Office REITs have been under tremendous pressure this year. The average one has lost about a quarter of its value, which is much worse than the roughly 10% decline of the average equity REIT. Weighing on this property class is concerns that more companies will allow their employees to work from home permanently. That would reduce their need for office space in the future, impacting office rental and occupancy rates.
However, those concerns seem overblown, given the importance of in-office work for both employers and employees. Because of that, valuations look attractive across the office REIT sector. Two that stand out as good bounce-back buys are Boston Properties (NYSE: BXP) and SL Green Realty (NYSE: SLG).
The industry behemoth
Boston Properties is the largest publicly traded developer, owner, and manager of Class A office properties. The REIT owns 195 properties with 51.2 million square feet of space spread across five major markets: Boston (34% of its NOI), New York (23.8%), San Francisco (23.5%), Washington, D.C./Northern Virginia (14.9%), and Los Angeles (3.8%). The company has leased 92% of its space under long-term contracts with a weighted-average lease term of 8.2 years to a diversified tenant base.
This portfolio has held up very well during the current industry downturn. Overall, the REIT collected 98% of the rent it billed office tenants during the second quarter, which continued in July. Meanwhile, it kept signing new and renewal leases for existing space at its development projects.
One reason office tenants continued to pay their rent and sign new leases is that most don't see remote work as a permanent option. That's because it's challenging to mentor younger employees, collaborate, and develop a culture remotely. Meanwhile, most employees want to go back to the office full-time. According to a survey by the Gensler Research Institute, only 12% of U.S. office workers want to work from home, up just slightly from 10% before the pandemic. Instead of needing less space, office tenants will likely need more of it in the future as they increase their health and safety precautions, like social distancing employee workstations. These trends bode well for the future of Boston Properties.
New York City has come back many times before
SL Green is the largest office landlord in Manhattan. The REIT owns 96 buildings with 41 million square feet of rentable space. It leases this space under long-term agreements (the average remaining lease term is nine years) to more than 800 high-quality tenants across several industries.
While COVID-19 hit the city hard, most of SL Green's tenants kept paying their rent. Overall, it received 95.7% of the office rent it billed in the second quarter and 91.7% of July's rent as of its last update. Meanwhile, it continued to sign new office leases, securing 35 during that turbulent period at just a slightly lower rate of 0.8% below prior leases.
However, even though times are tough in the city these days, it has endured similar challenges in the past and bounced back each time. Because of that, it seems premature to write it off this time. In the meantime, SL Green has the portfolio and balance sheet to endure these tough times, given its investment-grade credit and $1 billion in cash.
Meanwhile, with its stock down more than 46% this year, it looks like a bargain. SL Green seems to think so, which is why it reactivated its stock buyback plan in late May and had repurchased $163 million in shares by early July.
Leasing real estate portfolios
Investors are worried that COVID-19 will make remote work permanent for more office employees, reducing office space needs in the future. However, most employees and office workers prefer the office setting, which works better for collaborating and mentorship, suggesting that it likely won't be a long-term headwind. Because of that, office REITs should bounce back as more workers return to the office, making top-tier names like Boston Properties and SL Green appear to be great bounce-back buys these days.