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7 thoughts on “Why Are Office REITs Trading at Significant Discounts to NAV?”

  1. HI folks – SL Green just did a lot to answer this question.

    Today’s sale of 50% of 245 Park imputes a $2B valuation for the property (evidently a 3+% cap rate from what I have read). This is appears to be the same valuation paid by SL Green when they purchased the property out of BK in September from what I understand.

    Interestingly, and unrelated, BXP priced some 10 year notes in May which appear to be trading well.

    Manhattan Class A Office got a major shot in the arm.

    I don’t own any but I have been eyeing the SLG I preferred and might start nibbling on it.

  2. Charles:

    “My question is, When are the politicians who are talking about holding bank CEO’s responsible for a bank collapse going to hold these large Reits responsible for these loans they are walking away from with the same banks?”

    That is how a mortgage works since the dawn of time. Anyone can walk away and hand the keys back to the lender. You can’t blame a REIT or any office investor for walking away from an office building where the NOI no longer comes close to covering the debt costs. That’s called capitalism and is 100% on the banks for providing the mortgages.

    The stock prices of the office REITs have obviously been obliterated. I remember the Douglas Emmett (DEI) IPO back in 2006 at $20/share (went up 20% first day of trading). 17 years later and the stock trades below $12.

    Bloomberg came out with an article yesterday where Capital Economics said we won’t see a recovery in office values until……….2040.


  3. I agree with the article, Tim, and you already understand what I’m about to say. Back in the day, an office building, like any stabilized income-producing real estate, was valued either using a capitalization rate on net income (say net income is $100,000 and the cap rate is 4%, then value would be $2.5 million), OR replacement cost OR by applying the metrics of comparable sales to the property—or a combination of these three methods. This conventional approach, in my view, for SOME office buildings, no longer applies. “Stellar” properties in major city central areas, MAY be valued this way IF they are or are anticipated to be viable as office buildings for the long-term (there are value judgments to be made in this regard). The best properties formerly were underwritten at 95% occupancy. What is the “right” occupancy today for determining value?

    Today, particularly for suburban and class B central area office buildings, potential alternative uses must be considered. The so-called “highest and best use” of an office building may no longer be as an office building. In the current environment, with uncertainty regarding how many at-home workers will go back to their offices and having little notion as to what the best use might be for significantly vacant properties, it’s not possible to conclusively determine value. The same case can be made for non-grocery-anchored shopping centers. The banks know all of this, as does the Fed. If office building mortgages were accurately valued, we MIGHT have another banking crisis (banks are largely under-reserved) and, undoubtedly, banks that are heavy income-producing property lenders could go under. Real values, in many cases, are well below outstanding loan balances. IMO steer clear of the preferreds of office and some retail REITs, unless you’re a fan of roulette. Devil’s advocate: the same situation occurred with hotels a few years back and they largely recovered (even with business travel down). But, that “crisis” was solely occupancy-driven by COVID. The issues with office buildings are more complicated with more variables.

    1. On the topic of the banks and commercial real estate, I read the following from a white paper that was interesting.

      “At the end of April 2023, banks held $1.7 trillion of non-farm non-residential loans on assets on the balance sheet, which represented 7.4% of their $23 trillion in total assets. Of this amount, banks held roughly $700 billion in office and downtown retail loans, as reported in the Federal Reserve’s Financial Stability Report.

      Let’s assume these loans had a 60% loan-to-value ratio at origination and assume a worse-case scenario that those buildings have lost 50% of their value. By way of comparison, office buildings values decline -34% during GFC. Even still, if office buildings declined -50%, it implies banks could be exposed to loan losses of $115 billion or less. That amount represents 0.50% of assets and would lower the Tier 1 ratio by a fraction amount from their current level of 14.5%. “

    2. And also valuing shopping malls can be difficult. Just some anecdotal observations. A local small mall struggles with constant tenants moving out and new ones moving in and then out. This has been going on for 10 yrs with constant loss of occupancy. There are some solutions. A larger mall now has a large medical facility as a tenant. Also a large strip mall with empty stores now has a section converted to a 63,000 sq ft medical center. The trick with REITHs and property stocks, like most investments, is figuring out which have the best management.

  4. The explanation is pretty simple with two main variables:

    1) Work from home (WFH)- What percentage of office space will companies need going forward compared to pre-Covid (2019)? Is is 50% or 90%? The number has not settled out with a relatively wide range of estimates. Until it stabilizes, you cannot accurately forecast how much office space will be required.

    2) Where are long term interest rates headed which directly influences cap rates for commercial properties? The bond market says long term rates will come down, but CRE investors are not willing to bank on long term rates falling.

    Combine those two variables into your model for office space and you get a wide range of outcomes. Essentially it means the bid-ask spread for office buildings has widened considerably. Buyers will not come up and sellers will not come down, hence nobody can accurately price the markets today. Best guess is that it will take a few years to reach equilibrium. In the meantime, just keep buying NVIDIA common and all will be well. . .

    1. I am surprised this hasn’t been talked about here. Was in the news the last couple of days. This article is one I hope everyone can access.
      Actually The term applies to all major cities. Just 3 years ago everyone was talking about the demise of suburban living. Planners were saying the younger generations were moving to metropolitan areas where they didn’t need private transportation instead relying on public transport. Everything was being planned around dense housing close to public transport and short distances to large business campuses like Google and Apple’s spaceship.
      Now this has all flipped. I agree its going to take years to settle out.
      My question is, When are the politicians who are talking about holding bank CEO’s responsible for a bank collapse going to hold these large Reits responsible for these loans they are walking away from with the same banks ?
      This is going to be a classic case of investors dumping REITS and throwing the baby out with the bathwater. I would stand back and wait. I would be wary of large reits and lenders holding their loans and I am not talking about just banks.

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