Office REIT Cash Flow Faces Risks From COVID-19

Real Estate

The boom in working from home due to COVID-19 could crimp office REITs’ cash flow, according to a new report.

The report from Fitch Ratings expects that a long-term shift to remote work will reduce demand for new space and raise risks for future lease renewals. The office REIT sector did well in terms of rent collections after stay-at-home orders were issued, and only 10% of leases are expected to expire in the next few years.

But leases up for renewal are being signed for shorter durations as tenants seek time to assess the effects of the pandemic on the economy.

“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,” according to Fitch. “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.”

Fitch expects low- to mid-single digit same-store operating income declines for the sector in 2020. That’s compared with median annual growth of 3% to 6% since 2012. Growth is expected to rebound in 2021.

“The recovery in occupancies is expected to be a byproduct of an improving economy and pent-up demand,” according to Fitch. “However, more subdued demand for real estate could prove to be a headwind for a concomitant recovery in the sector.”

Ratings for REITs have drifted downward since the outbreak of COVID-19. Reduced ratings are primarily due to economic pressure on the office segment, and a heightened concern to successfully lease properties in the future.

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.

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