Company Reports

The US REIT sector remains significantly undervalued, in our perspective. While the pandemic hurt REIT valuations in 2020, the recovery of fundamentals across most sectors combined with low interest rates led to strong total returns in 2021 and early 2022. However, despite fundamentals continuing to perform well over the past two years, with many REITs reaching historical levels of net operating income growth, the sector has underperformed the broader equity markets over the past two years. We believe that the cause has been the sector’s negative correlation with interest rates as income-oriented investors rotate out of the sector, higher rates lower the value REITs can create with external growth, and property valuations fall in line with higher rates. However, we don’t believe that higher rates significantly change our fair value estimates for the sector. Additionally, interest rates are down from the October 2023 highs, and REIT share prices have generally inversely followed the movements of the US 10-year Treasury.

No-moat-rated Empire State Realty reported a decent set of numbers in the first quarter as core funds from operations, or FFO, was reported at $0.21 per share in the current quarter, around 31% higher than the $0.16 in core FFO during the same quarter last year. The full-year 2024 guidance was reaffirmed, which we see as a good sign for leasing momentum in the Manhattan office market environment. Core FFO for 2024 is guided at $0.90-0.94 per share, up 2.2% at the midpoint compared with $0.90 in core FFO during 2023 after excluding nonrecurring items. The occupancy rate is expected to be in the 87%-89% range by the end of 2024 compared with 87.6% as of the end of the first quarter. We are maintaining our fair value estimate of $9.60 per share for Empire State Realty after incorporating the first-quarter results.

We believe that there are several attractive opportunities across the US REIT sector for investors to consider. Following the recovery of many REIT sector fundamentals from the pandemic by mid-2021, we viewed the REIT sector as fairly valued through early 2022. However, the past two years have seen the rapid rise in interest rates and a slowing economy, which has led to major valuation declines across the sector. Our analysis of the REIT sector over the past 25 years suggests that the relative stock performance of REITs is negatively correlated with interest rate movements. The second and third quarters of 2023 saw large interest rate increases with the 10-year Treasury approaching 5%, which led to the sector underperforming. This occurred even as many REITs reported same-store net operating income, or NOI, growth at historical highs in 2022 due to high inflation. Higher interest rates, lower liquidity, tighter capital market conditions, and decelerating same-store NOI growth all led to a significant correction in the stock price for many REITs.

Empire State owns and manages about 9.4 million square feet of commercial real estate portfolio composed principally of office buildings in Manhattan and the greater New York area. Its office portfolio fetches lower rents and has higher vacancy rates, reflective of an older, less premium building stock. Management has successfully focused on redeveloping its older office properties in recent years by providing more amenities and aligning its portfolio to meet the maintainability requirements of its clients.

No-moat-rated Empire State Realty Trust reported a good set of results for the fourth quarter. Core funds from operations came in at $0.25 per share, around 14% higher than the $0.22 in core FFO in the same quarter last year. Full-year 2024 guidance was also quite decent, especially given the challenging Manhattan office market environment. Management expects 2024 core FFO of $0.90-0.94 per share, up 2.2% at the midpoint compared with $0.90 in core FFO during 2023 after excluding nonrecurring items. The occupancy rate is expected to be 87%-89% by the end of 2024 compared with 86.3% in 2023. Same-store property cash net operating income is expected to be in the negative 1% to positive 2% range. The same-store cash NOI guidance assumes positive revenue growth and a 6%-8% increase in operating expenses and real estate taxes, partially offset by higher tenant expense reimbursements. We are maintaining our $9.60 fair value estimate after incorporating fourth-quarter results into our model.

Empire State Realty owns and manages about 9.4 million square feet of commercial real estate portfolio composed principally of office buildings in Manhattan and the greater New York area. Its office portfolio fetches lower rents and has higher vacancy rates, reflective of an older, less premium building stock. Management has successfully focused on redeveloping its older office properties in recent years by providing more amenities and aligning its portfolio to meet the maintainability requirements of its clients.

No-moat-rated Empire State Realty reported a good set of numbers in the third-quarter results as core funds from operations, or FFO, was reported at $0.25 per share in the current quarter, around 19% higher than the $0.21 in core FFO during the same quarter last year. The shares of the company were up around 7% after the company released its third-quarter results. The demand for Manhattan office real estate remains muted because of macroeconomic factors and a slower recovery in physical office utilization rates, but the company has performed relatively well given the current environment. We are maintaining our fair value estimate of $9.50 per share for Empire State Realty after incorporating the third-quarter results.

The share prices of U.S. real estate investment trusts have fallen by approximately 30% from their 2021 highs because of higher interest rates and stress in some commercial real estate sectors. We think that the correction is overdone and the current valuations offer an attractive entry point for patient investors. Our core REIT coverage is trading at a discount of approximately 25% to our fair value estimate. We estimate that the average REIT within our U.S. coverage is currently trading at a dividend yield that is 126 basis points higher than the historical average. We see marked differences in valuation across different REIT sectors in the United States. For instance, the industrial sector is fairly valued, with stock valuations already accounting for future growth, but other sectors like offices, hotels, and malls are trading at attractive discounts.

No-moat-rated Empire State Realty reported middling second-quarter results as the core funds from operations, or FFO, were reported at $0.26 per share in the current quarter, around 11% lower than the $0.29 in core FFO during the same quarter last year. The demand for Manhattan office real estate remains muted due to macroeconomic factors and a slower recovery in physical office utilization rates. The shares have rallied by around 50% in the past few months on the back of some encouraging Manhattan office building transactions. The shares are still currently trading around 10% below our fair value estimate for the firm. We are maintaining our fair value estimate of $9.50 per share for Empire State Realty after incorporating the second-quarter results.

Empire State Realty owns and manages 9.4 million square feet of commercial real estate portfolio composed principally of office buildings in Manhattan and the greater New York area. Its office portfolio fetches lower rents and has higher vacancy rates, reflective of an older, less premium building stock. Management has successfully focused on redeveloping its older office properties in recent years by providing more amenities and aligning its portfolio to meet the maintainability requirements of its clients.

No-moat-rated Empire State Realty reported disappointing first-quarter results as the core funds from operations, or FFO, was reported at $0.16 per share in the current quarter, around 11% lower than the $0.18 in core FFO during the same quarter last year. The demand for Manhattan office real estate remains muted due to macroeconomic factors and a slower recovery in physical office utilization rates. The short-term outlook for office real estate remains challenging, but shares are cheap from a long-term perspective. We think that the current share prices of our office REIT coverage reflect excessive pessimism. Empire State Realty is trading at around $5.80 per share after releasing its first-quarter results, which implies a 7 times 2023 FFO multiple. We are maintaining our fair value estimate of $9.50 per share for Empire State Realty after incorporating the first-quarter results.

Empire State Realty Trust owns and manages 9.7 million square feet of commercial real estate portfolio composed principally of office buildings in Manhattan and the greater New York area. Its office portfolio fetches lower rents and has higher vacancy rates, reflective of an older, less premium building stock. Management has successfully focused on redeveloping its older office properties in recent years by providing more amenities and aligning its portfolio to meet the maintainability requirements of its clients.

No-moat-rated Empire State Realty reported decent fourth-quarter results as the core funds from operations, or FFO, was $0.22 per share in the current quarter, lower than the $0.18 in core FFO during the same quarter last year. Same-store property cash net operating income, or NOI, excluding lease termination fees decreased by 3.3% in the current quarter on a year-over-year basis, primarily because of higher property-operating expenses and real estate taxes. The company reported an occupancy rate of 85.2% in the fourth quarter, up 100 basis points on a sequential basis and 280 basis points compared with a year ago. The company has guided for an 85% to 87% occupancy rate for the 2023 year-end. The average starting cash rents on the newly executed leases in the office and retail portfolio of the company were 2.2% lower than the previously escalated cash rents in the fourth quarter. We are maintaining our $10 per share fair value estimate for the firm after incorporating fourth-quarter results.

No-moat Empire State Realty Trust reported middling third-quarter results. Core funds from operations came in at $0.21 per share, higher than the $0.20 in core FFO during the same quarter last year. As per management's previous guidance, same-store property cash net operating income excluding lease termination fees decreased 7.5% from the third quarter of 2021, primarily driven by the normalization of operating expenses due to increased building utilization. The company reported an occupancy rate of 84.2% in the third quarter, down 10 basis points on a sequential basis and up 70 basis points from a year ago. We have reduced our fair value estimate to $10 per share from $10.50 after moderating our long-term rent growth and occupancy expectations for the company.

Empire State Realty is a REIT that owns and manages 10.1 million square feet of commercial real estate portfolio composed principally of office buildings in Manhattan and the greater New York area. Its office portfolio fetches lower rents and has higher vacancy rates, reflective of an older, less premium building stock. Management has successfully focused on redeveloping its older office properties in recent years by providing more amenities and aligning its portfolio to meet the maintainability requirements of its clients.

No-moat-rated Kilroy Realty’s high-quality office portfolio now looks appetizingly cheap amid the steep selloff of office REITs in the last few weeks. We recognize the uncertainty surrounding the future of the office and believe that the environment will remain challenging for office owners in the near to medium term. Having said this, we also believe that the selloff has been overdone and the current implied valuation of Kilroy’s shares is completely divorced from the current private market valuations of its office portfolio. We think that long-term-oriented investors can consider this stock for their portfolios as the company is currently trading at approximately 40% below our fair value estimate of $69 per share. Our U.S. office REIT coverage is approximately 30%-40% undervalued. Kilroy Realty is our preferred pick in this sector given its risk-return profile.

With the United States experiencing historically high inflation growth, many investors are wondering if real estate provides a natural hedge against inflation and if the REIT sector should therefore outperform the broader equity market. Many REITs in our coverage have reported rent and revenue growth at or near historic peaks over the past several quarters, with inflation being one of the largest reasons for the high growth. Given this and some historical evidence that REITs outperformed in the 1970s and early 1980s when inflation was similarly high, some investors are questioning why REITs have not outperformed in 2022.

No-moat-rated Empire State Realty reported decent second-quarter results which were marked by a strong observatory recovery. The core office portfolio of the company continues to struggle as operating expenses normalize and workers remain reluctant in returning to offices. The physical attendance in restaurants, movies, and other entertainment-related events has reached pre-pandemic levels, but the recovery in physical office occupancy levels has remained tepid. We believe that employee behavior is primarily driven by preference and flexibility with regard to returning to the office. This is different from the early stages of the pandemic where the risk of getting the coronavirus was the main reason for lower office utilization. We would like to highlight that this dynamic does not bode well for the owners of office real estate as it points to a more permanent shift in worker and employer behavior. Remote work has now become a norm in corporate America, and we are also seeing increasing signs of employers accepting remote work and becoming comfortable with the new normal.

Empire State Realty is a REIT that owns and manages 10.1 million square feet of commercial real estate portfolio composed principally of office buildings in Manhattan and the greater New York area. Its office portfolio fetches lower rents and has higher vacancy rates, reflective of an older, less premium building stock. Management has successfully focused on redeveloping its older office properties in recent years by providing more amenities and aligning its portfolio to meet the maintainability requirements of its clients.

We are relaunching the coverage of Empire State Realty after taking a fresh look at it. We assign a no-moat rating, a negative moat trend, and a standard capital allocation rating to the company. We are decreasing the fair value estimate for Empire State Realty to $10.50 per share from $11.30 per share.