Work-from-home has proven to be a cloud over the office real estate investment trust (REIT) sector. As tenants continue to push back returning to the office, investors have fretted over whether the office REIT model still works. But office REIT SL Green (SLG 6.15%) gave a positive outlook that suggests the office REIT business model remains intact.
Workers are returning to the office -- just slower than expected
SL Green is New York City's biggest landlord, with just under 30 million square feet of office, retail, and residential space. Technology clients account for about a third of SL Green's tenant base, followed by financial services at 30%, and law firms at 11%.
While no one envisions a world without offices, investors are rightly asking whether businesses will downsize their office spaces. On the earnings conference call, CEO Marc Holliday gave some background on what the company is hearing from its tenant base. The big takeaway is that people are coming back to the office, slowly but steadily. In prior calls, tenants have cited deadlines (i.e. Labor Day, Jan. 1, etc) that ended up getting pushed back.
SL Green is seeing no evidence that companies are downsizing offices in response to remote work. If anything, COVID has encouraged businesses to include more personal space in office floorplans. Whether someone works five days a week in the office or three, they still need a desk and a workstation.
Revenues are still declining, as is occupancy
In SL Green's recently reported third-quarter earnings, net income rose smartly to $5.75 a share, compared to just $0.19 a year ago. This doesn't imply that business is taking off; accounting adjustments and profits from the sale of properties drove the increase. Stripping out these special items, SL Green earned $0.22 per diluted share. Revenues fell by almost 18%, and funds from operations (FFO) per share were roughly flat year over year at $1.78.
While it looks like Manhattan is getting back to itself after the pandemic, we are still seeing occupancy rates decline. In the third quarter of 2021, occupancy fell from 93.6% to 93.1%. That said, SL Green increased its guidance slightly for 2021 FFO per share, to a range of $6.45 to $6.65 -- still down 10% from the $7.29 in FFO per share the company earned last year.
SL Green indicated that it will lease an additional 1 million to 1.5 million square feet this year, atop the 29.5 million square feet with which it began the year. Its tenants are making 10-year commitments, so they are obviously comfortable that they will need that much space for the foreseeable future. Holliday said that CEOs believe having an on-site workforce gives them a competitive advantage.
Based on current guidance, SL Green is trading at 11.1 times FFO per share, which is certainly not a rich valuation. The company also pays a $0.303 monthly dividend, which works out to a 5.2% dividend yield. The annual dividend works out to be $3.64, which represents 56% of the company's guidance for 2021 FFO per share.
So while FFO per share may be falling compared to last year, SL Green's still making more than enough to cover its payouts. Companies like Kilroy (KRC 4.29%) and Alexandria Real Estate (ARE 2.21%) might have better prospects given their exposure to the life sciences sector, but SL Green shareholders are getting a much lower multiple and a higher yield.