Summary
- Management has to execute on the sales disposition goal.
- The stock price already is at 2020 levels without the 2020 shutdown challenges from the coronavirus issues.
- The CPI housing part of the index has a delay of about one year. Dropping housing costs for over a year mean great CPI housing news for this year.
- Energy and Food remain unpredictable. But the NYC location should buttress some unexpected effects.
- NYC is a money center and well diversified. The location is an advantage for SL Green Realty.
SL Green Realty ( SLG ) began last year with some high hopes. But then the Federal Reserve began to raise interest rates to counteract an ever-expanding money supply that was causing inflation. This spooked the market to send the shares of SL Green Realty lower. Higher interest rates would sooner or later to affect the floating debt rate and possibly economic activity enough to cause a lower year or so. Well, the price of SL Green is now down to the shutdown price levels of 2020, and we are nothing close to a shutdown.
Furthermore, those who know how the CPI is calculated k now that the largest chunk of the CPI index, especially that core rate is tied to housing. Housing also has a roughly one-year delay factor. Since housing and rents have been falling in key markets for some time, the largest part of the CPI index has a favorable outcome probably for the rest of this year. The news will not be "straight down" but it does appear to be largely favorable.
SL Green Realty is somewhat insulated from the pricing declines (but definitely not completely insulated), due to the expiration dates of leases being spread out. Also, the company is oriented towards office space. So, business activity is the key more so than retail housing prices. Last the concentration in New York City may well be an advantage because New York City as a money center is somewhat business cycle resistant and business diversified as well. There is a fair amount of exposure to government business as well as private business.
That is not to say that New York City is immune to the business cycle. It is more about the advantages of the location to minimize the impact of the business cycle. Some places, like San Francisco, and in fact much of Northern California, are the bullseye of the current correction. Those locations benefitted from years of easy money. Therefore, the latest Federal Reserve policies will have the exact opposite effect and that effect may last longer than some expect. Therefore, the effect on an REIT like Kilroy Real Estate ( KRC ) could therefore be more than some would expect due to that exposure. At the very least the market will pressure the shares of that well run REIT for some time to come.
Operating Results
SL Green had a sluggish December (leasing pace) and then followed it up with a busy January . It is likely to be the way the current fiscal year goes. The rise in interest rates has really not happened for a very long time. But for those of us who lived through the 1970's and early 1980's, this is a cakewalk compared to that event. Therefore, while concerns are justified. So far, the whole strategy appears to be on course for a result of a correction and not a depression that some fear.
The largest concern in an environment like the current one is the decline in leasing rates shown above. However, rates have been on the soft side ever since fiscal year 2020 due to all the challenges unleashed by the coronavirus shutdowns. The gyrations of concessions shown above will unsettle the market as well. In many ways, what's going on here is somewhat representative of the whole portfolio even though effects can vary a little bit by location in the city.
Thanks to the rising interest rates there is some concern about this lasting a few more years in addition to the time that the market was already weak. That is in addition to fears of the Federal Reserve not engineering a soft landing. So far, this economy is still going like gangbusters. So, any downturn that meets the recession definition is likely to be at such a high activity level as to minimize the recession effects.
That discussion leads to the company results shown above. Clearly funds flow from operations is holding up rather well. Management has provided guidance for the current fiscal year that in the past has held up rather well. A lot will depend upon the success of leasing activities currently underway. Management reported in the conference call that l easing condition s have not changed. To me, if the Federal Reserve is this far along raising interest rates, and management is not seeing a material weakening of the leasing market, then whatever lies ahead is likely to be brief and relatively inconsequential compared to say 2008 where conditions were really hurting for a while.
Sources Of Liquidity
Another risk for shareholders in the current year is the ability of management to generate the sources of liquidity as planned.
The biggest chunk to increasing liquidity has to be the planned sales. That's also the biggest risk. This brought up a lot of questions during the conference call. So, it was clearly on the minds of a fair number of analysts.
Management noted that they have to be realistic about the pricing in the current environment to meet that goal. So, the risk here is that it takes more effort than the Federal Reserve is currently planning to rein in inflation. This is where energy and food prices could really wreak some havoc. My own suspicion is that food prices are likely to overall return to something better than what recently happened. But energy is a whole other matter.
Still with large parts of the consumer price index now under control and the core rate itself seeming to improve, the rates needed to keep energy prices or anything else unexpected from reigniting inflation are very different from all the prices spiraling out of control from logjams all over the place.
Going Forward
After years of increasing spending (at a brutal pace no less even before the COVID issues happened), and an easy money Federal Reserve policy, we now appear to be on course to correcting those excesses. The federal general budget deficit has now declined for the second year in a row for the first time since the Obama administration. The Federal Reserve has clearly reversed its easy money policies.
Many people think that voters want "a little bit" of inflation (like 2% or so). That's likely a good long-term scenario. It appears we're returning to something like that in the future. Throughout our 200 years of history, high interest rates are generally an anomaly. Therefore, it would not be out of line to predict lower rates and decent economic growth (that goes with it) in the future.
SL Green is well positioned with some of the best locations in New York City. New York City itself is an excellent location. The stock price is now at a level that anticipates a disaster. If that were to happen (and I doubt it will) the stock price would not drop much from current levels.
A lot of interest rate sensitive stocks appear to be bottoming at the current time. That's because the market looks forward. "Buy straw hats in January" appears to apply to the current situation here. The main suggestion would be to diversify and make a basket as SL Green would be riskier than (for example) Simon Property Group ( SPG ). So, a basket would provide some safety that loading up on a riskier choice would not.
From current levels, the recovery potential is decent. This REIT is investment grade. Investment grade companies generally do recover to previous stock price levels. This one should do at least that.
For further details see:
SL Green Realty: It's Showtime