The COVID-19 pandemic cast a dark cloud over the office real estate investment trust (REIT) sector as it proved that companies could continue operations in a 100% remote environment. With a tight labor market, many companies are struggling to bring workers back to the office.

Rising inflation is causing companies also to question their spending on office space and also their commitment to expensive real estate markets. Office REIT S.L. Green (SLG 0.02%) recently cut its dividend as the Manhattan office market has been slow to recover. 

New York City skyline.

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S.L. Green recently cut its dividend

S.L. Green recently announced a 12.9% decrease in its dividend to $0.2708 per month. This works out to an annual dividend of $3.25 per share. It did this in order to meet its projections for 2023 funds available for distribution. This move will allow S.L. Green to repay $2.4 billion in debt next year and increase its liquidity to just shy of $1.6 billion. The stock had been trading with an outsized dividend yield compared to other office REITs, so investors were handicapping at least some risk of this happening. 

SLG Dividend Yield Chart.

SLG Dividend Yield data by YCharts.

S.L. Green also announced that it expects 2023 funds from operations (FFO) to be lower than 2022, largely due to rising interest rates. The company is guiding for 2022 FFO per share to come in between $6.70 and $7.00 per share. They see 2023 FFO per share declining by 21% to a range of $5.30 to $5.60.

When does the office market return to normalcy?

The ultimate question for S.L. Green is when the Manhattan office market will return to normalcy. S.L. Green has been in contact with its tenants since the pandemic began, and it is clear the companies would like their workers on-site and not working remotely. That said, we have a tight labor market, so workers have some bargaining power on this issue. Second, Manhattan office space is expensive, and companies could save money by moving out of the City. 

This may be easier said than done. Manhattan is centrally located and easily accessible from the outer suburbs. If a company relocated from Manhattan to suburban Long Island, commuters from New Jersey and Westchester County would be unhappy. Occupancy has been slowly picking up, increasing from 90.7% in the quarter ended June 30 to 91% for the quarter ending Sept. 30. To put those numbers into perspective, pre-pandemic occupancy was 94.2%.

At current levels, S.L. Green is trading at 6.4 times its guidance for 2023 FFO per share. This is not a stretched valuation by any means. Even with the reduced dividend, the stock still has a 9% dividend yield. The problem for S.L. Green is that if we hit a recession next year, we could see occupancy rates stuck in the low 90s, raising the specter of another dividend cut. The sentiment for office REITs, in general, is pretty sour, so investors should know that things could get worse before they get better.