Work from home has been a cloud over the office real estate investment trust (REIT) sector ever since the COVID-19 pandemic. Given that employees seem to prefer it, and companies can save on office rent, investors have begun to worry about office vacancies and growth in rents. A new paper from the National Bureau of Economic Research took a look at office real estate in New York City and found a 45% decline in value from pre-pandemic conditions. What does this mean for the biggest landlord in New York City, SL Green (SLG 3.30%)?
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SL Green is Manhattan's landlord
SL Green is an office REIT that focuses on New York City real estate. As of the end of June 2022, the company owned 50 buildings with about 27.2 million square feet of space, primarily in Midtown Manhattan. At the end of the quarter, the occupancy rate was 90.6%. Pre-pandemic, the company's occupancy rate was 94.3%.
The New York City office market is struggling
According to the study, the vacancy rate in New York City was 21.5% at the end of the second quarter. Furthermore, 71.6% of the leases in force at the beginning of the pandemic did not come up for renewal in 2020 or 2021, which implies that rents may have further to fall. The study noted that this decline in office-property valuation is an average; in other words, some properties might fall more, others may fall less. The highest quality properties seem to be the least affected. The study noted that rents were little changed for the highest quality properties on average.
SL Green's CEO describes the company as "stupid cheap"
On the Q2 earnings-conference call, Chief Financial Officer Matt DiLiberto characterized the company's share price as "stupid cheap" at a "50-plus discount to the Street's NAV." NAV stands for net asset value, which is the value of the company's assets minus liabilities. This is different than book value, which generally values buildings at cost less depreciation. It implies that if SL Green liquidated its portfolio for cash, stockholders would have twice the share value. The stock price has declined further since then.
SL Green is clearly doing better than the average office property holder in New York City, which is probably because it has higher quality properties. In Q2, funds from operations (FFO) rose 9.4% on a year-over-year basis, so the company is profitable and increasing its earnings. The work-from-home issue is more of a longer-term strategic question than a near-term issue.
The occupancy rate will tell the story
Its occupancy rate is much higher than the average. The big question for SL Green concerns the direction of occupancy. If it trends up toward the company's pre-COVID level of 94.3%, that is a good sign for the company and the dividend. If the occupancy rate trails downward, then investors are probably going to avoid the stock. SL Green has maintained its forecast of 2022 FFO per share of between $6.70 and $7 per share, although it said on the conference call that it is looking toward the bottom of that range.
Cheap multiple, big yield, and the dividend is well covered
At the lower end of that range, SL Green is trading at a cheap multiple of 5.7 times FFO per share. The monthly dividend of $0.311 works out to an annual payout of $3.73, which is amply covered by the company's low-end estimate of $6.70 FFO per share. While anything is possible, there is nothing in the earnings to suggest a dividend cut is necessary. At current levels, it has a dividend yield of 9.7%, which is quite attractive. The issue with the stock is that investors are wary about the future of office space in general, especially in high-cost areas like Manhattan. The long-term trend of work from home will eventually catch up with SL Green, though that hasn't happened yet.
