Sector Spotlight
Office REITs Down, But Far From Out
by Lynn Novelli
Office real estate is facing serious challenges
this year, and there’s no
shortage of negative
headlines: buildings
sold at fire-sale prices,
millions of square feet of vacant
space and new construction
projects being mothballed. Yet,
analysts say it’s not time for
REIT investors or landlords to
push the panic button.
The extremes reported by the
media may overstate the impact
on office REITs and their performance during the recession,
says Barclays Global Investors’
analyst Ross Smotrich. He reports that office REIT portfolios
are holding up better than their
non-REIT counterparts. “Office
markets are struggling and will
continue to struggle,” he says.
“However, it’s important to differentiate between the general
market and REIT portfolios. The
public companies tend to have
better quality assets and better
management teams than the
broader market. REITs generally do not have highly leveraged
distressed properties that they
need to unload,” he says. “Office
REITs have solid portfolios with
class-A assets.”
Also adding to the strength
of office REITs are their solid
balance sheets. REITs typically
are well-capitalized, and maintain higher liquidity and lower
leverage overall than the general
office real estate market.
As a result, experts say, while
office REIT fundamentals will
continue to erode due to the
overarching macroeconomic
weaknesses, REITs should continue to hold better occupancy
and leasing rates than the general market for the duration of
this economic cycle.
Jetta Productions/Getty imaGes
How Low Will They Go?
Demand for office space is
driven by economic growth,
corporate expansion and white
collar employment. With the
first two of those nonexistent this
year and unemployment heading
higher, office REI Ts undoubtedly are going to feel some pain.
Nationally, occupancy is
expected to hit a trough in late
2010 or early 2011 of approximately 80 percent, according to
Green Street Advisors senior
analyst Michael Knott, who
specializes in office REITs.
“However, you won’t see many
REITs that low. The strong
players still have 96 percent
occupancy,” he says.
If there’s anything positive
about the persistent economic
uncertainty, it’s the fact that it
tends to support lease renewals,
says Deutsche Bank REIT analyst Louis Taylor. “Renewal rates
will stay high,” he predicts, “as
companies try to avoid moving
expenses and paying higher rates
in a newer building.” Lease renewals are expected to be for the
same or less space with even the
most stable companies delaying
any expansion plans as long as
economic insecurity prevails.
Fortunately, constrained supply is expected to mitigate soft
demand for at least the next
couple of years. The challenging
credit market, concerns about
leasing ability and companies’
current cautionary spending
are all putting the brakes on
development, which will help
prop up occupancy.
A total of 70 million square
feet of new office space will be
delivered by early 2010, the tail
end of the sector’s development
pipeline. New starts are virtually
nonexistent, as REITs worry
