Company Reports

No-moat-rated SL Green Realty reported a mixed set of numbers for the first quarter. The headline numbers were lifted by nonrecurring gains related to discounted debt extinguishment, but there were some signs of stabilization for the Manhattan office market (although the firm is certainly not out of the woods yet). The company reported funds from operations, or FFO, of $3.07 per share, almost double the $1.53 per share in FFO generated during the first quarter of 2023. The headline FFO number included a gain of $141.7 million, or $2.02 per share, tied to discounted debt extinguishment at 2 Herald Square and another gain of $5.1 million, or $0.07 per share, from positive noncash fair value adjustments for mark-to-market derivatives.

We believe that there are several attractive opportunities across the US REIT sector for investors to consider. Following the recovery of many REIT sector fundamentals from the pandemic by mid-2021, we viewed the REIT sector as fairly valued through early 2022. However, the past two years have seen the rapid rise in interest rates and a slowing economy, which has led to major valuation declines across the sector. Our analysis of the REIT sector over the past 25 years suggests that the relative stock performance of REITs is negatively correlated with interest rate movements. The second and third quarters of 2023 saw large interest rate increases with the 10-year Treasury approaching 5%, which led to the sector underperforming. This occurred even as many REITs reported same-store net operating income, or NOI, growth at historical highs in 2022 due to high inflation. Higher interest rates, lower liquidity, tighter capital market conditions, and decelerating same-store NOI growth all led to a significant correction in the stock price for many REITs.

SL Green Realty is a real estate investment trust engaged in the acquisition, development, repositioning, ownership, and management of commercial real estate properties, principally office properties. Most of its properties are in Manhattan. The company holds interests in approximately 32.5 million square feet, which includes ownership interests in 28.8 million square feet in Manhattan buildings and 2.8 million square feet securing debt and preferred equity investments. The strategy of the company is to maintain a high-quality portfolio of buildings in desirable locations and focus on creating value through new developments, capital recycling, and joint-venture investments. As an example, the company's $3 billion megaproject One Vanderbilt was completed amid the pandemic and has already achieved high occupancy rates.

No-moat-rated SL Green Realty reported a decent set of numbers in the fourth quarter, especially given the challenging Manhattan office market conditions. The company’s reported funds from operations, or FFO, was $0.72 per share, around 51% lower than the $1.46 per share in FFO during the fourth quarter of 2022 partly due to some nonrecurring charges. The results in the current quarter were impacted by $10.3 million, or $0.15 per share, of noncash fair value adjustments on mark-to-market derivatives and $18.7 million, or $0.27 per share, of nonrecurring general and administrative charges related to the nonrenewal of the company's former president. Excluding the impact of these charges, the company reported an FFO of $1.14 per share, which was largely in line with our expectations.

No-moat-rated SL Green Realty continues to navigate the extremely challenging Manhattan office market. The company reported middling performance in the third quarter, as funds from operations came in at $1.27 per share, 23.5% lower than the $1.66 in the third quarter of 2022. The considerable decline in FFO can largely be attributed to higher interest payments on the company’s debt. SL Green has lowered its 2023 FFO guidance to $5.05-$5.35 per share from $5.30-$5.60, due to $0.10 per share of severance expense and $0.17 per share of accelerated stock-based compensation expense related to the nonrenewal of President Andrew Mathias' employment agreement. The severance-related expenses are nonrecurring in nature and are expected to result in general and administrative savings of $10 million-$11 million on a run-rate basis. We are maintaining our $45 fair value estimate after incorporating third-quarter results.

The share prices of U.S. real estate investment trusts have fallen by approximately 30% from their 2021 highs because of higher interest rates and stress in some commercial real estate sectors. We think that the correction is overdone and the current valuations offer an attractive entry point for patient investors. Our core REIT coverage is trading at a discount of approximately 25% to our fair value estimate. We estimate that the average REIT within our U.S. coverage is currently trading at a dividend yield that is 126 basis points higher than the historical average. We see marked differences in valuation across different REIT sectors in the United States. For instance, the industrial sector is fairly valued, with stock valuations already accounting for future growth, but other sectors like offices, hotels, and malls are trading at attractive discounts.

No-moat-rated SL Green Realty reported funds from operations of $1.43 per share for the second quarter, 7.3% lower than the $1.87 per share in FFO in the year-ago period. The decline in FFO can largely be attributed to higher interest payments on the company’s debt and the challenging environment for office real estate in Manhattan. After incorporating second-quarter results, we are maintaining our $45 fair value estimate.

SL Green is a real estate investment trust engaged in the acquisition, development, repositioning, ownership, and management of commercial real estate properties, principally office properties. Most of its properties are in Manhattan. The company holds interests in approximately 35 million square feet, which includes ownership interests in 26.7 million square feet in Manhattan buildings and 7.2 million square feet securing debt and preferred equity investments. The strategy of the company is to maintain a high-quality portfolio of buildings in desirable locations and focus on creating value through new developments, capital recycling, and joint-venture investments. As an example, the company's $3 billion megaproject One Vanderbilt was completed amid the pandemic and has already achieved high occupancy rates.

The shares of no-moat-rated SL Green Realty were up approximately 19% as it announced it sold a 49.9% interest in 245 Park Avenue to Mori Trust at a gross asset valuation of $2.0 billion. Built in 1967, 245 Park Avenue is one of the headquarters-caliber buildings on the coveted Park Avenue corridor between 46th and 47th Streets, with direct access to Grand Central Terminal. SL Green Realty bought this asset through the bankruptcy process in September 2022 and immediately embarked on repositioning the asset through redevelopments of lobbies, retail storefronts, and other infrastructure upgrades. The Manhattan office real estate market had significantly deteriorated in the past few quarters due to tepid return-to-office recovery, recession concerns, tech sector layoffs, higher interest rates, and lower availability of capital. This deal is a vote of confidence for the valuation of high-quality office assets in Manhattan. The market has been trying to price Manhattan office REIT in an environment where high-value transactions of trophy assets have almost dried up. This deal helps create a valuation benchmark for high-quality office buildings in Manhattan. SL Green reported that the building was 84% occupied and had an annualized contractual cash rent of around $133 million as of first-quarter 2023. Since the company does not provide property level net operating income breakdown, we therefore do not have a precise cap rate for the deal, but it would be safe to say that the cap rate was less than 5%. This is a relief for the Manhattan office REITs, which have sold off considerably in the last few quarters.

We are increasing our Uncertainty Rating for no-moat-rated SL Green Realty to Very High from High to reflect the significant uncertainty in the office market outlook and the highly leveraged capital structure of the company. SL Green owns high-quality commercial real estate properties, principally office properties in the Manhattan area. The economic uncertainty emanating from the remote work dynamic has created a challenging environment for office owners. Employees are still hesitant in returning to the office as office utilization remains around 50% of the prepandemic level. The vacancy rate for office spaces in Manhattan was recorded at 22.2% in the first quarter of 2022, which is roughly 1,000 basis points higher than prepandemic levels. On the supply side, approximately 10 million square feet of office space, which amounts to around 2.3% of the total inventory, is currently under construction in Manhattan and will be added to the market in upcoming years. We expect this additional supply to further pressure fundamentals in the market. The Manhattan net absorption rate remained negative as of the first quarter of 2023, and rental growth figures are disappointing, especially given the inflationary environment.

We are reducing our fair value estimate for no-moat SL Green to $45 per share from $55 per share after moderating our long-term rent growth, occupancy, and Manhattan office sector recovery expectations. Our estimate of SL Green’s weighted average cost of capital is 6.8%, and we apply an enterprise value/EBITDA multiple of 16.6.

SL Green is a real estate investment trust engaged in the acquisition, development, repositioning, ownership, and management of commercial real estate properties, principally office properties. Most of the companies' properties are in the Manhattan area. The company held interests in approximately 35 million square feet, which includes ownership interests in 26.7 million square feet in Manhattan buildings and 7.2 million square feet securing debt and preferred equity investments. The strategy of the company is to maintain a high-quality portfolio of buildings in desirable locations and focus on creating value through new developments, capital recycling, and joint-venture investments. As an instance, SL Green's $3 billion megaproject One Vanderbilt was completed amid the pandemic and has already achieved high occupancy rates.

No-moat-rated SL Green Realty reported middling first-quarter results as the Manhattan office market remains under stress. The firm reported funds from operations, or FFO, of $1.53 per share, 7.3% lower than the $1.65 per share in FFO during the first quarter of 2022. The decline in FFO can largely be attributed to higher interest payments on the company’s debt as interest rates have been rising. We are maintaining our $55 per share fair value estimate after incorporating the first-quarter results.

No-moat-rated SL Green Realty reported lackluster fourth-quarter results and reduced its annualized dividend by 13% to $3.25 per share from $3.73 per share. The firm reported funds from operations, or FFO, of $1.46 per share, 4.0% lower than the $1.52 in FFO during the fourth quarter of 2021. The company will continue to feel a disproportionate impact of higher interest rates due to its significantly leveraged capital structure. Management’s 2023 guidance implies a 1.5%-2.5% decline in same-store GAAP net operating income, or NOI, due to lower occupancy in its Manhattan office portfolio and downward rent pressure. The company expects approximately $70 million in higher interest expenses in 2023 compared with 2022. The midpoint of management’s full-year 2023 FFO guidance came at $371 million, 19% lower than the $459 million reported for the full year of 2022. A significant portion of the 2023 decline in FFO will be driven by higher interest payments. We have reduced our fair value estimate for SL Green Realty to $55 per share from $59 after moderating our long-term rent growth, occupancy, and interest expense expectations for the company.

SL Green is a real estate investment trust engaged in the acquisition, development, repositioning, ownership, and management of commercial real estate properties, principally office properties. Most of the companies’ properties are in the Manhattan area. The company held interests in approximately 35 million SF, which includes ownership interests in 26.7 million SF in Manhattan buildings and 7.2 million SF securing debt and preferred equity investments. The strategy of the company is to maintain a high-quality portfolio of buildings in desirable locations and focus on creating value through new developments, capital recycling, and joint venture investments. As an instance, SL Green’s $3 billion megaproject One Vanderbilt was completed amidst the pandemic and has already achieved high occupancy rates.

No-moat-rated SL Green Realty reported middling third-quarter results as share prices of office REITs have declined significantly in the past few months. The firm reported funds from operations, or FFO, of $1.66 per share, 6.8% lower than the $1.78 in FFO during the third quarter of 2021. The mark-to-market on signed Manhattan office leases for the company were 1.1% higher in the third quarter of 2022 than the previous fully escalated rents on the same spaces. The same-store cash NOI decreased by 0.5% in the third quarter of 2022, excluding lease termination income on a year-over-year basis. Manhattan same-store office occupancy increased 10 basis points on a sequential basis as it was reported at 92.1% for the current quarter. We have reduced our fair value estimate for SL Green Realty to $59 per share from $64 per share after moderating our long-term rent growth, occupancy, and interest expense expectations for the company.

SL Green Realty is a real estate investment trust engaged in the acquisition, development, repositioning, ownership, and management of commercial real estate properties, principally office properties. Most of the companies’ properties are in the Manhattan area. The company held interests in approximately 35 million SF, which includes ownership interests in 26.7 million SF in Manhattan buildings and 7.2 million SF securing debt and preferred equity investments. The strategy of the company is to maintain a high-quality portfolio of buildings in desirable locations and focus on creating value through new developments, capital recycling, and joint venture investments. As an instance, SL Green’s $3 billion megaproject One Vanderbilt was completed amidst the pandemic and has already achieved high occupancy rates.

No-moat-rated Kilroy Realty’s high-quality office portfolio now looks appetizingly cheap amid the steep selloff of office REITs in the last few weeks. We recognize the uncertainty surrounding the future of the office and believe that the environment will remain challenging for office owners in the near to medium term. Having said this, we also believe that the selloff has been overdone and the current implied valuation of Kilroy’s shares is completely divorced from the current private market valuations of its office portfolio. We think that long-term-oriented investors can consider this stock for their portfolios as the company is currently trading at approximately 40% below our fair value estimate of $69 per share. Our U.S. office REIT coverage is approximately 30%-40% undervalued. Kilroy Realty is our preferred pick in this sector given its risk-return profile.

With the United States experiencing historically high inflation growth, many investors are wondering if real estate provides a natural hedge against inflation and if the REIT sector should therefore outperform the broader equity market. Many REITs in our coverage have reported rent and revenue growth at or near historic peaks over the past several quarters, with inflation being one of the largest reasons for the high growth. Given this and some historical evidence that REITs outperformed in the 1970s and early 1980s when inflation was similarly high, some investors are questioning why REITs have not outperformed in 2022.

No-moat-rated SL Green Realty reported lackluster second-quarter results as the workers remain reluctant in returning to offices. The physical attendance in restaurants, movies, and other entertainment-related events has reached prepandemic levels, but the recovery in physical office occupancy levels has remained tepid. We believe that employee behavior is primarily driven by preference and flexibility with regard to returning to the office. This is different from the early stages of the pandemic where the risk of getting the coronavirus was the main reason for lower office utilization. We would like to highlight that this dynamic does not bode well for the owners of office real estate as it points to a more permanent shift in worker and employer behavior. Remote work has now become a norm in corporate America, and we are also seeing increasing signs of employers accepting remote work and becoming comfortable with the new normal.