Shares of SL Green Realty (NYSE: SLG) have shed more than a third of their value over the past year. The main factor weighing on shares of the office REIT, or real estate investment trust, is the impact the COVID-19 outbreak has had on the New York City office market, where it's the leading landlord. The city has been among the hardest hit by the pandemic.
However, with vaccines starting to roll out, there's optimism that we could return to some sense of normalcy by the middle of this year. Given that backdrop, here's a look at the case for and against buying shares of SL Green Realty these days.
The case for buying SL Green Realty
While SL Green's stock slumped last year, its financial results held up relatively well. Through the third quarter, the REIT had generated $443.6 million, or $5.54 per share, of FFO. For comparison's sake, FFO was $458.1 million, or $5.25 per share, through the first nine months of 2019. While FFO declined by 3.2% on an absolute basis due to asset sales and some pandemic-related issues, it was up 5.5% per share thanks to its stock repurchase program.
Overall, the company collected more than 90% of the rent it billed, with offices averaging more than 95% and retail closer to 70%. Compared to other property types, those relatively high rental collection rates suggest that tenants plan to return to their locations after the pandemic ends.
Further supporting that thesis was the REIT's leasing activity. The company signed more than 1.2 million square feet of new and renewal Manhattan leases last year, achieving its revised target with lease rates only slightly below its initial budget.
Meanwhile, the company successfully sold assets to shore up its balance sheet, giving it the cash to return to shareholders via share repurchases and dividends. Demand for high-quality office buildings remains strong, evidenced by the sale of 410 Tenth Avenue in November for $952.5 million. The company agreed to sell that building at a 4.6% cap rate, -- in line with pre-COVID levels -- generating a $175 million profit on its investment or a 35% internal rate of return (IRR). That sale demonstrated that institutional investors still highly value high-quality real estate because they believe that offices won't see diminished use or value deterioration in a post-pandemic world.
The case against buying SL Green Realty
The biggest risk with buying SL Green is that office tenants won't return to New York City at the same level as before the pandemic. Two factors could impact future occupancy levels in the city. First, companies could allow more of their employees to permanently work from home or implement a hybrid office model where they only come in for meetings or a couple of times a week. If there's widespread adoption of these flexible office solutions, companies likely won't need as much New York City office space in the future.
Another headwind specifically facing the New York City office market is that financial companies are opening offices and relocating to other markets, notably Miami. Driving this exodus is lower taxes, fewer government restrictions, less crime, more space, and better weather. If this trend accelerates in the coming years, it could cause vacancy rates in New York City to rise, affecting rental rates.
We've heard this story before
New York City has faced challenges before. However, it's bounced back each time. There's reason to be optimistic that will happen again since vaccines are starting to roll out. Further, while financial companies might be moving out of the city, tech companies moved in as 25% of all new leases in Manhattan last year. Add that to SL Green's desirable characteristics of a top-notch portfolio and balance sheet, and it looks like a great office REIT to buy on the bet the sector will recover this year.