Three Office REITs To Sell With Weak Balance Sheets

If you have read my recent articles, you know that I am expecting a major sell-off in REITs over the next 2 – 5 years.

As the graph below shows, the REIT rally that began in October, fueled by expectations of multiple rate cuts by the Fed, is showing signs of fizzling out.

This is a 180-degree about-face from my outlook at the beginning of this year. I base this new expectation primarily on the technicals, but also on a looming crisis in Office REIT debt.

Where the technicals are concerned, I had thought that the VNQ’s high of $116.71, struck on New Year’s Eve, 2021, was the culmination of a long III wave, with a IV wave pullback and a V wave rally yet to come. When REITs rallied off the October 2023 low, I thought that was the start of the V wave, that would take VNQ to the $130 range.

But the move down off the 2021 high was deeper than expected, and looks impulsive rather than corrective, and the rally off last October’s low now looks more like merely a B-wave bounce. We will know for sure if the price of VNQ falls below $70.61 before it regains its December 14 high of $90.09. If that is the case, then we are likely working on a C wave that will take the price down into the $50s before finding a bottom. Of course, there will be upward bounces along the way, but the overall picture is so bleak that I have liquidated all but two of my REIT positions.

Of course, you get to decide how much risk you take. But if I’m right about this, it’s time to start weeding the garden, at the very least. This article focuses on three of the weakest REITs in America, in addition to the eleven I identified in my most recent article.

The Office REIT sector will likely be the epicenter of the coming REIT meltdown. Not coincidentally, all three of the companies I will discuss in this article have extensive office holdings.

Criteria

All three companies ping at least 3 of the following 4 criteria:

1. Messy balance sheet, with high indebtedness, excessive variable rate debt, and/or weak EBITDA.
2. Weak forecast for FFO growth, when coupled with a messy balance sheet.
3. An unsafe dividend, or a profile of yield and dividend growth that is well below average.
4. Overvaluation, in terms of Price/FFO and/or premium to fair price, or excessive shorting, especially when coupled with any of the above.

Reading the charts

In all the tables that follow,

• Forward FFO Growth is the Bloomberg consensus (educated guess) for 2024, compared to 2023.
• Dividend Safety is a rating assigned by Seeking Alpha Premium Quant ratings, based on a complicated formula with about 20 input variables.
• Dividend Growth is 5-year CAGR from Q2 2019 through Q2 2024.
• Dividend Score projects the yield 3 years from now, assuming no change in the rate of dividend growth.
• Premium to target price is a metric supplied by Hoya Capital Income Builder, calculating the amount by which the current price exceeds the merited buy price.

Vornado Realty Trust

Vornado Realty Trust (VNO) is the largest of the three companies in this article, with a market cap of $5.28 billion. The company’s portfolio of office properties is concentrated in New York City, but VNO also has key assets in Chicago and San Francisco.

In a sector characterized by balance sheet problems, this company sports a debt ratio and Debt/EBITDA even worse than the Office REIT average. FFO is expected to sag by (-9.9)% in 2024, from $2.63 to $2.37, which will further constrain the company’s ability to pay its way out of debt.

Ticker	Debt Ratio	Debt/EBITDA	Var. Rate %	Fwd FFO Growth
VNO	58%	11.7	8.5%	(-9.9)%
Sector average	53%	8.7	11.8%	0.0%

Click to enlarge

Source: Hoya Capital Income Builder

VNO’s current forward yield of 4.63% is barely better than the “no-risk” rate of about 4.25% on treasuries, and well below the Office REIT average of 5.63%. But this company has already cut its dividend twice this year, and is paying less than half its pre-pandemic dividend. As a result, and with FFO projected to slide by almost 10%, it is hard to have a lot of confidence in the dividend going forward. Despite being in a high-paying sector, VNO instead earns a dividend score that is significantly lower than the average REIT.

Ticker	Div. Safety	Div. Yield	Div. Growth	Payout	Div. Score
VNO	NR	4.63%	(-8.0)%	60%	3.60
Sector average	C	5.63%	(-3.9)%	52%	5.00

Click to enlarge

Source: Seeking Alpha Premium, Hoya Capital Income Builder, and author calculations

Even at a low Price/FFO of 7.9, Hoya Capital Income Builder still considers VNO to be overpriced by about 33%. Meanwhile, the higher than average shorting of this company creates a headwind against share price gains.

Ticker	Price/FFO	Premium to Target Price	Short %	Short Ratio
VNO	7.9	32.9%	11.02%	15.14%
Sector average	9.0	(-9.1)%	7.07%	8.78%

Click to enlarge

Source: Hoya Capital Income Builder

Of the 14 Wall Street analysts covering this firm, 6 rate it a Sell or Strong Sell, and none rate it a Buy. The average price target for VNO is $24.75, which is only (-4.5)% down from its current level, but targets range as low as $19.00, which would represent a loss of about (-27)%.

JBG Smith

JBG Smith (JBGS) is a small-cap REIT at $1.35 billion. The company has 13.7 msf (million square feet) in its portfolio, with another 9.3 msf in the pipeline, all in Washington, DC and vicinity, and is transitioning from mostly office buildings to mostly multifamily. As of last month, 56% of the company’s NOI still comes from Office properties.

As with Vornado, the debt ratio for JBGS (58%) is even higher than the Office REIT average (53%), which in turn is much higher than the average REIT. Making matters considerably worse, variable rate debt accounts for an extraordinary 29.3% of the company’s total.

The company’s Debt/EBITDA is decent at 7.0, but unfortunately, the consensus calls for a (-22.2)% slide in FFO per share in 2024, compared to 2023 levels. Long-term earnings per share growth already stands at (-10.7)%, according to Seeking Alpha Premium.

Ticker	Debt Ratio	Debt/EBITDA	Var. Rate %	Fwd FFO Growth
JBGS	58%	7.0	29.3%	(-22.2)%
Sector average	53%	8.7	11.8%	0.0%

Click to enlarge

Source: Hoya Capital Income Builder

The company’s heavy reliance on variable rate debt results in a rather high weighted average interest rate of 4.84%.

The company earns a Dividend Safety score of C from Seeking Alpha Premium, but the yield of 4.73% is barely above the no-risk rate. JBGS never cut its dividend during the pandemic, but recently cut from $0.225 to $0.175 in February. As a result, JBGS earns a run-of-the-mill Dividend Score of 4.41. Share price has slid (-14.6)% since the company announced the divvy cut on February 14. Meanwhile, the expected slide in revenues this year likely precludes any dividend increases in the foreseeable future.

Ticker	Div. Safety	Div. Yield	Div. Growth	Payout	Div. Score
JBGS	C	4.73%	(-2.33)%	70%	4.41
Sector average	C	5.63%	(-3.9)%	52%	5.00

Click to enlarge

Source: Seeking Alpha Premium, Hoya Capital Income Builder, and author calculations

Even with a Price/FFO of just 11.4, Hoya Capital still considers JBGS to be overpriced by about 29%. Investors are shorting JBGS a little more heavily than the average Office REIT, and much more heavily than REITs in general.

Ticker	Price/FFO	Premium to Target Price	Short %	Short Ratio
JBGS	11.4	28.8%	8.74%	8.62%
Sector average	9.0	(-9.1)%	7.07%	8.78%

Click to enlarge

Source: Hoya Capital Income Builder

One of the three Wall Street analysts covering JBGS rates it a Strong Sell. None rate it a Buy. The Seeking Alpha Quant ratings system also maintains a Sell rating.

Alexander’s, Inc.

Alexander’s (ALX) is another small cap at $1.12 billion, and is externally managed by Vornado. The company owns precisely 5 properties, all in the greater New York City area. Although it owns office, retail, and multifamily properties, ALX is usually classified as an office REIT because the majority of its rental revenue comes from its Lexington Avenue property, which houses the corporate headquarters of Bloomberg.

Although the company’s debt ratio of 51% is typical of the dismal balance sheets in the Office REIT sector, the Debt/EBITDA for ALX is 10.0, which is substantially worse. Making matters worse still, a hefty 32.8% of ALX debt is held at variable (therefore higher) interest rates.

Ticker	Debt Ratio	Debt/EBITDA	Var. Rate %	Fwd FFO Growth
ALX	51%	10.0	32.8%	NA
Sector average	53%	8.7	11.8%	0.0%

Click to enlarge

Source: Hoya Capital Income Builder

Alexander’s has all the earmarks of a classic mousetrap. The 8.25% yield is tempting cheese, but the payout ratio of 114% is unsustainable. The company is paying the same dividend as 5 years ago, but with debt/equity at 484%, debt/capital at 83%, and FFO interest coverage ratio at just 1.69, according to Seeking Alpha Premium, it is questionable whether a cut in the next 12 months can be avoided.

Ticker	Div. Safety	Div. Yield	Div. Growth	Payout	Div. Score
ALX	D	8.25%	0.00%	114%	8.25
Sector average	C	5.63%	(-3.9)%	52%	5.00

Click to enlarge

Source: Seeking Alpha Premium, Hoya Capital Income Builder, and author calculations

Even with Price/FFO for ALX at just 12.8, Hoya Capital still rates the company’s shares as more than 50% above the merited buy price of $144. Meanwhile, the company’s short ratio is nearly as bad as Vornado’s, and considerably worse than the Office REIT average.

Ticker	Price/FFO	Premium to Target Price	Short %	Short Ratio
ALX	12.8	51.5%	6.16%	13.06%
Sector average	9.0	(-9.1)%	7.07%	8.78%

Click to enlarge

Source: Hoya Capital Income Builder

Only one Wall Street analyst covers ALX, but that one analyst rates it a Strong Sell, with a price target of $145, implying downside of about (-33)%.

Investor’s bottom line

Any company is more than just its numbers. A reasonable Hold case probably could be made for some, if not all, of these companies.

However, houses built on weak foundations suffer the most damage in a storm. Only the strong will survive the storm that appears to be coming to REITworld. The first step in preparing is to get rid of the flimsy firms. Two to five years from now, you will likely be glad you did. There are better places for your money.

But as always, the opinion that matters most is yours. Because it’s your money.