Office REITs Rally Into Earnings, But Investors Want to See Cash

Investors in US office real estate stocks are focused on two crucial themes as the sector kicks off earnings this week: leasing activity and the ability to tap capital markets for financing.

(Bloomberg) — Investors in US office real estate stocks are focused on two crucial themes as the sector kicks off earnings this week: leasing activity and the ability to tap capital markets for financing. 

Real estate investment trusts are bouncing of late, outperforming the broader market. But they’re still battling fierce headwinds, from elevated borrowing costs to falling property valuations to the tough economic backdrop in metropolitan areas, where office use cratered during the pandemic. 

The key question for investors is still, “Who will put money, whether debt or equity, into these properties with cash flow declining,” said Bloomberg Intelligence analyst Jeffrey Langbaum. 

New York-based SL Green Realty Corp., which reports after the market close, gave the sector a boost late last month with news that it sold an almost 50% stake in a Midtown Manhattan office skyscraper to a US affiliate of Mori Trust Co. 

The S&P Composite 1500 Office REITs Index is on track for a fourth straight weekly gain, something it hasn’t done in more than a year. Since the start of June, the index is up more than 17%, beating the roughly 9% gain in the S&P 500. The advance has trimmed the REIT gauge’s 2023 loss to 12%, from as much as 57% in late May. 

The big challenge for the firms, obviously, is that far fewer workers are streaming into office buildings than they were before the pandemic. In 10 of the largest U.S. business districts, office use was 49% of pre-Covid-19 levels in the week ended July 12, according to data from Kastle Systems.

However, things may not actually be as bad as they seem, says Michael Lewis at Truist Securities. Of the nine office REITs he covers, eight are operating at more than 90% occupancy.

“Office REITs are actually holding up much better than anybody probably would’ve expected in this environment,” Lewis said. He has a buy rating on both SL Green and another New York City bellwether, Vornado Realty Trust.

Dipping Toes

The move that SL Green announced last month jolted the market broadly because it shows an investor dipping their toes in the water.

“A lot of peers jumped on that simply because it was the first data point we’ve had in a while where somebody was willing to throw a big chunk of money at a New York City office building,” said BI’s Langbaum. 

And now, earnings season gives companies a chance to provide more clarity on leasing and financing, he said. 

Vornado’s results and those of Kilroy Realty Corp. are scheduled for the end of July, while Boston Properties Inc. is expected to report Aug. 1.

Sunbelt markets, especially Atlanta, continue to see stronger leasing activity than others, while the West Coast is still struggling with weak demand from the tech industry, Wells Fargo & Co. analysts led by Blaine Heck wrote in a note. New York City, meanwhile, is faring a bit better given its outsized exposure to financial services, they said. 

Of course, financial institutions have their own worries related to capital requirements and commercial real estate exposure, leaving investors wondering if the lenders will have adequate appetite to extend financing to office landlords, Langbaum said.

Read More: Real Estate Woes Drive Billion-Dollar Hit for Goldman Sachs

Goldman Sachs Group Inc. drove home the tough position banks face on Wednesday, when it said writedowns of real estate investments helped drive a nearly $1.2 billion hit in the second quarter. 

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