How Working at Home Is Bad News for Office REITs and Their Investors
Get back to the office, say CEOs like Jamie Dimon and Elon Musk. I couldn’t agree more. Exchanging ideas in person is the lifeblood of any thriving enterprise. Give me 50 hours in the big city any week—no, 60. Add 10 for commuting—that’s quality audiobook time.
Still there? Sorry—sometimes management reads the first few lines. Between us, I’m following a standard hybrid plan of high-output isolation mixed with strategic visibility. On the busiest work days, I roll out of bed and straight into business slippers, avoiding human contact at all costs. On office days, I do a bit of extra noisemaking to leave the impression that I was there for longer. Squeaky shoes and jingly pocket change help.
Office REIT yields of around 7.5% speak volumes about work-from-home expectations. That’s more than double the average payout for other types of real estate investment trusts. The market is saying that payment cuts are coming, suggesting that occupancy levels aren’t going to bounce back to former levels soon.
“If we don’t see signs of organic growth bottoming in the next 18 months, we think dividend cuts may be back on the table to preserve capital and reduce leverage,” wrote Morgan Stanley analyst Ronald Kamden this past week.
Office REITs have fallen harder than the rest of the group this year, and the average big one goes for just seven times next year’s projected funds from operations. That’s half the broader REIT average. Before Covid, the discount was 12%. Office landlord incomes are getting a lift from a bounceback in variable fees on things like parking, but vacancies have crept higher. REITs with New York City exposure enjoyed occupancy percentages in the mid-to-high 90s a few years ago. Now they’re in the high 80s to low 90s.
Kamden reckons that nearly all the office REITs he covers will post lower funds from operations next year. Cash balances will help, but if landlords want to preserve cash, many will need to raise outside capital. Kamden is bullish on an office REIT called Highwoods Properties HIW +2.33% (ticker: HIW), which yields 6.7% and operates in Sun Belt markets with lower exposure to work-from-homers. But he recently reiterated bearish calls on New York heavyweight Vornado Realty Trust VNO +1.71% (VNO), which pays 8%, and the smaller Office Properties Income Trust OPI +2.46% (OPI), with exposure to Washington, D.C.; Chicago; Atlanta; and Silicon Valley. It pays 13%.
There are better income opportunities, including outside of REITs. The market strategists at Morgan Stanley expect dividend stocks in general to outperform as inflation eventually comes down from peak levels. They recently ran a screen for promising ones, then asked the firm’s industry analysts which to prefer. Some of the picks are expected to pay more than 4% in dividends next year while providing total returns over 30%. Be reasonably confident in the first number but only prayerful about the second.
On that list are Ohio utility FirstEnergy FE +1.93% (FE), which for now yields 3.8%; drugmaker AbbVie ABBV +1.09% (ABBV), 3.9%; East Coast banker Citizens Financial Group (CFG), 4.5%; and wheeze facilitator Philip Morris International (PM), 5.4%.
As for the future of offices, economists say a labor shortage has shifted power to wage-earners, who want better work-life balance. They must be talking about younger ones. As a Gen-Xer, I’m motivated more by traditional business values, like greed and insecurity. I expect to gradually make more frequent trips to the office. For now, if anyone important is looking for me, you just heard me jingling into a meeting, and it sounded important.
Let me turn to something tangentially related to this week’s cover story: how to charge customers for sitting through advertising. Last week in this space I mentioned Apple ’s (AAPL) yearly iPhone presentation. It’s free, of course. Cupertino could learn a thing or two by looking south, to Anaheim, where Walt Disney (DIS) just held a typically biennial event called D23 Expo.
Tickets were $89 for one day, $229 for all three. Choice seating ran $899. Buyers had to belong to a fan club called D23, after Disney’s founding year of 1923, at gold level, which costs $99.99 a year. And they had to hurry, because expo tickets sold out in July. These lucky few—well, enough to pack the Anaheim Convention Center, which can hold 7,500—got to hear about things like minor ride enhancements and new character greetings. For example, the Star Wars land will soon have a Mandalorian walking around with an animatronic Grogu (baby Yoda to non-sticklers).
I mention this because I just returned from my first Disney World trip since before the pandemic. By now you might have heard that ticket prices have soared, and there’s a new upcharge for something called Genie+ to avoid punishing ride waits, plus another for something called Individual Lightning Lanes on rides too popular to be part of Genie+. Availability can run out. Effectively at 7 a.m. there’s a new show called Parents Frantically Poking Smartphones to Buy Privileged Access to Slinky Dog Dash.
It’s hard to quantify true Mickeyflation, because some previous freebies are gone, like the bus from the airport. But I’d guess that my costs were up 40%, fun was down 20%, and the kids were 15% whinier. That last one is on me—they turned feral from too much screen time during the pandemic.
All of this has done wonders for Disney’s park operating margins, but grumbling customers have taken to switching CEO Bob Chapek’s last name to Paycheck. I’m watching for signs of waning demand, but not seeing them yet. And the fact that so many paid so much for so little at the D23 Expo gives me confidence in the cash flows.
But I’m vacationing closer to home from now on, not least because airline travel has come to resemble a porta-potty visit—sometimes necessary, but never good. I’ve got my eye on Bushkill Falls, which they call the Niagara of Pennsylvania. Park entrance is $15, and there’s a $3 charge for a trail map, but no lightning lanes, so long as the weather holds.