Real estate investment trust (REIT) SL Green (NYSE: SLG) knows a thing or two about the New York City office market. As Manhattan's largest office landlord, the office REIT has a better grasp on what's happening in that market than almost anyone else. This means real estate investors interested in the New York City market should pay close attention to what it has to say.
The company recently provided a glimpse of what it sees in the market when it reported its second-quarter results. Here's what those earnings can tell investors about the future of Manhattan's office market.
A solid showing amid challenging market conditions
SL Green reported solid second-quarter results. The REIT generated $1.60 per share of funds from operations (FFO), down slightly from $1.70 per share in the year-ago period. FFO actually improved year over year after adjusting for the impact of lease termination income, which was $0.15 per share in the year-ago period compared to $0.02 per share in 2021's second quarter. Meanwhile, same-store cash net operating income (NOI) was down 3.7% year over year. That's due to slightly lower occupancy of 93.6% compared to 94.1% in the year-ago period and a decline in replacement lease rates.
Overall, leasing activity has held up relatively well even though physical occupancy is only now approaching 25% as most companies continue working remotely. SL Green signed 42 Manhattan office leases covering 557,703 square feet during the second quarter, at rental rates 1.1% lower than those they replaced. That was an improvement from the first quarter, when it signed 21 Manhattan office leases covering 352,752 square feet at rates 2.8% below prior leases.
What SL Green is seeing in the office market
SL Green CEO Marc Holliday provided greater insight into what the company is seeing in the Manhattan office market on the accompanying conference call. While physical occupancy is at a quarter of its pre-pandemic level, Holiday noted that "tenants are reopening new doors and more and more workers are returning to the office."
Further, he said: "Business leaders are now more than ever voicing their strong support, preference, and adherence to continued work from office model in the collaborative, communicative, and physically present matter. The majority of our tenants are planning for their workers to return after Labor Day and, more importantly, we do not see any material trends in hot desking or shrinking footprints."
That last point is worth highlighting. There has been a lot of talk about the impact increased remote work and hybrid models will have on office demand in the future. It won't have much effect in SL Green's view, at least in the New York City office market.
"To the contrary," Holliday continued, "we see a trend of businesses availing themselves at this moment in time in the market to lock in space and make investments and improve work environments, technology, and amenities as a way of competing for talent and making a compelling case to their employees for work-from-office."
In other words, companies see having high-quality office space as a competitive advantage. That's leading them to build out "more common space amenities, food and beverage offerings, collaborative meeting spaces, specialty areas, de-densified workstations, breakout rooms for privacy, and generally more thoughtful and efficient and healthy use of space," according to Holliday.
As both a leader in the Manhattan office market and owner of some of the highest-quality class A office space in the world, SL Green has the edge over other office building owners in delivering the space tenants need to increase their ability to compete for talent. Because of that, the company is seeing strong demand for its space. That has it on track to end the year with a 0.5% higher occupancy level than initially anticipated.
Holliday also noted that companies are adding 6,000 to 7,000 new office jobs each month in New York City, so it could return to its pre-pandemic level by the middle of next year. He said that information technology and professional service companies are creating the most jobs while the finance sector is driving the most demand for new leases. This growth suggests demand for office space should strengthen over the coming year.
The New York City office market is coming back strong
Some speculated that the pandemic would be the death knell of the Manhattan office market. They thought companies would seek to save money by allowing more of their employees to work remotely in the future, reducing their office space needs.
However, that's not what SL Green is seeing these days. Instead, companies view a high-quality office setting as a competitive advantage as they compete for talent. Because of that, they're taking advantage of the current uncertainty to lock up space at attractive rental rates. This trend suggests New York City will remain attractive for real estate investors in the future.