Office buildings across 10 major cities are just 24% filled with workers. Here, a view of Boston’s Prudential Center.
Maddie Meyer/Getty Images
Big-city office buildings remain mostly empty, but vaccinations are on the way. Should investors buy shares of office landlords now, while their prices remain depressed and their dividend yields plump?
Better to favor what is already working in real estate investment trusts, or REITs, says Brent Dilts, an analyst with UBS. That means warehouse owners. Their dividend yields won’t impress, but they are riding an e-commerce boom that is likely to drive future rents higher.
One challenge for office landlords is that managers are growing happier with the performance of their remote workers. In a recent independent survey of more than 1,000 hiring managers commissioned by Upwork, a jobs service for freelancers, 68% said things were going better than they were earlier in the pandemic, versus just 5% who said things were getting worse.
Asked about plans for staffing five years from now, managers, on average, said 37.5% of workers would be fully or partly remote. That’s down from 56.8% today, but up from 21.2% before the pandemic.
Not to worry, office bulls say. Companies will want more space for each worker, reversing years of densification, which will help to offset declines in the number of office workers. But the problem with that thesis, Dilts says, is that the vaccines have proven far more effective than initially expected, which could cut into demand for de-squishing.
All told, he predicts an 8% decline in office-space demand versus before the pandemic.
Any back-to-work scenario would compare well with now. Office buildings across 10 major cities are just 24% filled with workers, reckons Kastle Systems, a security company. In New York, the figure is 14%, and in San Francisco, just 12%.
If occupancy rebounds to something below prepandemic levels, it might take years to be fully reflected in market rents. For example, Boston Properties (ticker: BXP), the biggest U.S. office REIT, has an average weighted lease term of over 11 years. It traded recently at $92, down from over $140 a year ago, but up from the mid-$70s before effective vaccines were announced. The dividend yield is 4.3%. Vornado Realty Trust (VNO), the No. 2 office REIT, pays even more: 5.7%.
Dilts covers Boston Properties, and expects shareholders over the next year to be rewarded with their dividends, and not much else. He rates the shares at Neutral.
Among his top REIT picks for 2021 are industrial players Prologis (PLD) and Duke Realty (DRE), both of which trade higher than before the pandemic. Prologis yields a meager 2.2%, and Duke 2.5%, but Dilts sees further share-price upside of 25% and 13%, respectively.
Both companies specialize in warehouses and distribution facilities, Duke in the U.S., and Prologis worldwide. Covid-19 hurt store traffic last year, but overall spending rose, as online shopping more than made up the difference.
E-commerce requires roughly three times as much warehouse space as store-based retail. Sellers and manufacturers are also eager to build inventories, following supply disruptions from the pandemic and a trade war with China. That means warehouse demand is likely to outstrip new supply in the years ahead, pushing rents well higher. Already, Dilts estimates, market rents are 14% to 18% higher than ones embedded in contracts for Prologis and Duke.
Peloton Interactive (PTON), the seller of big-screen exercise bikes and virtual classes, said Thursday evening that its number of paying subscribers more than doubled over the past year, to 1.7 million, counting just those who use its machines, plus another 625,000 if users who pay a lower price for just its app are included.
That sounds like excellent news, but the stock skidded 8% on Friday. The company will spend $100 million over the next six months on expedited machine shipments, which will cut into nascent profits. That sounds like a high-class problem. So why the selloff?
BMO Capital Markets analyst Simeon Siegel, who is bearish on the stock, points out that Peloton beat revenue estimates, but only by 2%. And he says that the magnitude of its upside surprises has been steadily declining, while management’s guidance was barely above estimates.
“Now a beat is a beat, and PTON is clearly posting strong results,” Siegel wrote in a Friday note to investors. “However, given where shares trade, as guides and/or beats slow, we worry [the] share price will follow.”
Siegel notes that Peloton, sometimes called the Netflix (NFLX) of connected fitness, had recently traded at 22% of the stock market value of the streaming giant, but has only about 1% of its subscriber base.
There is another, perhaps less immediate threat. I spoke recently with Scott Watterson, co-founder and chief executive of privately held ICON Health & Fitness, which makes fitness machines under brands like NordicTrack and Proform. It has a software platform called iFit, which allows users to participate in live training or simulate runs and rides in exotic locales worldwide.
Watterson told me that iFit is up to five million members, a million of whom pay subscription fees. That suggests that paying subscribers may have tripled in a year and a half. Watterson says customers today shop as much for fitness software platforms as for the machines. Part of ICON’s pitch is that with a single fee, users can connect to its treadmills, bikes, rowers, ellipticals, and strength trainers.
The connected-fitness boom and Peloton’s lofty stock valuation would seem to invite ICON to pursue an initial public offering soon. Watterson had no comment on that.
If ICON does go public, Peloton could find itself jostling not just for fitness subscribers, but also to hold onto its share of the affection of growth investors.
Write to Jack Hough at [email protected]. Follow him on Twitter and subscribe to his Barron’s Streetwise podcast.
