In the Shadows: Navigating the Challenges and Opportunities for Office REITs in 2024
As office real estate investment trusts (REITs) brace for another challenging year, some money managers believe there might be compelling entry points in the sector for long-term investors. Michael McNabb, portfolio manager at Purpose Investments Inc., characterizes the current scenario as a 'darkest before dawn' moment for office REITs. While acknowledging their affordability, he emphasizes the numerous headwinds that office landlords are currently confronting.
Reflecting on the pre-pandemic era, McNabb notes that office REITs were the hottest asset class heading into 2020, marked by tight vacancy rates and investor enthusiasm for the sector's monthly payouts. However, the paradigm shifted with the COVID-induced work-from-home trend, causing a reevaluation of office footprints by employers and a broader reconsideration of real estate holdings to cut expenses in a weaker economy.
Maria Benavente, vice-president and real estate-focused portfolio manager at Dynamic Funds, estimates that 10 to 15 percent of demand may have been permanently affected by work-from-home trends, shaping a market of 'haves and have-nots.' Colliers Canada's September report revealed a national office vacancy rate of 14.1 percent in the third quarter of the previous year, indicating a continuous rise over three and a half years. The report anticipates further increases in vacancy rates in the short term, given the prevalence of remote work.
Despite the challenges, average asking rents for offices have approached a record high, reaching $21.08 per square foot, driven by the removal of older office buildings and landlords negotiating concessions beyond lower rent. John Duda, Colliers' president of real estate management services in Canada, foresees a 'slow uptick' in office space absorption by the end of 2024 but cautions against expecting a radical turnaround. The enduring challenge lies in the disparity between employer and worker preferences, with the employment market's imbalance hindering a more significant shift back to the office.
Charting the Course: Office REITs Navigate Challenges Amid Shifting Dynamics
As office real estate investment trusts (REITs) face continued headwinds, some industry experts suggest potential opportunities for long-term investors. Michael McNabb, a portfolio manager at Purpose Investments Inc., describes the current scenario as a shift from the employees' power dynamic to a more nuanced landscape. Particularly noticeable in downtown cores, the rise in activity levels hints at a potential turning point.
However, major players in the sector, such as Slate Office REIT, Allied Properties REIT, True North Commercial REIT, and Dream Office REIT, have witnessed significant declines, ranging from 62 to 85 percent since March 1, 2020. Despite the negative sentiment surrounding the sector, Maria Benavente, vice-president and real estate-focused portfolio manager at Dynamic Funds, emphasizes the value investment aspect of office REITs. She stresses the need for investors to exercise patience and focus on key factors such as balance sheet strength, liquidity, and dividend coverage.
Benavente acknowledges the challenges, citing instances of office REITs cutting dividends, including Slate Office REIT suspending its monthly distribution in mid-November. The recovery of the office REIT sector is expected to hinge on economic rebound and businesses returning to hiring mode. Furthermore, increased lending support from banks is crucial for revitalizing activity in the sector.
While McNabb maintains a cautious stance, he envisions longer-term investors selectively exploring opportunities among higher-quality companies. He highlights the fundamental economic principle of supply and demand, noting the current imbalance with supply outstripping demand. The path forward for office REITs involves careful navigation of these complexities, with an eye on the evolving dynamics of the commercial real estate landscape.
In conclusion, the trajectory for office real estate investment trusts (REITs) remains complex, marked by challenges and potential opportunities. As industry experts navigate the shifting dynamics, the sector grapples with significant declines in major players since 2020. While caution is advised, particularly in assessing vacancy rates, the emphasis on long-term value investment signals that patient and selective investors may find opportunities amidst the volatility. The recovery of the office REIT sector hinges on broader economic rebound, a return to hiring activities, and increased support from lending institutions. As stakeholders tread carefully in this landscape, the conclusion underscores the delicate balance between patience and strategic decision-making in charting the course for the future of office REITs.