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Office REITs See Financials, Fundamentals Improving Under Hybrid Work Cloud

Office leasing and occupancy is up, but existential uncertainty looms over the market amid the pandemic-induced work-from-home revolution.

The owners of Class-A office buildings were brimming with optimism during fall earnings season.

In quarterly earnings calls in recent weeks, publicly traded office landlords touted indicators of a recovering market and brushed off questions about the long-term implications that fully remote and hybrid work will be fixtures of the future office conversation.

“While the timing of complete return to the office at each company's hybrid plan are still unknowable, it is clear to me that the office is still and will be the center of work and of success,” Vornado Realty Trust Chairman Steven Roth said on his company's earnings call last week. 

But despite the optimism that offices will remain a staple of professional life, office REIT executives admitted that the upheaval to the workplace over the past 21 months has impacted how tenants think about space and the future of the workplace is far from settled. 

“None of these tenants really know where their requirement is going to be a year or five years from now, [it’s] not necessarily driven simply by a work-from-home component,” SL Green Realty Corp. Executive Vice President and Director of Leasing Steve Durels said on the company’s earnings call.

“They don't know their headcounts. They have confidence that their businesses are going to remain strong, but they're changing how they use the space — they may or may not have some work-from-home component," he added. "I think there's a lot of uncertainty on the tenant's side as to where their space requirements are going to go.” 

The industry was expecting a post-Labor Day full return to office last quarter, which fell short of expectations due in part to the ultra-contagious delta variant. Now many employers have pushed back their return-to-office dates to next year. But overall, the market seemed to be looking up last quarter.

“I think the office REITs reported earnings for Q3 that were generally as expected and maybe even a little bit better,” JP Morgan Chase Executive Director Anthony Paolone told Bisnow.

Most major office REITs saw income and cash flows, or funds from operations, improve. Sun Belt office specialist Highwoods Properties Inc. reported net income of $72.1M and FFO of $102.8M in the third quarter, up from $40.3M and $91.7M in the same period last year. It raised its guidance going into the fourth quarter. 

Boston Properties, the largest office REIT, projected its cash flow to increase by over 13% in 2022 after beating analysts' FFO estimates in the third quarter. SL Green, with a portfolio almost entirely based in Manhattan, also beat analyst estimates for FFO, but missed revenue projections.

While leasing is still around 20% below what it was pre-pandemic, Paolone said, lease terms have begun to normalize compared to what they have been for the past year and a half. 

Boston Properties' average lease term, for example, rose from seven-and-a-half years in the second quarter to 9.3 years in the third quarter, according to Boston Properties CEO Owen Thomas, bringing the REIT’s year-to-date average lease term up to 8.3 years across the 3.3M SF of office that tenants have signed for. 

Vornado saw rents and concessions stabilize last quarter as its lease pipeline picked up — 1M SF is in negotiations while the company is in talks with potential tenants to start negotiations for another 1.5M SF, Vornado President and Chief Financial Officer Michael Franco said. 

The big question moving forward is how the workplace revolution over the past year will play out in the long term. PwC, which has over 295,000 employees, announced that it would give its employees the option to work entirely remotely in late September, Reuters reported. An Ernst & Young survey released last month found the majority of tenants had not made return-to-office plans at all. 


Despite the headwinds, the market nationally stabilized in Q3 for the first time since the coronavirus pandemic hit with an overall positive absorption rate, according to Colliers. The recovery is disparate around the country; cities like New York are still struggling with oversupply despite an uptick in demand, while Boston REITs announced significant progress on the number of people coming into the office each day during the last quarter. SL Green CEO Marc Holliday said the REIT’s building occupancy ticked over 40% and is increasing as the weeks go by, and Vornado put its occupancy at 43%.

But in Sun Belt markets, owners such as Highwoods CEO Ted Klinc and Cousins Properties CEO Chris Connolly admitted their returns have likely peaked until after the holidays. 

“We now do not expect usage to meaningfully increase until the new year,” Klinck said on his company's earnings call. 

But beyond immediate occupancy and leasing, the future of the office as a whole amid the work-from-home revolution were among the most asked-about topics from research analysts on the call. When asked, several executives pointed to a rise in leasing last quarter. 

“I think the other demonstration of proof of concept is look at all the leasing that's going on in our own company and in the market,” Thomas said. “If companies weren't committed to the office, why would they be leasing all the space?” 

BXP signed 1.4M SF of leases in the third quarter, an increase over Q2 and more than double its first-quarter performance — but Thomas said that figure was slightly below its historical third-quarter average.

REIT executives all predicted that a large return to office was imminent as tenants realized that the full potential of its business could not be achieved in a fully remote workplace. 

“As time progresses and the shortcomings of remote work become more apparent, we increasingly hear concerns from business leaders about the decaying cultures of their companies, inadequate training and difficulties in onboarding new professionals, as well as the potential for deterioration in innovation and competitiveness,” Thomas said. “We believe it's only a matter of time before employers more strongly encourage their teams to return to in-person work.”

But some analysts pushed back on this, pointing to scores of companies that have and surveys that show a majority of workers are set on a more flexible workplace arrangement.

SL Green CEO Marc Holliday, Chef Daniel Boulud and Mayor Bill de Blasio at the One Vanderbilt ribbon-cutting in September 2020.

“Listen, I love New York. I live in New York. And I love every aspect of the interactions I get when all the cultural activities and when I'm in the office with my team. So that's my personal view,” Citi Managing Director Michael Bilerman, a REIT analyst, said on SL Green’s earnings call. “The question now is the office market in general … just feels that the employees every survey that you read, the employees themselves have a lot of hesitation, not from safety. They feel that they can do their job effectively.” 

“Do you not think that was the case before Covid?” SL Green Chief Financial Officer Matthew DiLiberto said to Bilerman in response. “If you polled employees before Covid, I think there were employees who would have said I think I could be affected. I mean, come on.”

Bilerman said while it may have been a trend before the pandemic, the remote work “experiment” has shifted things, he said.

“We went through this test as a guide,” he said. 

While Holliday said he and Bilerman may just have a “difference in opinion” on the matter, Bilerman said he wasn't trying to state his opinion, but rather to get answers based on the facts that have come to light.

"The dynamic in the city right now I feel is very strong, because businesses are doing well, people are hiring," Holliday said in response. "It's hard to hire. There's like a land grab for human resources and an educated workforce. We have a pipeline of 826,000 feet. We're filling our buildings. I can't speak to others, and we can operate well in this environment. And the business leaders themselves say we want to bring our people back. I believe at the end of the day, that will be the last word on the topic."

Bilerman didn't respond to Bisnow's requests for comment.

Paolone said it’s not the uncertainty of work-from-home that makes him bearish on the office market, but instead how significant slight shifts in office demand can be on the revenue of an office portfolio. Even if demand goes down 5%, it could mean a 15% decline in rents, he said.

“We've been pretty bearish on the office REITs for a bit, and we've been bearish even before the pandemic on some of these names,” Paolone said. “From our vantage point, it's not because we don't think people are going to come back to the office or because we don't think there will be demand for space and there won't be an office environment in the future. It's just that when you look at how sensitive the lease economics are to small changes in demand, it just makes for a very challenging business for landlords.

"We don't have a draconian view on the return to the office," he added. "But even small amounts of reduction in demand have a big impact on rents.”