The COVID-19 pandemic proved that working from home can be sustainable for most businesses. This realization has cast a shadow on the office real estate sector, especially office buildings in expensive cities. If companies can save money by reducing office space, many will do so. This has affected most office real estate investment trusts (REITs) and Manhattan landlord S.L. Greeen (SLG 1.92%) in particular. The stock has plunged in the past year and this is why its dividend yield is so high.
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As Manhattan goes, so goes S.L. Green
S.L. Green holds interests in 61 buildings with 33.1 million square feet of space as of Dec. 31, 2022. Most of that is in Manhattan. The company has not recovered from the pandemic, and occupancy continues to fall. At the end of 2021, it stood at 92.1%, well below pre-pandemic levels. It fell throughout 2022, and the company ended the year with occupancy at 90.9%. According to recent data, Manhattan office workers are spending 30% fewer days in the office than in 2019.
The company recently cut its dividend
S.L. Green cut its monthly dividend in December from $0.311 to $0.271 a share. It did this in response to the company's declining cash flow, to maintain liquidity in a rising interest rate environment, and to allow for debt repayment in 2023.
S.L. Green reported that 2022 funds from operations (FFO) per share came in at $6.64. REITs generally use FFO to describe earnings because net income as reported under generally accepted accounting principles (GAAP) tends to understate cash flow. This is because depreciation and amortization is a big expense for REITs, but it isn't an expense that a company would write a check for. It is a noncash charge, and REITs generally leave it out to more accurately describe their fundamental operations.
The company has projected 2023 FFO per share to decline to between $5.30 and $5.60. Using the midpoint of the forecast, this works out to an 18% decline in FFO per share. Ultimately, the FFO-per-share estimate covers the dividend, but FFO and occupancy are still heading the wrong way. Pricing also appears to be a problem, with cash rent per square foot declining 9.2% in the fourth quarter of 2022.
When will workers return to the office?
The big question for S.L. Green is, When will more workers begin to return to the office? The company has been saying on earnings calls since the pandemic began that corporate executives want a full return to the office, but so far it hasn't happened. The US labor market is extraordinarily tight, with the unemployment rate back where it was in the late 1960s. This gives employees the leverage to keep working remotely. If the US enters a recession and the Fed gets its wish for a more balanced labor market, we might see a return. Ultimately, for New York City–based companies, Manhattan is the easiest commute for the office as a whole. It would be hard for a company to relocate offices to Northern New Jersey, Long Island or Westchester County without making some of its employees unhappy.
Investors will have to accept that the office REIT sector is under a cloud at the moment, and this is partly due to a potential sea change in the way Americans work. S.L. Green is trading relatively cheaply at 7.3 times projected 2023 FFO per share and a 8.2% dividend yield. The problem is that the shares, which are down almost 50% in the past year, may not recover until occupancy starts heading in the right direction. Manhattan office real estate isn't going away, but the investment sentiment is terrible for S.L. Green.
