So Far, No Crisis

Aerial View of Buildigns

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Last week’s earnings reports from a few different REITs indicated that commercial office space and commercial lending have not fallen into the crisis the financial media has warned of. The fear in the markets is that low office space occupancy will lead to declining property values and commercial mortgage defaults.

Also, since commercial mortgages are almost exclusively adjustable, rising interest rates hurt commercial property owners with sometimes significant increases in the cost of servicing their debt.

There have been anecdotal stories of downtown office buildings remaining mostly empty post-pandemic. There also has been a couple of defaults on commercial loans. The question now is whether these will be isolated problems or indicate a larger issue with commercial property (especially office buildings) and commercial mortgage lenders.

Last week, a couple of office building REITs, as well as one of the larger commercial loan REITs, announced earnings. Here is what they reported:

Boston Properties (BXP) owns office buildings in Boston, Los Angeles, New York, San Francisco, Seattle, and Washington, D.C. Those cities are often cited when discussing occupancy and value problems. For the first quarter, BXP reported FFO of $1.73 per share, beating the Wall Street estimate by five cents. The company increased its full-year FFO guidance by four cents, to $7.17 per share. The company reported positive net operating income growth and signed 522,000 square feet of office leases during the quarter with healthy GAAP and cash rent spreads. This office REIT posted very good first quarter results. BXP currently yields 7.8%.

Highwoods Properties (HIW) owns business district office buildings in Sunbelt cities, including Raleigh and Charlotte in North Carolina; Nashville, Tennessee; Atlanta, Georgia; Tampa, Florida; and Dallas, Texas. Highwoods reported FFO of $0.98 per share for the first quarter, beating the Wall Street estimate by five cents. At the end of the quarter, occupancy was 89.6%.

During its earnings call, the Highwoods management team acknowledged industry headwinds. They will selectively sell properties as the $518 development pipeline projects come online. The company appears to have a plan for the current market, and the 8.9% dividend yield makes the shares attractive.

Blackstone Mortgage Trust (BXMT) is a commercial mortgage REIT. The company owns a $26.7 billion senior loan portfolio across 199 loans. The portfolio has a 64% loan-to-origination value.

For the first quarter, Blackstone Mortgage Trust reported distributable earnings of $0.79 per share, up 27% over the year-earlier period. Management also noted that 3% of loans were non-performing, and the company had increased its reserves against defaults. The BXMT results highlight both the pros, greater interest income, and cons, higher chances of default resulting from higher interest rates. The shares yield 14.7% on a very well-covered dividend.

The earnings results from these three companies show that the businesses continue operating as expected, but caution levels have ratcheted higher. We are entering a period where market conditions could be very tough on less-than-well-managed companies, but provide once-in-a-decade opportunities to those with dry powder to invest.

Earnings results over the next few quarters will let investors separate the good from the scary in the commercial real estate sector.

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