2024-01-08 17:57:10 ET
Summary
- SL Green Realty Corp. has been hurt by higher interest rates and lower occupancy rates in the Manhattan office real estate market.
- The company has made progress on divestments and business development, but the overall picture is still unclear.
- Lower interest rates and recent real estate sales have provided some relief, but there are still concerns about sustainable profitability.
When SL Green Realty Corp. ( SLG ) announced a (partial) real estate sale in the summer, I believed it looked promising, but definitely did not mark the end of all woes. The Manhattan-focused office real estate company has been hurt by a combination of higher interest rates and lower occupancy rates, a dreadful situation given the leverage employed.
Ever since, the company has announced some more divestments and made progress on the business development side, while lower interest rates in the final quarter of 2023 provided some relief as well. These green shoots are very real and substantial, but the overall picture is still a bit too opaque for me to get involved, after a partial re-rating as well.
A Recap
SL Green is a real estate investment trust, or REIT, focused on Manhattan office real estate, having seen many boom and bust cycles in the past. A $150 stock in 2007 fell to just $10 in 2009, but recovered to the $130 mark in 2015, only to trade stagnant around the $100 mark pre-pandemic. After an initial scare reaction, shares traded in the $80s in 2021 and earlier part of 2022, before plunging to a low of $20 in the first half of 2023.
For the year 2022, SL Green reported a small drop in revenues, with proceeds down about 2% to $827 million. Most of these revenues are derived from rental revenues (in fact nearly $600 million), with that number complemented by escalation, investment income, and other income, all derived from (partial) ownership in 60 buildings which cover 33 million square feet in the Manhattan region.
The company posted a $93 million loss, mostly explained by an $85 million loss incurred on real estate, as well as substantial depreciation charges of course. The so-called funds from operations, or FFO, number came in at $6.64 per share.
The numbers were quite complicated, as the balance sheet totaled $12.4 billion, mostly comprised of $7.1 billion in the value of land, buildings, and lease of buildings, as well as $3.2 billion in investments in joint ventures, as well as investments in debt and other securities. An equity position of $4.6 billion was relatively modest, equal to 37% of the total assets.
Despite first quarter revenues for 2023 increasing from $193 million to $224 million, the FFO measure fell twelve cents to $1.53 per share, as the company was refinancing rates in excess of 6%. Ironically, these proceeds were used to finance a monthly dividend which exceeded $0.27 per share on a monthly basis, translating into (at some point) a double-digit dividend yield.
In June, the company sold a 49.9% stake in 245 Park Avenue, with the property valued at $2.0 billion, indicating that about a billion dollars in proceeds are seen in relation to the 1.8 million square foot building. The deal was mostly related to getting rid of liabilities, as the company reportedly carried nearly $1.8 billion in loans.
In response to the news, SLG shares rose from $24 to $28 per share, adding about $300 million to a market value of $1.8 billion, a number which trailed the book value of the equity of $4.5 billion by a wide margin. Investors liked the sale, but of course, it was just a drop in the bucket, and while the short thesis was way too late, the small green shoot was by far not enough to get convincingly upbeat on the name.
A Recovery
Since the summer, shares have done quite alright. A $28 stock still traded at just $30 in October, but a rally later in the year, driven by lower interest rates, has sent shares up to $44 per share here.
The big other news on the corporate front was the sale of 625 Madison Avenue, as SL Green sold its stake in the building for $632 million to an unnamed global real estate investor. Not all proceeds will benefit the company, as a $234 million preferred equity investment will be made into the building, with the remainder of proceeds used for deleveraging.
The deal is significant, of course, as the balance sheet of the company has now shrunk below $10 billion and while the equity portion of the balance sheet has been impaired as well, deleveraging at acceptable prices should reduce relative leverage and provide more clarity.
The company will see some deleveraging from a near 8% dividend cut announced in December as well, on top of general cost-saving measures. The monthly dividend has been cut to $0.25 per share, still representing a $3 per share annual payout, saving the company an estimated $17 million per annum here.
The biggest driver on top of these developments of course has been the big move lower in interest rates which have lifted all REIT boats, and certainly the office real estate sector as well. That being said, questions on demand remain, although the company did issue some upbeat notes about workers being required to go back to work later in 2023 or early in 2024.
In fact, occupancy levels improved 10 basis points over the most recent quarter, to 89.9% in the third quarter of 2023. This might be driven by the fact that nearly half of its tenants operate in the financial sector, a sector which has been more known for demanding its workers to return to office.
Shrinking To Grow
What is very clear is that divestments already have taken a toll on the size of the business. As of the third quarter, pure rental income had fallen to $131 million and change, down from a near $143 million number in the same quarter in the year before. This came as the balance sheet shrank from $12.7 billion as of the third quarter of 2022 to $9.7 billion in the third quarter of 2023.
While equity has fallen in nominal terms to $4.1 billion, ratios have compressed, with the balance sheet having fallen to less than $10 billion. That statement is a bit too complicated as well, as the company has some debt being unconsolidated related to the joint ventures of the business, which means that "headline" debt might underestimate the real leverage employed.
Given all these moving factors, it is hard to disentangle the real value of the properties here. Of course, there are still many properties out there, but it is hard to say if recent transactions are indicative and comparable for the portfolio at large. Moreover, the balance sheet is hard to read given an active development portfolio and many partnerships, which complicates the nature of the financial statements.
Amidst all these uncertainties, I am still taking a somewhat cautious approach, although I recognize that divestments and lower interest rates have taken out the worst concerns of investors out here.
While quality businesses and quality buildings prevail over time, there simply are too many SL Green Realty Corp. moving parts out there. While I applaud the positive developments, there is still a long road to go and many questions to be asked on sustainable profitability here.
For further details see:
SL Green: More Green Shoots, Still Many Questions