The 2020 pandemic hit was particularly hard on landlords with properties located in big cities. You don't get much bigger than Manhattan, which is where Empire State Realty Trust (ESRT 1.55%) calls home. As 2021 has progressed, the real estate investment trust's (REIT's) portfolio performance has started to improve. But there's more to understand here before you make the decision to jump in.

Coming back to life

When the coronavirus first started to spread around the globe, it was clear that it spread most easily in group settings. People started working from home, and many basically fled big cities to find refuge in more suburban environments. It was tough on office-focused REIT Empire State Realty. But as vaccines rolled out and efforts to reopen the economy progressed, things have gotten better.

People walking in the atrium of an office building.

Image source: Getty Images.

For example, in the third quarter, Empire State Realty's adjusted funds from operations (FFO) came in at $0.20 per share. That's up from adjusted FFO of $0.12 per share in the same quarter of 2020, a huge 67% increase.

Although occupancy numbers are still kind of weak, not shocking given the company's focus on office properties, the revenue it generates from the observation deck of its trophy Empire State Building property has started to rebound. That's helped to buoy the REIT's overall results and provides anecdotal evidence that the Big Apple is starting to come back to life.

Overall, the REIT's business trends are actually not so terrible. And it seems that Empire State Realty has learned a lesson from the pandemic, as it just agreed to buy two apartments in a diversification move. That sounds great, but it actually highlights the deeper problem with Empire State Realty.

Too much focus

The first thing to note about this REIT is right up front in its name. It is heavily reliant on New York City and its surrounding suburbs. How reliant? Basically, 100% of its business comes from NYC. That's a big bet on just one region.

Furthermore, almost all of its rents come from office properties. (The two apartment acquisitions still have yet to close.) Only about 7% of rents come from retail tenants, but even there, those businesses are operating in the street-level space at office properties. Put that number together with the 75% of rents directly tied to New York City offices, and Manhattan, despite its splendor, desirability, and size, makes up a massive 82% of rents. 

Adding to the risk here, just six properties (out of a portfolio of 14 at the time) represented nearly 75% of the company's rents in 2020. That's not even a full picture of the concentration, either, given that the Empire State Building alone accounted for nearly a third of the REIT's overall rents. This is a very concentrated bet on New York City.

Chart showing steep drop in Empire State Realty's price and dividend in 2020, followed by rebound.

ESRT data by YCharts.

This brings up the Empire State Building observation deck, which generated around $130 million in revenue in 2018 and 2019. Rounding, that was roughly 18% of each year's revenues. That's a pretty big number for a business that is highly dependent on tourism. In 2020, amid the pandemic, the observation deck brought in just $29 million.

In the third quarter, despite notable improvement, the observation deck's revenues were $12.8 million, or an annual run rate of a bit more than $50 million. It's nice to see things working back to normal, but it just highlights the importance of this unique New York-centric asset to the REIT's overall business.

And then there's the recent move into the apartment space, which is basically just a statement about how Empire State Realty's business is too focused. While it's nice to see management taking action on this issue, there's more that needs to be done before conservative investors should feel comfortable owning this REIT.

Not bad -- just a leveraged bet

This isn't to suggest that Empire State Realty Trust is a bad REIT. In fact, it owns some pretty incredible buildings (you know, like the globally iconic Empire State Building). However, it is a leveraged play on New York City. In fact, even after it diversifies by acquiring a pair of New York City-based apartments, it will still be a leveraged play on New York City.

Most investors should probably look elsewhere, unless you can stomach the concentration risk that is inherent in Empire State Realty Trust's business model. While that might be exactly what some investors want as the city works back from the pandemic hit it took, it could still cause some sleepless nights for more risk-averse types.