The Empire State Building is the marquee asset of the real-estate investment trust Empire State Realty Trust. It and other REITs are ways to wager on the city’s future.
Photo: Michael Noble Jr. for The Wall Street JournalThe pandemic has raised important questions about the future of New York City. Will residents flee its concentration of people? Will the need for closely packed elevators cripple city office towers? Can employees work as well from home?
Clues to the answers—or a way to bet on them—can be found daily in the price moves of four real-estate investment trusts that have a majority of their assets in New York and trade on public stock exchanges.
They own stakes in dozens of Manhattan towers, including the Empire State Building, the Bloomberg Tower, the former New York Daily News building, the supertall luxury condo 220 Central Park South, and the 1,401-foot One Vanderbilt office and observatory under construction next to Grand Central Terminal.
The stocks of New York REITs Empire State Realty Trust Inc. ; SL Green Realty., which is Manhattan’s largest office landlord; Vornado Realty Trust ; and Paramount Group. all took hits of more than 54% during the one-month bear market in the spring, compared with the broader market’s drop of 35%.
But unlike the broader market, which has regained three-fourths of its bear-market losses, none of the REITs have recovered one-fourth of theirs, and Empire State has recently traded near its lows.
Their stock prices actually began declining four to five years ago. The city’s office rents have leveled off since then partly due to new supply at the Hudson Yards complex. Another blow was a trend called “densification,” where tenants squeeze in more employees per square foot of space to save on rent. (That trend is now expected to slow or reverse because of the pandemic.)
Empire’s state
Currently, the weakest of the four stocks has been Empire State, with a stock-market value of $2.1 billion and assets of $4.7 billion. The observatory of its marquee asset, the Empire State Building, accounted for 25% of the entire company’s operating income last year. Even if the Covid crisis passes, its tourist traffic might not fully recover until 2022 or later.
Since the pandemic hit, analysts’ estimates of the next 12 months’ funds from operations have fallen by 29.4% for Empire State, compared with drops of 12% for SL Green, 10.8% for Vornado and 9.9% for Paramount Group, according to data provider FactSet. As a group, the stocks trade at just 8.9 times next year’s estimated funds from operations, far below the office REIT average of 13.8 times.
Two of the REITs, SL Green and Empire State, drew down credit lines to boost liquidity amid the pandemic. Vornado put 1,800 cleaning employees, 44% of its workforce, on leave, though some have returned. Last month, it put two of its office towers in San Francisco and New York, both 30% owned by the Trump Organization, up for sale or recapitalization.
The pandemic has raised questions about the future of New York City real estate.
Photo: Michael Noble Jr. for The Wall Street JournalOn quarterly earnings calls in April and May, executives of the New York REITs generally ducked questions about how far rents may decline, and scoffed at the “work-at-home” trend as a long-term proposition.
“The socialization and collaboration of the traditional office is the winning ticket,” said Vornado Chief Executive Steven Roth.
Analysts and investors predict New York office rent declines of 5% to 20% over the next year or two, though the full revenue hit won’t occur immediately because many tenants have long-term leases. While some tech companies such as Facebook Inc. and Alphabet Inc.’s Google signed new Manhattan leases before the pandemic, many corporate executives have talked about reducing their office footprint.
Steve Sakwa, a REIT analyst at Evercore ISI, predicts a 20% rent decline within 12 to 18 months. “The next 12, 18, 24 months are going to be challenging,” he says. Among the negatives he cites are the city’s reliance on mass transit and the possibility that office buildings will be limited to 50% capacity.
Empire has said that 20% of its total April rent and 25% of its May rent was unpaid as of June 1. Empire covered part of the shortfall with security deposits, and agreed to deferrals for tenants who account for 9% of the company’s total rents. Vornado has said 17% of its April rent went unpaid, while SL Green reported shortfalls of 11% for April and 15% for May and Paramount just 4% in both April and May. One Empire executive said on a call that “new leasing activity is largely frozen.”
Hotel slowdown
Vornado, the largest New York REIT, with a market value of $7.3 billion and assets of $18.2 billion, owns the Hotel Pennsylvania, which closed temporarily and faces a slow return to its former occupancy rates over the next 18 months. Vornado may cut its dividend by up to 20% in the third quarter, Mr. Sakwa predicts.
SL Green Realty Corp.’s One Vanderbilt Place, a $3.2 billion skyscraper being completed later this year.
Photo: Michael Noble Jr. for The Wall Street JournalSL Green, the second largest, with a market value of $4.1 billion and assets of $13.2 billion, took a hit in March when its planned $815 million sale of the former Daily News building fell apart. Green refinanced instead. To raise cash it has also sold stakes in two other buildings.
Green has leased 67% of the space at its new $3.2 billion One Vanderbilt skyscraper, being completed later this year, but prospective additional tenants want “a month or two pause while we work through this situation,” CEO Marc Holliday told analysts on a call. “We are hopeful that rents are going to hold.”
The reversal of densification, Mr. Holliday added, should “more than offset whatever we might lose to work-from-home technology.” But Daniel Ismail, an office analyst at Green Street Advisors, argues the opposite, namely that work-from-home will outweigh less density.
Alec Overby, an analyst at Cohen & Steers, which manages $12.9 billion in REIT mutual funds, prefers office REITs with West Coast and Sunbelt assets, newer buildings, less debt and more exposure to tenants in technology, advertising, media and information.
Mr. Overby believes New York office rents will decline 15% to 20% or more, weakened by the retreat of co-working tenants like WeWork and a 5% to 10% drop in demand. He believes rents may not rebound until 2022 or later.
The REIT executives acknowledge a recovery will take time. New York will come back because “the best, the brightest, the smartest, most motivated want to be here,” Empire State CEO Anthony Malkin said in early June at an investor conference. But he added that it may take 18 to 36 months “before we start to see an upswing again.”
Mr. Smith, a former financial reporter for The Wall Street Journal, is a writer in New York. He can be reached at reports@wsj.com.
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