30 BARRON’S August 3, 2020
INCOME INVESTING
Just how much staying power working from home
will have is uncertain, but Green Street Advisors
says officedemand may fall by 10-15%.
Do Your Homework
On Office REITs
In the Age of Covid-19
I
f there is one takeaway from
the mass work-from-home
experiment the American
workforce has been conduct-
ing in recent months, it’s that
office buildings will never be
the same. And that has big
implications for investments in the
real-estate investment trusts that spe-
cialize in them.
The owners of office buildings,
many of which have seen their use
plummet as companies across the
country instituted remote-work poli-
cies to combat the coronavirus, are
finding that many employees want to
work from home, even in a post-Covid
world. A recent survey by Morgan
Stanley found that among employees
who would like to work from home
more often in the future, 75% would
like to do so at least three days a week.
While REITs can be attractive to
income investors because of their divi-
dends —they are required to pay out
at least 90% of their taxable income to
shareholders—the office REIT seg-
ment requires caution. This work-
from-home trend marks another
headwind for what “was already an
unloved sector,” says Danny Ismail, a
senior analyst at Green Street Advi-
sors, a research firm specializing in
real estate.
This year, as of July 29, shares of of-
fice REITs, which own and operate var-
ious office properties, had returned
minus 23%, versus minus 9% for the
FTSE Nareit All Equity REITs Index. In
contrast, industrial REITs are up 15%,
on average, because their properties
include warehouses and distribution
centers, which e-commerce benefits.
Office REITs have trailed the
broader industry index over one-,
three-, and five-year periods, as well,
according to Nareit, a trade group.
And even though many office REITs
have seen their share prices do better
recently, they have still lagged behind
the broader industry during the past
30 and 90 days “as concerns on funda-
mentals in the current recession and
longer-term WFH-driven headwinds
have grown,” according to a July 27
research note by Vikram Malhotra of
Morgan Stanley, using the common
initials for working from home.
Ismail says the lagging stock per-
formance reflects a disconnect be-
tween how the public—in this case
publicly traded shares—and private
markets are valuing the properties
held by office real-estate investment
trusts. “Over the last few years, the
office REIT sector has generally been
out of favor with most public inves-
tors,” says Ismail.
Why the lack of love for the office
sector? “It’s a tough business to operate
in,” says Ismail. “The fundamentals are
a derivative of the overall economy. But
in this last cycle, it didn’t perform as
well as one would expect.”
One factor is “densification”—em-
ployers squeezing more workers into
the same amount of space, sometimes
in open floor plans. “Office demand
didn’t correlate during this cycle to
overall job growth,” says Ismail. “Peo-
ple weren’t consuming as much office
space as they used to.”
Another obstacle for office REITs
has been an uptick in capital spending
for many building owners. That in-
cludes renovating lobbies, adding fit-
ness centers, upgrading technology
infrastructure, and reconfiguring
spaces into open floor plans.
“Office capex, already among the
highest out of all property sectors,
might creep even higher as the recon-
figuration of workplaces puts pres-
sure on landlord economics,” accord-
ing to Green Street Advisors.
For now, it’s hard to precisely gauge
how quickly offices are returning to
normal, as different parts of the coun-
try try to reopen their economies.
Brandywine Realty Trust..................
BDN) CEO Gerard Sweeney recently
estimated that occupancy in the com-
pany’s buildings in Philadelphia’s
central business district was around
5% to 10%. For Austin, Texas, it was
about 10%, and about 20% in Wash-
ington, D.C.
Just how much staying power
working from home will have when
the pandemic is over is uncertain. “It
is important to keep in mind signifi-
cant issues that will limit WFH
growth for many organizations, such
as culture, employee morale, and col-
laboration,” according to a Green
Street Advisors note. Working re-
motely, which “has been on a slow but
steady march since the ’80s,” involved
3% of workers on a permanent basis
in 2018, Green Street observes.
Still, the firm notes that “reduced
in-office work means office demand
may decline by 10%-15%.”
In a July 9 note, however, Goldman
Sachs said it expected working from
home “to have a marginal impact on
office demand as we expect most em-
ployees will return to the office as
business activity rebounds.”
Despite the uncertainty the sector
faces, there are some office REITs
with attractive traits. “In general,
we’re bigger fans of the non-gateway
markets, relative to the coastal mar-
kets,” such as New York and San
Francisco, Green Street Advisors’ Is-
mail says. Gateway markets serve as
entry points to the country.
New York City, the epicenter of the
pandemic this spring, faces many dif-
ficulties getting its offices up and run-
ning again–one being the sheer mass
of people that work in these buildings.
Malhotra of Morgan Stanley observed
in a note this past week that New York
City has seen more than 160,000 “of-
fice jobs lost so far amid Covid.”
He points out that “office REITs
have not outperformed historically
until fundamentals turn”—notably
vacancies and market rent growth.
That hasn’t happened yet.
Case in point: Shares ofVornado
Realty Trust(VNO), whose New
York assets include the Hotel Pennsyl-
vania and other properties near Penn
Station, are down about 45% this year.
On Thursday, the company said it
would cut its quarterly common divi-
dend to 53 cents a share from 66 cents,
a move that reflects the pressure some
of its properties have faced during the
pandemic. Shares ofCousins Prop-
erties(CUZ) andHighwoods Prop-
erties(HIW) have fared relatively
better, down 25% and 20% in 2020,
respectively.
Based in Atlanta, Cousins has prop-
erties in Sun Belt markets, such as
Charlotte, N.C., Austin, and Dallas. The
stock recently yielded 4%. Certain Sun
Belt states, such as Texas and Florida,
have seen spikes in Covid cases, so the
path to resuming full operations has
potential roadblocks in the near term.
Shares of Highwoods, based in Ra-
leigh, N.C., recently yielded 5.1%. The
cities in which the company operates
include Atlanta, Charlotte, Nashville,
Tenn., Orlando, Fla., Pittsburgh, Ra-
leigh, Richmond, Va., and Tampa, Fla.
So while Highwoods has exposure to
some markets where Covid has
spiked, it isn’t a bet on just one city.
Investing in office REITs was diffi-
cult before the pandemic. Now, given
the uncertainty, investors need to pay
even more attention to selection.B
Rent Woes
Office rent declines have been especially steep in gateway markets
such as New York and San Francisco during the previous three
recessions.
Average Office Rent Declines
Recession Time Frame U.S. New York San Francisco
1990 -9% -14% -14%
2001 -21 -22 -48
2008-09 -18 -21 -29
Sources: CBRE Econometric Advisors; Morgan Stanley