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Is This Trend a Bad Omen for Office REITs?


Nov 28, 2020 by Matthew DiLallo
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Office building owners have been under pressure this year due to the impact the COVID-19 outbreak has had on the sector. Many companies easily adapted to working remotely thanks to the rapid adoption of communication tools like Zoom (NASDAQ: ZM) and Slack (NYSE: WORK). That drove concerns that many workers might not return to the office even after the pandemic has ended. Those worries caused the average office real estate investment trust's (REIT's) stock to tumble more than 35% this year, according to Nareit.

While most office REITs firmly believe that their tenants will return to the office as they had in the past once the outbreak is over, the current wave of new cases is causing more office workers to stay home, according to recent data. That's delaying the return to normal that these landlords had hoped to see.

Opting to stay home

According to Kastle Systems, the recent surge of COVID-19 cases across the country is causing a notable dip in the average office occupancy level across major markets. The company, which provides access control systems to office buildings, has been tracking data on keycard, fob, and app access to office buildings across 10 major cities. Usage has declined in recent weeks, with occupancy averaging just 25.7% in the week of November 18. That's down from an average of more than 27% throughout most of October and well off the more than 90% occupancy levels most office buildings experienced in early March.

This data suggests a growing reluctance by office workers for in-person work given the current surge in COVID-19 cases across the country. Occupancy remains lowest in San Francisco and New York City at 13.4% and 15.9%, respectively, which both saw a decline in the number of workers heading to the office in recent weeks. Those regions are in stark contrast to other metro areas like Dallas (40.3% occupancy), Houston (38.7%), Austin (34.2%), and Los Angeles (33.1%).

With workers in New York and San Francisco the most reluctant to return to the office, it's causing some concern that tenants might not be in a hurry to sign new leases in those cities. That's weighing on the stock prices of office REITs with large exposure to those two cities like Boston Properties (NYSE: BXP), SL Green (NYSE: SLG), Vornado Realty Trust (NYSE: VNO), Empire State Realty Trust (NYSE: ESRT), Hudson Pacific Properties (NYSE: HPP), Kilroy Realty Corporation (NYSE: KRC), and Columbia Property Trust (NYSE: CXP).

Confident in the eventual return

Office landlords are eager to have their tenants back in the office. At the moment, though, they're playing the waiting game. Marc Holliday, CEO of leading Manhattan landlord SL Green, discussed the situation on the company's third-quarter conference call, stating:

It's always sort of right around the corner. We're hearing in August, it will be right after Labor Day and Labor Day, it's October. So it feels imminent, and yet the numbers don't bear that out. We're still, as a portfolio, right around the city average of probably 15% to 20% back to office work. And that's out of 1.5 million office workers. So that means 80%, 85% of the people that work in office buildings are still home, and that's frustrating. And I think they will be back. The reality, whether they're back next month, December, or Jan, Feb, March, that doesn't, in our estimation, affect any of the long-term fundamentals of the things we look at. I mean the sooner, the better, and I would expect by December to see those numbers be somewhere between 20% and 30%, up from 15% to 20% today. And then, hopefully, it just grows from there.

So, while SL Green is frustrated by the slow trickle back to the office, the REIT believes that workers will return at some point. One recent positive development is the recently released data on vaccines, with three showing the potential to effectively prevent the virus. As these shots win approval and start rolling out to the general public, it will likely give office workers more confidence to return to in-person work.

Owen Thomas, CEO of Boston Properties, the largest owner of Class A office properties in the country, discussed the company's view on a timeline for when to expect a full return to the office on its third-quarter conference call. He stated:

While we anticipate a vaccine will likely become available by year-end, it is unlikely to be a magic bullet that immediately eliminates the pandemic, given broad deployment will face issues around manufacturing, distribution, uptake, and efficacy. Though difficult to assess, we think economic conditions for the first half of 2021 will remain sluggish but expect a more pronounced reopening of the economy and return to the office in the second half of 2021 due to distribution of a vaccine, better therapeutics, and more individual adoption of health and safety protocols, as we all learn how to combat and live with COVID-19.

Thus, it seems like office REITs will need to muddle through a few more quarters before their buildings will once again be nearly fully occupied. However, what has become clear is that office tenants fully expect to return to the office as they once did because working from home just hasn't worked out well for most of them.

An eventual recovery seems inevitable

A return to in-person office work has declined in many major cities as COVID-19 cases rise, which might have some near-term effects on leasing as companies wait for more clarity on vaccine availability. However, most office REITs believe this is only delaying the inevitable fact that workers will eventually return to their offices. Because of that, shares of office REITs could rebound sharply in the coming months as the workplace starts returning to normal.

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Matthew DiLallo owns shares of Slack Technologies and Zoom Video Communications. The Motley Fool owns shares of and recommends Empire State Realty Trust, Slack Technologies, and Zoom Video Communications. The Motley Fool has a disclosure policy.