Office real estate investment trusts (REITs) have been hit hard by the pandemic. Shares of the average one produced a total return of -18.4% last year. Some are down even more because they focus on high-cost coastal cities where remote work could shift the post-pandemic world's dynamics. Investors worry an increase in remote work will cause lower office occupancy levels and rental rates in these cities.
However, that might not be the case, given current leasing trends in places like Manhattan and San Francisco. Because of that, office REITs SL Green Realty (NYSE: SLG) and Hudson Pacific Properties (NYSE: HPP) could have significant upside potential as the market realizes that remote work just isn't cutting it for most companies.
This market will rise again
Shares of SL Green Realty are down about 19% since the start of 2020. That slump comes even though Manhattan's largest office landlord has weathered the pandemic reasonably well. It collected 97.9% of the office rent it billed last year and 80.8% of the rent from its retail tenants for a 94.8% overall rate. Meanwhile, it took advantage of a healthy market for high-quality office properties to sell assets, giving it the cash to repay debt, pay a special dividend, and repurchase shares.
The company also continued to secure leases for space within its office buildings, even though most tenants aren't currently occupying their physical space due to the pandemic. Overall, it signed 125 Manhattan office leases last year for nearly 1.25 million square feet of space. The average lease term was almost seven years, at rates only 3.6% below the previous ones for currently occupied space.
Meanwhile, it has continued to sign new leases in 2021, including contracts that raised the occupancy of its recently completed One Vanderbilt Avenue skyscraper to 73% at rates consistent with its underwriting.
The company firmly believes that the Manhattan office market will bounce back in a post-pandemic world, just as it has recovered from prior downturns. That's why the REIT has been buying back as much of its stock as it can, given its belief that shares are significantly undervalued compared to the underlying value of its high-quality office real estate.
Heating back up
Shares of West Coast-focused office REIT Hudson Pacific Properties are down about 25% since the beginning of last year. That's due to some pandemic-related impact on its rental collection rate from storefront retail, parking at its offices, and the effect shelter-in-place orders had on production activities at its Hollywood studios. The market also has some concern with its technology-focused tenant base, since these workers have adapted to working remotely very quickly and might not need as much office space in a post-pandemic world.
However, those concerns seem overblown, given the increasing leasing activity the company is starting to see. Hudson Pacific recently noted it signed more than 300,000 square feet of new and renewal leases in the San Francisco area (its biggest market). It addressed its largest 2021 lease expiration as Alphabet's (NASDAQ: GOOG) (NASDAQ: GOOGL) Google re-upped its more than 200,000 square foot lease in Palo Alto's Stanford Research Park.
Leases are coming in at much higher rates than expiring ones, mainly because current in-place rents are well below market rates. As the company continues to sign new leases and its tenants return to their offices in the coming months, it could lift the weight holding down its stock price.
High-quality office REITs on sale
Investors are worried about the future of office buildings in high-cost coastal cities. Some fear companies won't need as much space in these cities because they'll allow their employees to work remotely. However, that doesn't appear to be the case, given the leasing trends SL Green Realty and Hudson Pacific Properties are seeing. Because of that, these office REITs look undervalued and could bounce back in the coming months as their tenants return to the office.