benefit multifamily operators or cause similar headaches as those felt by office leasehold owners.