Remote work has pummeled revenue for office landlords to historic lows over the past year and demand for office space has shown no signs of full recovery – leading to credit downgrades and widespread concerns about economic fallout.
But not all investors are buying into the doom and gloom. Over the past six months, commercial real estate properties with assets primarily in Manhattan have vastly outperformed competitors in the rest of the country, despite decades-high interest rates and recent credit downgrades.
Manhattan’s largest commercial real estate investment trust (REIT), SL Green (SLG), appreciated by 81% since the end of March, closing at $36 per share on Monday. Vornado Realty Trust, the second largest REIT entailing 25.4 million square feet of office space across New York City, kept pace, surging by 59% over the same period, closing at $22 per share on Monday.
At the same time, comparable commercial REITs in other parts of the country have only continued to suffer, especially as analysts widely predict the Fed will keep interest rates high well into next year. Both Cousins Properties (CUZ) and Boston Properties (BXP) have experienced only a fraction of Vornado and SL Green’s growth, and have portfolios primarily composed of properties outside of New York City. Alexandria Real Estate Equities (ARE) saw share prices decline altogether.
SL Green and Vornado outpace competitors from other parts of the country
Bullish investors for SL Green and Vornado argue that Manhattan is still an attractive commercial location – albeit less concentrated than before the pandemic. On top of that, analysts say, Manhattan’s dense and small landscape puts an inherent cap on supply, which means that the national CRE downturn vastly overcorrected Manhattan’s true market value.
“These companies own real estate in some of the most supply constrained markets like Manhattan – those properties will make money over the course of the next 50 years,” said Suryansh Sharma, an analyst at Morningstar.
Sharma added that things were likely to get worse before improving and that the recent rally was likely to taper off soon. But ultimately, he said, holding Manhattan-based securities will inevitably pay off in the long term.
The pessimists still outweigh the believers, despite the recent market rally. Only three analysts have a buy rating for SL Green stock compared to five with sell recommendations. Likewise, no analysts have buy recommendations for Vornado while seven have sell ratings.
There is a reason many analysts are still bearish.
SL Green and Vornado share prices are still far below pre-pandemic levels, when people were still going into the office five days a week.
Manhattan’s office space stock rebound is inconsistent with dire financial conditions and the endless stream headlines predicting an imminent financial crisis. Brokers with large holdings in New York City have had numerous high profile defaults, including Brookfield, Blackstone and Pimco throughout the year as the direct result of dampened office space demand. Many of SL Green and Vornado’s long term lease agreements are set to expire in the next few years, and there is no guarantee that there will be eager new tenants or lease renewals.
As of mid-September, just over half of all office space in the city was occupied – a months-long high and still below national averages – according to office security and data firm Kastle.
In August, Moody’s and Fitch both downgraded both Vornado and SL Green’s credit rating to BB+, citing a weakening demand for office space and remote work.
These declines came shortly after Vornado’s abrupt defeat in the years-long battle to redevelop Penn Station. New York governor Kathy Hochul publicly “decoupled” the office development project from the renovation of subterranean train lines, pointing to depressed demand for office space explicitly.
The five-year trends have outweighed recent performance in the minds of some former investors. Sudir Pattath has invested in commercial real estate for over four years, but has held fast in his investments in stocks that are tied to storage facilities and industrial production rather than office space. In fact, barring a drastic change in economic conditions, Pattath is only investing in Realty Income Corporation (O), despite the fact that the company has vastly underperformed other commercial REITs year to date.
“I was looking to add to the diversification of my portfolio by including dividend income streams,” said Pattath, adding that he did not want a volatile stock and was not confident in the return of office space.
SL Green and Vornado have grown up to ten times faster than the stock market
Still, Alexander Goldfarb, Piper Sandler’s managing director, is convinced investors like Pattath are overlooking the unwavering attractiveness of Manhattan.
“Leverage and death of office narrative getting old,” Goldfarb said in a note.
He added separately, “We believe SLG’s leasing leverage will grow quicker than peers with Grand Central Terminal’s re-establishment as the dominant submarket given commuter-convenience.”