San Francisco and New York City are two of the highest-cost real estate markets in the country. That's because they're major gateway cities that employ many people, as they've become hubs for major industries like technology (San Francisco) and finance (New York City). As a result, real estate values and rental rates have historically grown steadily, making them great cities for long-term real estate investors.
One company that focuses on these top-tier gateway cities is Paramount Group (NYSE: PGRE). Here's a closer look at this big-city real estate investment trust (REIT).
Paramount Group profile
Paramount Group is an office REIT that concentrates on owning, operating, managing, acquiring, and redeveloping high-quality, Class A office properties. It focuses on the central business districts of New York City and San Francisco. The company owned 13 properties with about 14 million square feet of leasable space as of October 2020. The portfolio consisted of:
- New York City: Seven properties with 8.6 million square feet of space. Six of the seven properties are in the Midtown area, while the seventh is in the Financial District.
- San Francisco: Six properties with 4.3 million square feet of space. All these properties are in the city's Financial District.
The company's office portfolio generated $698.6 million of annualized rent as of the third quarter of 2020. The majority (69%) came from its New York City assets, while San Francisco contributed another 29%, and Washington, D.C., supplied the final 2% (though it sold its last remaining property in the nation's capital at the end of 2020). That's a notable shift from its initial public offering in 2015, when New York City contributed 78%, followed by Washington, D.C., at 14%, and San Francisco at 8%.
The company has a diverse tenant base, including:
- Legal services: 22.5% of annualized rent
- Financial services (commercial and investment banking): 20.5%
- Technology and media: 19.2%
- Financial services (all others): 16.5%
- Insurance: 5.7%
- Retail: 2.1%
- Travel and leisure: 1.9%
- Real estate: 1.9%
- Other professional services: 1.7%.
- Other: 8%
Paramount also boasts high-quality tenants, as a high percentage of its annual rent comes from investment grade-rated or nationally recognized office tenants. Meanwhile, only 3% of its annualized rent comes from retail, theater, and parking garage tenants, three sectors that struggled during the pandemic in 2020.
In addition to that 14-property REIT-owned portfolio, Paramount Group manages five properties for its real estate funds. Three are in New York City, and two are in Washington, D.C. The company generates fee revenue for managing these funds on behalf of investors. Overall, 5% of its revenue came from fees and other income sources in 2019, while rental revenue supplied the other 95%.
Paramount Group news
While the COVID-19 outbreak has had a widespread impact across the country, certain industries and cities seemed to get hit harder. Among those that have gotten particularly whalloped are the office markets in high-cost gateway cities like New York and San Francisco. That's due in part to stricter government restrictions in those areas and the quick adoption of remote work by companies with offices in those cities.
That's had some effect on Paramount Group's results in 2020. During the third quarter, the company collected 97.5% of the rent it billed, 99% from office tenants, and 50.4% from nonoffice tenants like retailers, theaters, and parking. That impacted FFO, which declined from $168.2 million through the third quarter of 2019 to $162 million during the same period of 2020 because it wrote off nonreceivable rent and other uncollectible accounts. Meanwhile, same-store cash NOI declined by 0.5% during that period due to lower occupancy levels and lower initial lease rates due to tenant improvements and leasing commissions.
Paramount Group also continued its strategic transition to a New York- and San Francisco-focused REIT. At the end of 2019, the REIT completed its acquisition of Market Center, a two-building Class A office complex in San Francisco through a joint venture. The company owns 67% of the joint venture, which purchased the property for $722 million.
Meanwhile, the REIT announced its plans to exit the Washington, D.C., market in March 2020 by agreeing to sell 1899 Pennsylvania Avenue for $115 million. The company anticipated that deal would close by the end of 2020, which it did. However, because of the pandemic's impact, it reduced the final sales price by 10% to $103 million. Paramount Group also sold a 10% interest in 1633 Broadway, a 2.5 million-square-foot trophy office building in Manhattan, for $114 million in net proceeds, valuing the building at $2.4 billion. These sales helped increase its financial flexibility.
Paramount Group stock price
Paramount Group's strategic shift out of Washington, D.C., to San Francisco and New York has not paid dividends for investors.