Against the backdrop of a measured return to the workplace, office REITs are pursuing strategies to address current challenges and build more resilient portfolios. Even the best-in-class landlords are facing some turmoil these days, with remote working and higher capital costs creating a formidable undertaking.
Office occupancy stood at 49.7% for the week ending September 27, according to weekly data from Castle Systems’ 10-city Back to Work Barometer. Leasing activity across the United States is well below 2018 levels, creating a difficult environment for companies. To be able to increase net effective rent and increase occupancy.
“Although a lot of REIT landlords have high quality portfolios and may be more insulated than the market average, they are still seeing a lot of the pressures you hear about in the headlines,” said Dylan, head of Burzynski says. Office area team on Green Street.
According to JLL, market data shows consistently negative absorption over the past three years, which has pushed office vacancies nationally to an all-time high of 20.6% at mid-year. On a positive note, major employers appear to be accelerating announcements of new return-to-work orders. BlackRock, Goldman Sachs, Amazon and Salesforce are among the companies requiring employees to return to the office at least three days a week.
JLL estimates office occupancy is now between 40% to 60% compared to pre-COVID 19 levels, with expectations that occupancy levels could exceed 80% on the most popular midweek days by the end of the year. Meanwhile, data from Nereit’s T-Tracker report shows office REIT occupancy at 88.35% for the second quarter.
“The idea that the office market is forever fragmented or going away is clearly not true,” says Matt Diliberto, CFO. SL Green Realty Corp. , (NYSE: SLG). He says that before Covid the market was changing with a population of poorly performing buildings, and it is the older, non-institutional buildings that are creating a lot of the negative sentiment around office space. “The office is not going away. “It will grow and have great buildings and great locations with great operators,” he says.
Opinion on the future of the office is mixed. “We do not see a significant improvement in leasing activity next year either. “This could be a two to three-year long process where we are in a weak leasing environment, which will impact even some high-quality office owners,” Burzynski says.
Some experts are predicting an even longer road to recovery that could last five to seven years or longer, with the market likely to decline as some low-quality buildings are demolished or replaced with alternatives. Will be converted into use. Given that backdrop, Office REITs are making a number of moves and dispositions to maintain and increase occupancy, strategically deploy capital, and guide portfolios through current market challenges.
flight to quality
Market data shows that leasing activity has tilted more towards quality properties. According to Cushman & Wakefield, Class A buildings accounted for 60.7% of all office leasing over the last six quarters to Q2 2023, compared to 58.1% in the three years leading up to the pandemic (2017-2019).
Additionally, while overall absorption has been negative since 2020, there has been positive absorption of 83 million square feet in the latest and best office buildings. Cushman & Wakefield data also shows that vacancy rates in top-tier office buildings are 300 basis points lower than the rest of the office market.
As the largest REIT in the premier workplace sector, bxp (NYSE: BXP) has been tracking the disparity in vacancy and rental rates in the prime workplace market versus the overall office market for the past several years.
“The trend is clear. Premier workplaces – high quality, well-located, highly amenity assets – represent approximately 18% of total space and 10% of total buildings in our five cities, based on data provided from CBRE, and the overall Offices outperform the market where we track data,” says Owen Thomas, president and CEO of BXP.
Additionally, there is further fragmentation in demand for space based on job function, says Thomas. For example, customer and product-facing employees typically demand high-quality workplaces that support creativity and personal collaboration. In comparison, support staff that provide services for the core functions of businesses are often located at lower level properties and secondary locations.
“Business leaders understand the importance of individualized work for customer and product-facing workers and are providing key workplace accommodations to enhance the implementation of individualized work policies,” says Thomas.
BXP’s strategy is focused on maintaining its leadership position in the key workplace sector. Thomas says, “We continue to invest in our properties to ensure they meet the needs of our customers as they look to engage their workforce in personalized ways, including restaurants, amenities and experiences ” For example, BXP recently added the Savoy Club at the GM Building in New York and the 360 Observatory Deck, View Boston, at the Prudential Center in Boston.
In a bifurcated market, the office REITs that will come out on top will be those with well-located properties. Burzynski says that in particular, well-located properties in mixed-use environments with lots of nearby amenities and a vibrant atmosphere continue to be in demand that helps draw employees back to the office. He further said that the challenge for office landlords will be to invest in the right design and amenities to create collaborative environments that attract tenants.
Certification of Future Assets
Many office REITs have done a good job of keeping their buildings updated and modern. However, there is now a larger portion of office stock post-COVID that may require greater dollar investment to renovate and modernize to meet the changing needs of tenants, Burzynski says. This means that capital requirements for future improvements may increase as owners need to invest more in their buildings to remain relevant, he added.
SL Green’s strategy throughout its history has been to develop a high quality portfolio of properties with a continued focus on upgrading. “Those assets will always outperform, and in this new market environment, which has just accelerated,” Diliberto says. While the average office occupancy rate in New York City is around 80%, SL Green’s occupancy rate is 90% and the company aims to reach 92% by the end of the year. Overall, the office market will likely shrink with obsolete and non-performing buildings that will be torn down or reused for other uses in the future. “We are focused on making the best of what is left,” he adds.
One way SL Green can make its portfolio better in the future is through convenience. The REIT created a facilitation group within the firm two years ago, which includes appointing two executives from the hospitality sector to run the programme. That amenity group began with One Vanderbilt as a prototype for how the company wanted to operate an amenity program within one building.
SL Green is now expanding that amenity offering across its entire portfolio depending on building and location. Some buildings also have free or pay-to-use conference facilities, as well as amenities such as food and beverage, fitness and golf simulators. Diliberto says a strong amenity offering can differentiate one building from another, even at the same price.
SL Green is also exploring opportunities to leverage its facilities to create new profit centers. For example, the company generates an incremental revenue stream by coordinating after-hours programs for tenants in some of its buildings. “It’s a new profit center for us and also something that is very attractive to the tenant base as they try to get people back into the office,” says Diliberto.
strengthen the defense
Meanwhile, the offices are working to improve REIT balance sheets and access to capital. “There is a focus that has shifted toward liquidity and debt repayment,” Burzynski says. Many office REITs have cut dividends over the past 18 months, in some cases by as much as 50%. Vornado Realty Trust (NYSE: VNO) and Hudson Pacific Properties (NYSE:HPP) have said they will suspend their common stock dividend until the end of 2023. Additionally, some office REITs are looking to sell office properties in the private market, on a small scale, to generate funds to pay off their debt. ,
SL Green made a strategic decision a few years ago to take on a larger asset manager role and reduce its ownership position in assets. For example, the REIT announced in June that it had sold a 49.9% stake in 245 Park Avenue to a U.S. affiliate of Mori Trust Co. Ltd. at a gross asset valuation of $2.0 billion. Being an asset manager allows the company to invest less equity but receive a greater return on that equity through fee streams for managing assets on behalf of its joint venture partners. According to Diliberto, this strategy coincides with other efforts to diversify the business, such as expanding its supporting income streams. An example of this is generating revenue from its Summit Observatory experience at the top of One Vanderbilt.
Another common theme among many office REITs is greater diversification. For example, Kilroy Realty Corp., (NYSE:KRC) and BXP have invested in the residential sector. “By far the largest other asset type that these REITs are investing in is the life sciences sector,” Burzynski says. Kilroy, BXP and Brandywine Realty Trust (NYSE: BDN) are all looking to shift their portfolios a bit away from the traditional office to growth in the life sciences sector, he added.
“We have invested in the life sciences and residential sectors where we can use our expertise to drive future growth,” says Thomas. BXP currently has approximately 1.9 million square feet of laboratory and life sciences development work underway, representing an investment of $2.1 billion, which is 65% pre-leased. The REIT is also developing over 500 new residential units and has an additional 3,000 units in its development pipeline.
Many office REITs are dealing with market challenges by simply keeping their heads down and executing their existing strategies. “What really needs to be sorted out is what happens to the rest of the market,” Diliberto says.
Much of the focus in the market is on poorly performing assets with high vacancies. He added, “The other side of the coin is that it is creating an opportunity for us to evict tenants from underperforming buildings with landlords who do not have good capital, or high quality operators , and add them to your portfolio.”
