The majority of US office real estate investment trusts ended the second quarter with relatively weaker operating metrics, with the demand for offices declining further as reflected in the sector's most recent dip in occupancy rates.
Declines in funds from operations, recurring EBITDA
Nine office REITs reported quarter-over-quarter declines in their operating funds from operations (FFO) per share during the second quarter. Operating FFO per share improved sequentially for seven REITs while remaining flat for three REITs during the fourth quarter, according to an S&P Global Market Intelligence analysis.
Market Intelligence defines operating FFO as FFO adjusted for extraordinary items or other nonrecurring items at the discretion of the company. Office REITs sometimes refer to this as normalized FFO or core FFO.
SL Green Realty Corp. posted the steepest sequential decline in operating FFO, with a 33.2% quarter-over-quarter drop to $2.05 per share during the second quarter. However, compared with the same quarter in 2023, SL Green's operating FFO actually soared by 43.4% from $1.43 per share in the second quarter of 2023, one of the highest year-over-year gains during the second quarter.
In a July 17 earnings release, the REIT said operating FFO in the second quarter excludes $48.5 million, or 69 cents per share, of gains on discounted debt extinguishments at its 280 Park Ave. and 719 Seventh Ave. properties in New York City, as well as $1.4 million, or 2 cents per share, of positive noncash fair value adjustments on mark-to-market derivatives.
The REIT raised its 2024 FFO guidance by 10 cents per share at the midpoint to a range of $7.45 to $7.75 per share. The guidance increase reflects incremental fee generation, as well as the outperformance of the REIT's real estate portfolio and the Summit One Vanderbilt complex in New York City.
Apart from SL Green, four other office REITs reported double-digit quarter-over-quarter declines in operating FFO per share during the second quarter: Orion Office REIT Inc. at 30.6%, City Office REIT Inc. at 15.2%, Office Properties Income Trust at 13.9% and Brandywine Realty Trust at 12.5%.
The majority of office REITs posted lower operating FFO per share compared with their year-ago and pre-pandemic levels.
Looking at the sector's recurring EBITDA, the proportion of REITs with sequential losses are even higher, with 12 REITs posting quarterly declines during the second quarter. The remaining 10 office REITs logged quarter-over-quarter gains during the same period.
SL Green also had the largest quarterly drop in recurring EBITDA, falling 31.2% to $85.9 million. Orion Office and Net Lease Office Properties also posted double-digit quarterly declines, at 20.3% and 13.9%, respectively.
More than half of the office REITs recorded higher recurring EBITDA than their pre-pandemic levels.
Occupancy rate at historic lows; median rent barely down
The office REIT median occupancy rate plunged to 83.5%, a 2.1-percentage-point drop from the previous quarter and the lowest it has been since occupancy rates started declining in 2020. The median occupancy rate was down 3.4 percentage points year over year and dropped 9.5 percentage points compared with the fourth quarter of 2019, just before the COVID-19 pandemic.
Franklin Street Properties Corp. had the lowest office occupancy rate during the second quarter at 70.2%, a slight drop from 70.4% from the previous quarter.
"The decrease in lease occupancy was primarily attributable to one property disposition in the first quarter and multiple lease expirations during the first 6 months of 2024," Franklin Street Executive Vice President John Donahue said on an earnings call July 31.
Equity Commonwealth and Hudson Pacific Properties Inc. had the second- and third-lowest office occupancy rates during the same period, at 71.4% and 80.0%, respectively.
By contrast, COPT Defense Properties recorded the highest office occupancy rate at 94.9%. Vornado Realty Trust came in second, with an occupancy rate of 89.3%, while Cousins Properties Inc., Highwoods Properties Inc. and Empire State Realty Trust Inc. all reported occupancy rates of 88.5%.
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The median rent across US office REITs was relatively flat during the second quarter, declining slightly by 0.1% from the previous quarter to $51.80 per square foot per year. However, the median rent was still comparably higher than $51.23 in the second quarter of 2023 and a 15.6% spike from the pre-pandemic level of $44.80 during the fourth quarter of 2019.
Paramount Group Inc. had the highest average office rent at $92.47 per square foot per year. It was followed by Vornado and BXP Inc., with average office rents per square foot per year of $89.76 and $80.70, respectively.
Empire State Realty registered the largest sequential hike in office rent, increasing 6.2% to $70.67 per square foot per year during the second quarter. Cousins Properties and Vornado followed, posting office rent increases of 4.4% and 4.3% from the previous quarter, respectively.
On the other hand, Office Properties Income posted a 0.3% quarter-over-quarter decline in average office rent to $29.14 per square foot per year. The only other office REIT that booked a sequential drop in rent was Hudson Pacific Properties, falling 0.2% from the prior quarter to $55.84 per square foot per year during the second quarter.
Property transactions down
Transaction activity slowed within the office REIT sector during the second quarter, following a strong showing during the previous quarter. The overall drop in transaction activity was felt in both asset acquisitions and dispositions.
For the fifth consecutive quarter, the amount of property dispositions by office REITs was much higher than acquisitions. During the second quarter, dispositions by office REITs amounted to $1.02 billion, less than half of the $2.25 billion worth of dispositions reported in the prior quarter.
SL Green contributed about 65% of the disposition value during the second quarter, totaling $665.1 million. The REIT sold its fee ownership interest in the 625 Madison Ave. tower in New York City for $634.6 million plus certain fees payable to SL Green. In relation to the sale, the REIT and its joint venture partner originated a $235.5 million preferred equity investment in the property. The REIT also sold the 719 Seventh Ave. property for $30.5 million toward the end of the second quarter.
Two other REITs sold properties exceeding $100 million in total value during the second quarter: Net Lease Office and Vornado, with dispositions worth $152.4 million and $117.1 million, respectively.
Property acquisitions remained relatively low during the quarter, at $59.1 million, down 88% from the first quarter.
Dismal stock performance
US equity REIT stocks underperformed the broader market during the second quarter. Office REIT stocks were among the worst-performing REIT stocks across all property types, with the Dow Jones US Real Estate Office index losing 4.4% for the quarter.
As of Sept. 5, the Dow Jones US Real Estate Office index was still down 43.5% compared with the end of 2019. The index also underperformed the broader Dow Jones Equity All REIT index, which rose 5.4% over the same period.
