Fitch Ratings Wire

Pandemic Spurs Remote Work, Raises Office REIT Cash Flow Risk

Cash flow will be affected over the near term

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Fitch Ratings-New York/Chicago- 01 September 2020 – The acceleration of the remote working or the work from home (WFH) trend and the loss of office-based jobs due to the coronavirus pandemic is pressuring US office REIT cash flows, says Fitch Ratings. We expect recent tenant densification and the prevalence of long-term leases to lessen risk. However, cash flow will be hurt over the near term by limited growth from new leasing activity, given the logistical inability to effectively conduct property tours during the pandemic.

A long-term shift towards remote working would reduce demand for new space and raise lease renewal risk. The office REIT sector has been fairly resilient in terms of rent collections after government stay-at-home orders and safety concerns resulted in a large number of US office employees working remotely, partially due to average lease durations of 8-10 years. Only about 10% or less of office leases expire over the next few years. Leases recently up for renewal have been signed with shorter durations as tenants seek time to assess implications of the pandemic and economic contraction.

Demand Will Remain Uncertain

Low levels of new supply will provide some support for sector fundamentals, but demand will remain uncertain over the medium term as tenants evaluate space needs. Demand will be driven by business confidence, corporate profits and employment. Demand will also depend on the pace at which the recent trend toward office space densification, which had a negative effect on space requirements, is reversed to accommodate social distancing as well as the extent WFH becomes the norm.

We expect low- to mid-single-digit same-store net operating income (SSNOI) declines for the sector in 2020, compared with median growth of 3%–6% annually since 2012. A rebound to positive SSNOI in 2021 is assumed, with low- to mid-single-digit SSNOI growth in 2022 and 2023, due to a substantial recovery in occupancy as rent growth remains limited. The recovery in occupancies is expected to be a byproduct of an improving economy and pent-up demand. However, more subdued demand for real estate could prove to be a headwind for a concomitant recovery in the sector.

Rating actions across Fitch’s universe of office REITs since the onset of the coronavirus have skewed to the downside. SL Green Realty’s (BBB) and Vornado Realty Trust’s (BBB) Rating Outlooks were revised to Negative from Stable, and Mack-Cali Realty’s rating was downgraded to ‘BB-’/Negative from ‘BB’/Stable earlier this month.

The rating actions were primarily due to the potential for leverage to increase as pandemic-related economic pressure builds on the office segment, even after the outbreak subsides. For some, there is also heightened concern about the ability to successfully lease up properties.