Office Real Estate Looks Dicey With REITs Plunging to a 2009 Low

May 29, 2023
Posted in News
May 29, 2023 veps

Office real estate investment trusts are trading at their lowest level since 2009 as the trend toward remote work leaves desks empty and economic pressures tighten corporate budgets.

The S&P Composite 1500 Office REITs index is down 27 per cent in 2023, plunging to its worst reading since July 22, 2009. Office landlords comprise just 6 per cent of the REIT sector, which explains why the broader S&P Composite Equity REITs index is down just 5.2 per cent year-to-date and the S&P 500 Real Estate sector has dropped 4.5 per cent. Offices are what has weighing on the group.

“There are two ways to lose money: You can own a boat, or you can own an office building,” Piper Sandler analyst Alexander Goldfarb said. “At least with the boat you can take your friends out on a sunset cruise.”

While the stress on the office sector may not be new, the shift to working from home has exacerbated the problem. However, much of the damage could already be priced into the stocks after this latest sell-off, analysts said.

In addition, fears about commercial real estate have added to the woes of regional bank stocks that typically fund local projects such as strip malls and small office buildings. The sector has been pressured since the collapse of Silicon Valley Bank in March sparked industry-wide turmoil. Now some investors fear that its exposure to office weakness could be the next shoe to drop.

However, those worries may be overblown.

“There’s probably going to be some heartburn in the bank space and probably some charge-offs,” said Ben Gerlinger, an analyst at Hovde Group. “But I think a lot of smaller and community regional banks are well-positioned.”

Quality counts
What is more, the outlook for office landlords could improve as companies encourage workers to return to their desks and restrict remote work policies.

“We’re starting to see some of that reversal,” RBC Capital Markets analyst Michael Carroll said. “You’re seeing the first steps of people starting to reutilise their office spaces when they weren’t just a few years ago.”

The age and quality of each building will be a key differentiator in which offices succeed over the long term and which do not. Newer office buildings with modern amenities will likely benefit the most as companies seek out spaces that will entice workers back into the office.

And of course, the financial make-up of each office landlord is key. Industrial and senior housing landlords could prove to be potential bright spots because of their healthy fundamentals and strong cash flow generation, according to Carroll.

Similarly, Piper Sandler’s Goldfarb recently upgraded Douglas Emmett Inc to overweight because of its small tenant focus and lower cost of leasing. On the opposite end of the spectrum, he slapped an underweight rating on New York-based Vornado Realty Trust because of its struggling balance sheet and development exposure around Manhattan’s Penn Station expansion project.

So identifying winners and losers among office REITs remains a stock-picker’s game. But in the end, the damage may not turn out to be as bad as investors’ angst.

“There are a lot of headwinds out there,” Carroll said. “But when you really look into it, the fear is much bigger than reality.”

source: afr