Linking strategy

SL Green Realty: recovery is underway (NYSE: SLG)

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Investment thesis

As pandemic risks fade, SL Green Realty Corp. (NYSE: SLG) may be a good choice even in this high inflation environment. For income-seeking investors looking for monthly dividend payouts, SLG could be an ideal choice with a Dividend yield of 4.62% and possibility of payment of an additional single dividend at the end of the year. SLG is fairly valued and I would prefer to see a price closer to $70 to buy, but the fundamentals are stable and SLG’s dividend is safe and well covered. Despite not-so-stellar 2021 annual results, occupancy is very impressive and new developments could fuel the company’s growth in the future.

business model

SL Green Realty is Manhattan’s largest office landlord. SLG is a fully integrated REIT, primarily focused on acquiring, managing and maximizing the value of commercial properties in Manhattan. The company owns approximately 5% of the total office real estate in Manhattan and has another 1.3% in the form of secured debt and preferred stock investments. As of December 31, 2021, SL Green held interests in 73 properties totaling 34.9 million square feet. Because SLG is a REIT, it recognizes the lion’s share (nearly three-quarters of its revenue) of rental income. 35% of their tenants come (unsurprisingly) from the financial services industry, as you would expect in Manhattan. Their top 10 tenants include Nike, Bloomberg, ViacomCBS, Credit Suisse Securities USA, etc.

SLG revenue streams

The table is created by the author. All figures are taken from the company’s financial statements and SA earnings estimates.

Finances and income

2021 Q4 and annual results

The business has been hit hard by the pandemic, although they were the first to return from the WFH to lead by example in 2021. SLG management has realized in recent years that providing only office, residential or retail would not suffice for tenants, so the company develops its new projects with amenities integrated into the workplace or living space. Funds from operations was $1.52 per share in the fourth quarter of 2021, below the estimate of $1.56 per share. Total FFO was approximately 14.5% lower in 2021 compared to full year 2020 results due to the ongoing pandemic. Rental income decreased by 14.69%, investment income by 33.14% and other income by 33.3%.

The decline in rental income is mainly attributable to the disposal of properties ($45.5 million) and properties put into redevelopment ($39.7 million). The decrease in investment income is the result of a decrease in the weighted average balance and weighted average yield of the Company’s debt and preferred equity portfolio, which decreased by 21.43%, while the average yield fell from 7.7% to 7.1%. Other revenue was down primarily due to lower lease termination revenue, which would have been great had the other revenue segments increased.

Future plans

The company has an above average occupancy rate of 93% and management intends to reduce the 7% vacancies. “This market – the Manhattan market has a vacancy rate of 16% to 18% depending on which source you use and our portfolio is only 7% vacant and going down.” Mark Holiday, CEO. The company earned a total of $605.1 million in net operating income in 2021 and management intends to grow it by 18% CAGR through the end of 2024.

SLG CAGR 18%

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Evaluation

SLG is quite valued. The company lost around 55-57% of its value during the first shock of the pandemic and since then the share price could more or less recover. However, it is still 18% below its pre-pandemic level. Currently, it is trading at around 8.4 times its forward FFO, which is better than the industry average. Additionally, there is a relatively high short interest in the stock at 8.67%. SLG’s price to tangible book value has remained relatively stable over the past 9 months, ranging between 1.16 and 0.96. At the moment, it is trading at 1.12x its TBV.

It is interesting to compare its price back in the market as this can lead to some interesting facts. If we compare the price return of the S&P500 to SLG, we can see that the pandemic has hit the company hard while the overall market not only recovered, but hit new highs. This is the same situation as during the financial crisis of 2008 when SLG was hit hard and took many years to recover (if only the actual crisis of 2008 is considered) while the S&P 500 could recover relatively quickly. However, looking only at this year, when the overall market was hit by interest rate hikes, the war in Ukraine, etc., SLG remained strong and posted a positive return against the S&P. 500.

Graphic
Data by Y-Charts
Graphic
Data by Y-Charts

Company specific risks

A large majority of SLG’s real estate is comprised of commercial office properties located in midtown Manhattan. Their real estate portfolio also includes some commercial buildings. Due to the Company’s concentration of assets, its business is dependent on the state of the New York metropolitan area economy in general and the midtown Manhattan office space market in particular. Five of their properties accounted for 39% of the portfolio’s annualized cash rents. Moreover, it unfortunately makes the company vulnerable to terrorist activities. In the wake of a terrorist attack, tenants in the New York metropolitan area may choose to relocate their business to less populated and less publicized areas of the United States that these tenants believe are not as likely to be the target of future terrorist activity.

the increase in construction cost is a major risk factor for new developments at SLG. Supply chain disruptions due to the war in Ukraine could affect the cost of raw materials and supply difficulties may arise. In my opinion, this increase in raw material costs will not affect SLG’s operations significantly as the company recognizes the majority of its revenue from rental income.

The vast majority of the company’s investment loans are variable rate loans, which means that rising interest rates benefit them. However, under their 2021 credit facility and certain property-level mortgage debt bear interest at variable rates. Additionally, SLG may increase the amount of its floating rate debt in the future, in part by borrowing additional amounts under its 2021 credit facility, but the interest on these loans will be higher than before.

My take on the SLG dividend

Current dividend

SLG has been paying a consecutive dividend for 24 years, but the company has no history of consecutive dividend growth. Management intended to increase the dividend when the real estate and office market was stable, but had to reduce the dividend in 2008. Since the beginning of 2020, the company pays a monthly dividend. Management announced a slightly increased monthly dividend of $0.3033 per share to $0.3108 per share from December 2021. SLG is currently yielding 4.62%, which is slightly above the industry average.

Future sustainability

Earnings estimates are realistic in my opinion for the next few quarters, as businesses have already returned to the office and old leases are up for renewal. FFO growth may be further supported by residential and commercial units and investment income. The payout ratio is sustainable and secure over the long term even if management decides to increase the current dividend. Analysts expect a smaller dividend increase in 2022 than the year before. The last increase was 2.47% and analyst estimates are 0.33%, but I think that’s a very conservative estimate. I would suggest a 1-2% increase instead due to rent increases due to inflation.

SLG Dividend Payout Rate

The table is created by the author. All figures are taken from the company’s financial statements and SA earnings estimates.

Final Thoughts

There is no doubt in my mind that SLG is a good company with excellent dividend coverage and stable future prospects. Comparing SLG to the overall market, I think it’s a safer choice at the moment due to fears of recession due to inverted yield curve, war insecurity and supply chain disruptions . For income investors, SLG can be a safe and good long-term choice, however, I would like to see a better valuation to have a shorter-term capital gain as well. I would consider a buy position at around $70 as $81 is a little expensive for me considering all valuations and fundamentals.