Are Dividend-Paying Office REITs Finally Staging A Comeback?

Key Points

• Small-cap office REIT SL Green Realty announced the sale of a 49.9% interest in a New York property, lifting confidence throughout the industry.
• The pass-through requirement for REITs mandates that at least 90% of generated income must be distributed to shareholders.
• Barclays and BMO Capital Markets increased price targets for SL Green Realty stock after the sale.

If you haven’t exactly been monitoring the performance of office-building investments, that’s understandable. With offices sitting empty as employees prefer to work from home, the biggest real estate investment trusts, Alexandria Real Estate Equities NYSE: ARE, Boston Properties NYSE: BXP, Corporate Office Properties Trust NYSE: OFC, Kilroy Realty NYSE: KRC and Vornado Realty Trust NYSE: VNO were among the most-beaten down equities in the past 15 months. 

But in recent weeks, the industry has been seeing green shoots, not based on hopes and wishes, but on actual developments that are sending office REIT stocks higher. In addition to recent price increases, it’s worth noting that these REITs still pay good dividends. 

The REIT pass-through requirement mandates that at least 90% of the income generated must be distributed to shareholders, allowing REITs to avoid corporate-level tax rates. 

Before looking at what’s driving prices higher today, let’s take a step back to understand how the asset class became so downtrodden.

Office REITs stabilized beginning in November 2020, amid hopes that Covid would quickly recede and cities would once again fill up with office workers. As we now know, neither of those things happened, but office REITs, as a group, managed to trade sideways throughout 2021, without undercutting their 2020 lows. 

Back-To-Office Mandates Didn't Work

The floor fell out from these REITs in 2022, however, as it became clear that back-to-the-office mandates weren’t working. According to a report from S&P Global, “Office REIT financial performance dips amid declining occupancy,” the median office occupancy rate dropped to 87.4% during the first quarter, the lowest it has been since occupancy rates started declining in 2020.

That may not sound like such a bad rate, but it’s a real problem for not only REITs, which own and manage office properties, but also for employers, especially corporations with payments for leases they signed well before the pandemic. 

Many corporate tenants have been downsizing or not renewing leases at all. In June, Yelp Inc. NYSE: YELP said it was closing offices in New York, Washington, D.C., and Chicago, and downsizing its Phoenix office due to low utilization. Alphabet Inc. NASDAQ: GOOGL, Uber Technologies Inc. NYSE: UBER, AT&T Inc. NYSE: T, UnitedHealth Group Inc. NYSE: UNH and Electronic Arts Inc. NASDAQ: EA are among many corporations that are downsizing their real estate footprint in one way or another. 

SL Green's Plants Green Shoots

So where, exactly are these green shoots?

Look no further than an announcement from small-cap office REIT SL Green Realty Corp. NYSE: SLG, which on June 26 announced the sale of a 49.9% interest in an office property at 245 Park Avenue in New York. The buyer was Mori Trust Co., a development and investment company based in Tokyo.

Looking at SL Green Realty analyst ratings, you can see that after the announcement of the sale, Barclays boosted its price target on the stock. 

In addition, BMO Capital Markets analyst John Kim, who boosted his price target on the stock in April, reiterated his "outperform" rating and maintained his target of $32, an upside of 32.89%. 

Renewed Confidence In NYC Office Market

In his latest note, Kim said the sale of the stake in 245 Park Avenue adds confidence in the New York City transaction market, as well as in SL Green’s track record of executing deals. 

A glimpse at the SL Green Realty chart shows an uptrend that began when news of the transaction broke. Other REITs also notched big gains on June 26 and rallied in subsequent sessions.

The deal has illustrated that the market for office real estate may be more robust and liquid than investors previously believed, and maybe, just maybe, over time, workers will gradually start returning to offices, even in hybrid arrangements. Some analysts believe this trend could take three to five years to fully play out, but office REITs may still have potential. 

One week does not make a trend, but office REITs seem to be an asset class worth watching again, after their long decline. While the broad sentiment, at least among the general public, remains bearish, the dividend yield and the potential of gains could make these attractive once again.