SL Green Realty: Manhattan Downbeat

When asked if I am pessimistic or optimistic about the future, my answer is always the same: If you look at the science about what is happening on Earth and aren’t pessimistic, you don’t understand the data. – Paul Hawken

Manhattan’s largest office landlord, SL Green Realty (NYSE:SLG), is passing through very trying times, and it does not seem that the rough patch will end soon. Offices and other commercial properties will start filling up once the virus is contained and the economy is back on its track, but these events appear some distance away despite the buzz around vaccines and cures. Meanwhile, CMBS (commercial mortgage-backed securities) delinquencies have risen, and the signs are not good for the commercial property sector.

Image Source: My tweet based on a CMBS-related risk-off recommendation in The Lead-Lag Report

SLG has depreciated 45% from its February 2020 level and has been consolidating at around $50 since June 2020. Here is my take at its prospects:

Financial Projections

As of Q2 2020, the company’s focus was to get past the next 18 months, and it had $1 billion in liquidity to help it tide over difficult times. The management informed analysts that tenants were paying at a slower pace. However, it also informed that cost savings from reduced occupancies and other measures would help the company save $14 million in operating expenses for the year. In Q2 2020, SLG reported a net income of $66.6 million after booking a gain of $64.9 million from the sale of investments.

Based on SLG’s Q2 2020 numbers as per its SEC filing and a roughed-up market, here are my approximate projections for the next 12 months based on a 10%, 20%, and 25% decrease in rental revenues.

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Image Source: Self-generated

Without accounting for gains from investment and real estate sales, SLG can end up with a net loss of $49 million, $128 million, or $167 million if its rental revenues were to drop by 10%, 20%, or 25%, respectively.

Despite the net loss projections, SLG is likely to report positive cash flows because of its non-cash depreciation and amortization charge.

Projected FFOs

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Image Source: Self-generated

Based on the profitability projections above for the next one year, and assuming that EBT will equal net income (zero taxes assumed), SLG is geared up to generate FFOs of $334 million, $256 million, or $217 million if its rental revenues were to drop by 10%, 20%, or 25%, respectively.

The projected FFO for the next one year is much lower than the FFO of $553 million the company generated in 2019, a non-COVID-19 year. The only consolation is that the estimated FFO is positive even if SLG’s net income takes a 25% hit.

The caveats are that the investment income should hold steady in the next 12 months, and rental revenues should not drop below, say, 30%. Other than these, SLG, with its current $1 billion liquidity and positive FFO in the next 12 months, seems all geared up to navigate through troubled times.

Manhattan Market Recovery in Question

As per a survey conducted by Partnership for New York City, a business group, just 8% of NY’s workforce returned to their offices in August 2020. The surveyors also estimated that about 26% of the workforce would be back at their office desks by December 2020 and 54% by July 2021. Tech employers in this survey expect not more than 74% of their staff back by July 2021. If all this proves true, the WFH trend will strengthen and tenants will renegotiate rents going forward.

Don Peebles, a NY real estate developer, believes that it would take a decade for the city to dig out of the COVID-19 hole. He also feels that rents will be much more affordable in the future. EastBanc’s Anthony Lanier estimates that there will be a massive collapse in real estate values. NY’s real estate czars, including SL Green, are already pleading with tenants to return to office.

Summing Up

NY rents and property values are falling, and so long as the virus is on the loose, I estimate they will continue to soften. We are now in the flu season, and things could worsen unless an effective and safe vaccine gets discovered. No one is sure of how the virus situation will unfold, and now the elections have gotten added to the mix.

It also doesn’t matter how much dividends the company has paid in the past, how much liquidity it has, its profitability or positive FFO, or how regular it is with share buybacks. All that matters is its future business prospects.

SLG faces many headwinds – fall in rental rates and estate values, virus uncertainty, the timing of economic recovery, strengthening of WFH trends, a downbeat demand for Manhattan offices, election blues, and tenant defaults. I reckon that my profitability scenarios will prove true (more or less) and that any net loss/lower FFO reported by the company going forward will negatively impact investor sentiment.

Though SLG is a quality REIT, it faces too many adverse variables. I would avoid investing in this stock.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This writing is for informational purposes only and Lead-Lag Publishing, LLC undertakes no obligation to update this article even if the opinions expressed change. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. It also does not offer to provide advisory or other services in any jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Lead-Lag Publishing, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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