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Morningstar | 2Q Results Illustrate the Resiliency of the New York Office Market; We Raise Our FVE to $105

Shares of SL Green are up around 3% after the company reported impressive second-quarter results, suggesting that investor trepidation surrounding the New York City office market is unwarranted. The company reported funds from operations of $1.82 per share, up from $1.69 in the second quarter of 2018. We think these results support our assertion that the long-term prospects for the Manhattan office market remain robust despite a recent flurry of supply additions, most notably the Hudson Yards development. Furthermore, we think SL Green’s portfolio of high-quality assets should allow it to continue to perform well within this market. Accordingly, we’re raising our fair value estimate for no-moat SL Green slightly to $105 per share from $102, mainly due to increased long-term rent-growth assumptions and the time value of money, slightly offset by more conservative assumptions for near-term occupancy rates. At current prices, we think shares are moderately undervalued.

Same-store occupancy in SL Green’s Manhattan portfolio remained strong in the second quarter at 95.2%, down slightly from 96% a year earlier. Meanwhile, the company’s suburban portfolio continues to struggle, with second-quarter same-store occupancy at 90%, down from 92.2% a year ago. In addition to declining occupancy, the suburban portfolio saw replacement leases decline 3.5% over previous fully escalated rents. This compares to a 30.5% increase for the company’s Manhattan portfolio. We think these figures point to the chasm emerging between the performance of urban and suburban office properties. We expect this trend to endure as corporations continue to pursue talent in vibrant urban locations where supply constraints help support rent growth. Among these urban locations, New York City should remain particularly attractive as it cements its preeminence as a hub for global talent.

Management indicated that the One Vanderbilt development is proceeding nicely, with construction on pace for a third-quarter 2020 completion and the property now 59% leased. The company also confirmed that it has now repurchased 1.3 million shares in 2019 in accordance with a previously announced $2.5 billion share repurchase plan. This plan derives from management’s opinion that there exists a disconnect between the intrinsic value of its assets on the private market and the public market’s perception of the value of its share price. We think this action is prudent given that the company’s shares are currently undervalued.