SL Green Realty (NYSE:SLG), New York City's largest commercial landlord, has seen its stock price cut in half from its highs earlier this year. On its first-quarter earnings call, management optimistically noted that the company had collected 90% of its commercial real estate rents and 60% of its retail client rents. Given the relative weighting of its portfolio, this meant that SLG collected 86% of all rents through March. This number improved to 89% overall in April (including rents collected a month late), but declined to 85% in May.
Do these collection rates for real estate in New York City -- the U.S. city hit hardest so far by the pandemic -- suggest that COVID-19's expected longer-term impact on commercial real estate might be more muted? And if so, has SL Green's stock been hit too hard?
To answer those questions, we have to consider not just the short-term opportunities but also the longer-term risks of structural shifts in the market for commercial real estate. The most significant of these shifts, which is playing out in real time, is the transition to working from home.
Long-term, the threat of remote work looms largest
The potential impact on demand is threefold.
First, as companies grow increasingly comfortable with allowing workers to work from home, workplaces will adopt shared workspace concepts that allow them to get equal or greater mileage from less square footage. McKinsey reports that 69% of workers believe they have been at least as productive working from home, that working from home will increase to 27% of hours worked, and that hours worked at a main office will decline by 12%. Some companies are already predicting that "hoteling" -- employees reserving time in a shared office and working remotely otherwise -- will lead to a reduction in leased square footage.
Second, and relatedly, the looming second wave of COVID will impact population centers most significantly, simply due to the close proximity in which people interact. Measures put in place to mitigate the health safety risks of commuting will also highlight how inefficient and unproductive any commute that requires use of public transportation or crowded rush-hour spaces. Just as companies will realize more productivity from remote workers, workers will demand more opportunities to work remotely due to safety and productivity concerns.
These two factors -- greater supply and less demand -- both serve to lower the cost of rentals. Landlords will be forced to either lower prices or invest more in quality accommodations in order to stay competitively occupied.
Third, COVID accelerated adoption of new technology that may have taken years to play out without such a catalyst. Video conferencing is perhaps the most visible example, as evidenced by the success of Zoom Video Communications (NASDAQ:ZM). As McKinsey's study indicated, managers are realizing that it's possible for workers to be equally if not more efficient working from home. Thus, the cohort of people who most needed to be convinced of the idea that technology-enabled remote work can save money and allow workers to be more productive is becoming sold on the utility of this model.
What do these trends mean for SL Green?
At the annual REITweek conference in early June, SL Green Chairman and CEO Marc Holliday sounded an optimistic tone on the company's prospects:
Despite the challenges created by the COVID-19 crisis, I'm very pleased with the performance of the Company throughout the last several months. Our collections have held up well as a result of our high quality, long dated and creditworthy rent roll, and we have amassed a substantial amount of cash liquidity in a short period of time, which is the reflection of the hard work of our employees and the resiliency of the Manhattan real estate marketplace. We have developed a strong reentry plan to welcome tenants back to their offices in the coming weeks.
While the steps Holiday outlines represent a prudent management strategy, the need to take such measures also highlights the short- and long-term risk facing SL Green.
As the company said in its latest quarterly SEC filing, its ability to meet future guidance depends on COVID-19's impact on New York real estate, on SL Green's business specifically, and on the commercial real estate industry as a whole. Whether the risks materialize to a greater or lesser extent than "base case" depends on many factors that have yet to play out.
Despite only a small decline in enterprise value, SL Green's stock is trading at about half of where it was in early 2020. Its dividend yield is about double where it was at the end of 2019 (at a payout of $3.54 per share). Furthermore, the company increased its available cash to over $1 billion as of June 2020. However, in SL Green's REITweek investor forum, the company also noted that seven of its 30 leases are delayed due to COVID-19, as well as fully half of its 56 outstanding term sheets for new deals.
The risk to investors is that these delays could turn into cancellations and non-renewals. While the company has ample liquidity to weather a near-term revenue shortfall, if longer-term trends play out faster than expected and investors don't have confidence in the sustainability of cash flows, then it's hard to imagine the company sustaining its current dividend rate.
The stock market is pricing downside risk to SL Green's payout at its current trading price. Furthermore, a reasonable assessment of COVID-19's impact on longer-term trends suggests that commercial real estate in crowded, expensive, high-commuter cities may come under pressure from the increased prevalence of remote work. Ultimately, these market forces may be too powerful for SL Green to overcome, and its payout will likely adjust accordingly.