I caught the faintest flash of blue out of the corner of my eye. Was it my imagination?
There it was again.
I abandoned my cart and rushed toward the center of the store. All around, other shoppers were doing the same as the speakers crackled to life overhead: “Attention Kmart shoppers…”
You might be too young to remember, so let me explain. Kmart was a department store that was known for their “Blue Light Specials.” They’d bring out a flashing blue siren to draw people to a discounted item that was on sale for a limited time – sometimes just 15 minutes. You might compare it to a modern-day Amazon Lightning Deal.
When the blue lights started flashing, you knew there was something going for cheap, and it wouldn’t last long.
Well, the sirens are going off for one of the most overlooked sectors in the market right now: office real estate investment trusts (REITs). Many of these companies are trading at less than half of their pre-pandemic valuations and prices last seen during the depths of the Financial Crisis.
Here at the Intelligent Income Daily, we’re focused on finding the safest income investments on the market. Everybody loves a good deal, but before you throw your hard-earned money at whatever seems to be on sale, you should consider if it’s a treasure that’s mispriced or just trash that no one wants.
Today I want to explain why there’s a growing divide in the office sector and why some office REITs are positioned to thrive while others will continue to struggle.
Pulling Back on Properties
Ever since the pandemic hit, offices have been stuck in a state of limbo.
Large companies kept paying their leases in anticipation of someday bringing everyone back. But they never really used all the space they had as people continued working from home.
Now reality is kicking in – remote work is likely here to stay. And, as interest rates rise, companies looking to cut costs are moving out of offices they don’t need anymore.
As that happens, the landlords who own those office buildings are feeling the pressure.
Recently there have been several high-profile defaults on office buildings: Brookfield defaulted on $784 million of loans tied to office skyscrapers in Los Angeles; Pimco defaulted on $1.7 billion in loans backed by offices in New York, San Francisco, and Boston. RXR Realty is trying to restructure debt on its office building in Manhattan. Washington Capital Partners is facing imminent default on a building in downtown D.C.
And it’s likely to get worse as the economy slows down.
That’s why many investors are starting to consider the office sector “uninvestible.”
But, it’s not gloom and doom for all offices. Bruce Flatt, CEO of Brookfield commented that:
“High-quality space is very sought after as companies want to bring people back and have engaging space,” noting that some office properties are close to fully leased at prices 50% higher than pre-pandemic.
That’s where knowing what creates lasting value in these properties comes in…
Three Trends Running the Office Space
I recently interviewed Owen Thomas, CEO of the office REIT Boston Properties (BXP). According to him, there are three major market trends affecting the office space.
Firstly, the economy: “Companies are experiencing this slowdown and many of them were focused on growth, now they’re more focused on profit and loss and they’re cutting costs. And that’s leading to corporate layoffs, and layoffs usually lead to taking less space.”
Second, work-from-home trends: “Work from home…is clearly going to have an impact on the use of office space over the long-term. However, we know we’re seeing a very significant return-to-office trend in the country right now. Just in the last few weeks, Salesforce, Amazon, Disney, and Google have all announced return to work programs.”
Third, a flight to quality: “Right now is the most intense flight to quality that I’ve ever seen in the commercial real estate sector… employers are saying, ‘Look, if half my employees come back to the office, it’s got to be a better experience,’ and they’re not leasing the lower quality buildings anymore.” And demographic trends continue to support growing demand for suburban offices in the Sunbelt states.
So while the market dumps everything related to offices in a fire sale, there are some office REITs with valuable properties that are getting thrown out with the bathwater. The key is finding the ones with portfolios of modern, high-quality buildings in locations that are supported by a growing population.
If you’d like more in-depth research on this, consider signing up for our Intelligent Income Investor premium service. You’ll get access to our model portfolio, which has one office REIT we think is poised to outperform. We also provide trade alerts and special reports on the highest-quality dividend-paying companies the market has to offer. Our focus is on finding safe and secure dividends to create a growing income stream that will passively support your lifestyle with stress-free investments.
Happy SWAN (sleep well at night) investing,
Brad Thomas
Editor, Intelligent Income Daily