The real estate sector was one of the worst performing parts of the stock market in 2020, with the FTSE Nareit Equity REITs Index generating a total return of negative 8% for the year. This dramatically underperformed the S&P 500, which delivered a total return of more than 18%.
Office REITs were among the hardest-hit subsectors. Even after getting a big boost from positive COVID-19 vaccine developments in the last couple months of the year, office REITs as a group dropped by more than 18% last year due to fears that COVID-19 will have a big lasting impact on office demand.
With that in mind, here are three things office REIT investors should keep in mind in 2021.
The office industry will get worse before it gets better
There's a fear among analysts that millions of Americans who formerly worked in offices will work remotely permanently after the pandemic. In simple terms, remote work has become much more practical in many cases, as companies have adopted collaboration and productivity technologies like Zoom (NASDAQ: ZM), Trello, Slack (NYSE: WORK), and many more.
In addition, not only is there fear about post-pandemic office demand, but don't forget about all of the businesses that have closed their doors forever as a result of the pandemic and therefore don't need office space any longer. So, while there's debate over how bad it will be, it's fair to assume that the office industry will be negatively impacted by the pandemic.
However, the important thing for REIT investors to know is that we haven't likely seen the worst of it yet. It will take time for companies to assess their office space needs and make adjustments once things get back to normal. After the 2008 recession, office vacancies didn't peak until late 2010. Rent growth and property values didn't bottom until after the recession had ended as well. In short, things are likely to get worse for office REITs before they get better.
The impact will be lighter than expected
As mentioned, remote work is much easier now than before the pandemic for millions of Americans, and there are concerns that office demand will plummet in the post-pandemic economy. But to put it mildly, investors shouldn't bet on that happening, at least not to any massive extent.
For one thing, a survey of knowledge workers (the type of jobs that typically could be done remotely) by workplace collaboration software company Slack discovered that while only 12% of workers want to go back to the office full time, 72% want a hybrid remote-and-office work structure.
Beyond the survey, leasing activity shows that office work isn't going anywhere. Amazon (NASDAQ: AMZN) has been very active when it comes to leasing new office space, and Facebook (NASDAQ: FB) signed a lease for more than 700,000 square feet of new office space in Manhattan during the pandemic.
Office REITs have tons of capital to put to work
One other important fact is that many office REITs have tons of capital to spend. In fact, office REITs as a group have more liquidity than any other REIT subsector besides industrial and data centers.
Consider Empire State Realty Trust (NYSE: ESRT), which owns the iconic Empire State Building and a portfolio of other mostly-NYC office properties. The company has $1.7 billion of available liquidity, a remarkable amount of financial flexibility for a company whose total market cap is $2.6 billion. Empire State's CEO has specifically said that he sees an 18-to-36-month window of opportunity, and having recently hired a Chief Investment Officer for the first time in its history, it looks like the company plans to take advantage.
Other office REITs are in similar positions. So, while 2021 will largely be a wait-and-see year when it comes to the impact of the pandemic on office REITs, it could also be a very active year for growth.
The Millionacres bottom line
Office real estate will certainly take a hit from the pandemic. It's abundantly clear that COVID-19 accelerated the adoption of remote work technologies, and more people than ever before are able to work from home. But the actual impact to office REITs is likely to be significantly less than feared, and most have rock-solid balance sheets and tons of liquidity to not only make it through but also to pursue opportunities while the market is weak.
Here's the bottom line. Patient investors who buy some of the major office REITs now could be handsomely rewarded but should expect some turbulence in the near term as the true effects of the COVID-19 pandemic continue to play out.