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Morningstar | SL Green Reports Reasonable Growth in Line With Expectations

We continue to believe that no-moat SL Green Realty Corp’s portfolio of class A New York office and retail space will attract the strongest tenants, and we will maintain our $114 per share fair value estimate for the firm. SL Green generated $1.69 in funds from operations, a penny less than our projections, and same-store cash net operating income grew about 8% from second quarter 2017. SL Green’s 7.1% trailing six-month Manhattan leasing spreads on new leases demonstrates a relatively strong portfolio, though this is generally expected as it is only 10 basis points above our annual forecast Manhattan spreads. Renewal leasing spreads were modestly lower than anticipated, but we do not believe this is cause for concern yet as the first half of the year only had a few, small leases up for renewal while 98% of the annualized cash rent expiring this year will occur in the second half of the year. Year-over-year same-store leased occupancy in the Manhattan portfolio grew 1.2%, somewhat ahead of schedule and on track for our long-term forecast of 96% to 97% occupancy for the portfolio. We see SL Green’s Manhattan leasing spreads and occupancy growth as reaffirmations of our thesis that the company’s strategy of offering class A office and retail space in Manhattan will be successful over the long term, given our belief that many companies are using class A offices to attract talent and that elite retail is more resistant to e-commerce.

While at first glance, SL Green appears to be progressing quickly with preleasing its new trophy property, One Vanderbilt, we estimated that about 40% of 2018’s preleasing was due to the company closing a single lease for about 6% of the total property. We continue to believe that One Vanderbilt runs a risk of office vacancies when the property opens in 2020 because SL Green is asking for both extra-premium rents and to lease huge blocks, which limits the list of potential tenants. Looking forward, we are watching developments regarding reports that SL Green may purchase 245 Park Avenue, a skyscraper the Chinese HNA Group purchased in 2017 for what we estimated to be 24% of SL Green's current market capitalization, $2.2 billion, as we would be interested in seeing the extent to which the potential purchase would impact SL Green’s balance sheet. We recognize that the company is disposing of assets quickly, which could partially finance such an acquisition. Overall, while we believe that these top tier office buildings offer a large potential reward, investors should recognize the risks involved.