Earnings Season Begins – Oct. 14, 2024
This week will mark the beginning of third-quarter earnings season for office REITs. SL Green Realty Corp. is scheduled to release its Q3 results on Oct. 16, with Empire State Realty Trust and Alexandria Real Estate Equities reporting the following Monday and other publicly traded companies taking their turns in the weeks to come.
This much-challenged commercial real estate sector has had some encouraging macroeconomic news recently. Occupiers appear to be getting more serious about bringing office-using employees onsite again, and the onset of the Federal Reserve’s reductions to the benchmark effective federal funds rate bodes well for all REITs, regardless of property type.
Even so, rating agencies continue to warn that office REITs, and office owners in general, will continue to encounter choppy waters. Although employers have begun to reverse their hybrid working arrangements, “so far this has not translated into meaningful improvement in occupancy rates for REITs,” Fitch Ratings reported.
“More days in office does not necessarily require more floor space,” according to Fitch. “Tenants most often look to consolidate and reduce space when leases expire, and many leases signed before the pandemic are still coming up for renewal.”
Prior to the Fed announcing its 50-point cut to the EFFR, S&P Global noted that the majority of U.S. office REITs ended Q2 posting “relatively weaker operating metrics, with the demand for offices declining further as reflected in the sector’s most recent dip in occupancy rates.”
Nine office REITs reported quarter-over-quarter declines in their operating funds from operations (FFO) per share during Q2. Operating FFO per share improved sequentially for seven REITs while remaining flat for three REITs during the quarter, according to an S&P Global Market Intelligence analysis.
The office REIT median occupancy rate plunged to 83.5%, “a 2.1-percentage-point drop from the previous quarter and the lowest it has been since occupancy rates started declining in 2020,” according to S&P Global. The median occupancy rate was down 3.4 percentage points year-over-year and dropped 9.5 percentage points compared with Q4 2019, just before the COVID-19 pandemic began.
For at least some of the publicly traded office REITs, Q3 results may mark the beginning of a turnaround. Certainly, we’ll have a clearer picture by the end of this month, by which time numerous office REITs will have issued their reports.
However, it may be too soon to expect a broader improvement in the sector’s performance. Attendees at the CREFC conference in New York—held the same day as the Fed’s announcement—heard that the recovery in CRE will be uneven. Multifamily and industrial are likely to fare better than office, which is expected to remain challenged.
Fitch said it expects operating performance for office landlords to continue diverging, “as office demand has structurally changed after the pandemic. Those offering modern workspaces located near commuter destinations and central business hubs will be best equipped to achieve the highest levels of demand and the highest rents.”
The rating agency has downgraded some office REITs to below investment grade. “For these issuers to regain investment grade status, we would need to see a meaningful improvement in financial metrics, including REIT leverage and unencumbered assets to net unencumbered debt (UA/UD),” reported Fitch. “This would likely be accompanied by a sustained recovery in occupancy rates.”