REITs struggle to stay afloat despite return-to-office, rate cuts

October 10, 2024 (MLN): The outlook for office REITs remains challenging, despite positive developments such as back-to-office mandates and the start of the Fed easing cycle, says Fitch Ratings.

Some large employers have reversed flexible working arrangements enacted during the pandemic as the labor market weakens. The latest example is Amazon.com, Inc requiring employees to go in to the office five days a week.

So far this has not translated into meaningful improvement in occupancy rates for REITs. More days in office does not necessarily require more floor space.

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.

Fitch expects that operating performance for office landlords will continue to diverge, 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.

Among Fitch-rated issuers, occupancy rates for SL Green and Vornado may have troughed and began to improve this year, but deteriorated further for Hudson Pacific Properties.

Fitch downgraded Hudson Pacific to ‘BB-‘/Negative from ‘BBB-‘ but revised the Outlook for SL Green to Stable from Negative in August 2024.

Liquidity remains adequate, even for issuers that we downgraded to non-investment grade ratings over the past 18 months. These issuers have continued to refinance mortgages and access their revolving credit facilities.

No issuer has refinanced their unsecured debt since being downgraded from investment grade. Depending on market conditions, issuers may have to consider other funding options such as secured, hybrid debt or joint ventures, which could reduce future financial flexibility.

The upcoming unsecured maturities to watch would be VNO’s $450 million notes maturing in 1Q25 and HPP’s $259m notes maturing in 4Q 2025, which the issuers may pay off with asset sales.

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).

A sustained recovery in occupancy rates would likely accompany this.

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