After a yearslong downturn that left U.S. offices empty, Blackstone Inc. President Jon Gray sees the sector as ripe for new bets. His real estate dealmakers are preparing to scoop up a stake in a 50-story building in Midtown Manhattan, the strongest signal yet that it sees the market primed for a rebound.

Executives running the firm’s commercial mortgage trust, meanwhile, are still sorting through old office loans gone bad. Blackstone Mortgage Trust Inc. untangled more than $1 billion of soured debt, mostly tied to offices, in the final quarter of last year. 

And the REIT — known by its ticker, BXMT — still has more than $1 billion of troubled loans in its roughly $17 billion book. It’s a reminder that the real estate recovery is uneven and halting.

“We’ll certainly see less office in the portfolio as we move forward here,” BXMT Chief Executive Officer Katie Keenan, a 13-year Blackstone veteran, told analysts last month. The trust had just posted its first full-year net loss since Blackstone took it over in 2012. Much of the loss came from recognizing that BXMT couldn’t collect some loans in full.

BXMT shares finished last year down some 50% from their pandemic peak, lopping off about $2 billion in market value before rebounding in February. It’s just a small part of the wider firm that manages $1.1 trillion, but the lender’s health is intertwined with parts of Blackstone. A handful of borrowers — such as Australian gaming company Crown Resorts — are managed by the world’s largest commercial real estate owner.

Blackstone has emphasized that offices are less than 2% of its US real estate equity portfolio. BXMT, on the other hand, was filled with office loans — more than 50% of its portfolio — at the very start of the Covid-19 pandemic. Through write-offs, repayments and taking the keys to buildings, it has shrunk that share to about a third. More than half of BXMT’s US office loans are watchlisted or impaired.

“The office loan exposure was the big overhang on their stock for about two years,” Harsh Hemnani, a senior analyst at real estate research firm Green Street, said of BXMT. “Now we’re seeing that resolving itself, but also certain things will take time to play out.”

Short sellers such as Carson Block warned the REIT would get swept up in the commercial property meltdown. Block disclosed a bet against BXMT in late 2023, and the trust slashed its dividend less than a year later. Block didn’t respond to a request for comment on the status of his short position, though he told Bloomberg Television this week his firm is “happy” its thesis played out. Still, Block said he’s less sure about the short case for commercial real estate going forward given uncertainty around rates. Short positions in BXMT have halved to about 8.4% of outstanding shares over the past year or so, according to data compiled by S&P Global.

BXMT says its fortunes are lifting as a real estate recovery gathers momentum. 

“One year ago, we said that real estate values were bottoming and that’s exactly what has happened,” BXMT said in an emailed statement. The trust is moving aggressively to deploy near-record liquidity into new loans, and office loans are throwing off cash, according to the statement. More than half of repayments in roughly the past year have come from office loans.

Still, investors have little appetite for all but the best offices. The trust is working to sell a collateralized loan obligation — essentially a bond made up of loans it has originated — for the first time since 2021. The deal will be backed mostly by apartment complexes, hospitality and industrial properties, a shift from prior CLOs linked mostly to office buildings. 

Blackstone’s real estate team was bullish on office landlords in major metropolitan areas a decade ago, according to people familiar with the matter. CEO Steve Schwarzman told associates the buildings could still be profitable even if they were only half occupied, another person said.

But few predicted the upheaval that the Covid-19 pandemic would bring. Values have fallen by more than 75% on average from the peak for most buildings in New York, according to Stijn Van Nieuwerburgh, a professor at Columbia University’s Graduate School of Business.

And BXMT carried much greater global office exposure than peers. While the Blackstone unit had more than half its portfolio tied to office loans at the start of the pandemic, similar arms at Apollo Global Management Inc. and KKR & Co. reported concentrations below 30%. 

Analysts have questioned whether the trust needs to reserve more for potential credit losses. BXMT set aside about $734 million to account for near-term credit losses at the end of 2024, according to company filings. That’s up from $125 million at the end of 2021.

Hemnani, the Green Street analyst, said the trust’s loan loss reserves still aren’t big enough. 

“We still think their CECL reserves are not fully accounting for the losses that they might experience,” he said, referring to the accounting term for near-term loan losses. “But the gap between the losses we’re expecting and their reserves is narrowing very quickly.”

In a statement, the trust said it has taken a prudent approach to its reserves that has been “validated by the fact that our resolutions have overall been more favorable than implied by our loss reserves.” 

It resolved $1.6 billion of impaired loans in 2024 above carrying values.

Queens Warehouse

BXMT has been working to clean up less-than-pristine deals as the office market slowly recovers. In New York, for example, Blackstone put additional capital into the Falchi Building, which has a $200 million loan with BXMT that wasn’t repaid upon maturity, according to people familiar with the matter. Located in an industrial part of Queens near a recycling plant and construction suppliers, the warehouse-turned-office leases space to Uber and New York City’s taxi commission. 

BXMT also resorted to some financial engineering to buy borrowers time. In the past year, the trust has agreed to let certain borrowers delay cash payments in exchange for higher interest and more fees. Some of the modifications include payment in kind, which means interest payments are delayed and instead added on to the principal due. Such maneuvers are rarely a good sign for a borrower. Still, these represented a small fraction of BXMT’s interest income — only 1% by one measure — last year, the trust said. 

The trust has received more financial wiggle room itself. Last year, to avoid violating a covenant on BXMT’s own borrowings, executives persuaded banks to loosen restrictions on the debt. It said the agreement is “generally standard” among its peers. 

Blackstone’s broader real estate lending unit, helmed by 14-year firm veteran Tim Johnson, has been through some personnel changes. Mike Nash — who co-founded the real estate debt business and was known for composure during complex workouts — moved to the firm’s hedge fund arm in 2021 and recently retired, though he remains on BXMT’s board. Jonathan Pollack, Blackstone’s former head of real estate credit, left last year to become Starwood Capital Group’s president.

In a call with analysts last month, BXMT painted a picture of an enterprise firmly in rebound mode. But there’s more to do before the unit can fully take advantage of the more attractive rates boosting other corners of the credit market. It’s still seeing some losers trickle in: executives referenced one new impairment, an unnamed UK office loan. The building represents less than 1% of its portfolio and sits in a “strong submarket of London,” the trust said. 

Investors appear sanguine. In the days after its most recent earnings release, traders bid up the stock some 5%. It’s up 17% year-to-date, outperforming peers.

And BXMT executives aren’t swearing off offices for good. They just saw their marquee deal — a 2018-era, $1.8 billion loan for a Manhattan skyscraper called The Spiral — repaid in full.  

“If we could do more deals like The Spiral, we absolutely would,” Keenan, the CEO, said during the earnings call. But in a quarter in which BXMT invested and pledged more than $2 billion in originations, she warned the firm will tread carefully. “The aperture of the type of office opportunities and where we see outperformance is quite narrow, and we’re going to be extremely selective.”

This story was originally featured on Fortune.com