Most office REITs post drop in Q3 2023 funds from operations per share

Most US office real estate investment trusts had weaker operating performance during the third quarter, as occupancy rates and property transaction activity further declined.

Funds from operations, recurring EBITDA

Fourteen office REITs reported a quarter-over-quarter drop in operating funds from operations (FFO) per share. FFO was flat for four other REITs, while three reported sequential gains during the third quarter, according to an S&P Global Market Intelligence analysis.

Market Intelligence defines operating FFO as FFO adjusted for extraordinary items or other nonrecurring items at the discretion of the company. Office REITs sometimes refer to this as normalized FFO or core FFO.

Office Properties Income Trust reported third-quarter FFO of $1.02 per share, down from $1.11 per share in the second quarter. Office Properties CFO Brian Donley attributed the decline mainly to higher interest expense and lower net operating income that was impacted by a seasonal increase in utility expense. Donley also hinted that the sequential drop will continue in the fourth quarter.

"We expect normalized FFO to be between $0.96 to $0.98 per share. The decrease from Q3 is made up of several items, most notably increased interest expense and projected increases in operating expenses," Donley said on an earnings call.

Creative Media & Community Trust Corp., which also booked a quarterly and annual decline in FFO, reported a similar issue. "These reductions were primarily driven by the increase in interest expense, largely due to our multifamily acquisitions, two of which are still in their initial lease-up phase," said Creative Media CFO Barry Berlin on an earnings call.

Just over half of office REITs reported improvements in recurring EBITDA during the quarter. Twelve office REITs logged gains in EBITDA, while 10 others posted quarterly losses.

The majority of office REITs posted lower operating FFO per share compared to their year-ago and pre-pandemic levels. More than half of the office REITs logged higher recurring EBITDA than their prepandemic levels.

Median rent up; occupancy rate down

Rents considerably increased during the third quarter. The median rent across US office REITs went up by 7.9% from the previous quarter and by 9.3% from the year prior, to $55.28 per square foot per year. The median rent also increased from $44.80 per square foot per year during the fourth quarter of 2019.

Paramount Group Inc. had the highest average office rent, at $90.92 per square foot per year. It was followed by Vornado Realty Trust and Boston Properties Inc., with average office rents per square foot per year of $86.49 and $78.33, respectively.

Highwoods Properties Inc. logged the highest increase in average office rent during the third quarter, up 0.9% quarter over quarter to $31.88 per square foot per year.

The biggest decline in average office rent was reported by Cousins Properties Inc., down 12.2% from the previous quarter to $33.94 per square foot per year. The REIT posted a rent increase during the second quarter.

On an earnings call, Cousins Properties Executive Vice President of Operations Richard Hickson said the average rent for the third quarter was substantially in line with full year 2022, adding that the REIT's average net effective rent is still strong at $23.77.

COPT Defense Properties and Kilroy Realty Corp. also posted quarterly declines in average rents, down 0.5% and 0.2%, respectively.

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The office REIT median occupancy rate fell in the third quarter, at 86.7%. On an annual basis, the median occupancy rate was down 1.1 percentage points and plummeted 6.3 percentage points compared to the fourth quarter of 2019, just before the COVID-19 pandemic.

Franklin Street Properties Corp. had the lowest office occupancy rate during the third quarter, at 72.4%, followed by Equity Commonwealth, at 80.8%.

Peakstone Realty Trust maintained the top position in terms of occupancy rate, at 97%. COPT and Vornado followed, with occupancy rates of 95.1% and 91.6%, respectively.

Drop in property deals

Office REIT transaction activity has considerably dropped during the third quarter, after the previous quarter's significant rise that was buoyed by increased asset dispositions.

Property dispositions by office REITs amounted to $292.4 million, down massively from $2.98 billion in the previous quarter. These dispositions were largely driven by Vornado, after selling four Manhattan, NY, retail properties for $100 million in August and The Armory Show in New York City for $24.4 million in July.

Hudson Pacific Properties Inc. also sold two properties during the third quarter — 3401 Exposition and 604 Arizona in Santa Monica, Calif. — for a combined sale price of $72.5 million.

Property acquisitions remained low during the quarter, at $85.9 million, compared to $100.5 million in the second quarter.

Stock performance well below prepandemic levels

US equity REIT stocks further underperformed the S&P 500 during the third quarter. Office REIT stocks posted a negative return, albeit performing better than the other REIT sectors. The Dow Jones US Real Estate Office Index lost 3.7%.

As of Nov. 27, the Dow Jones US Real Estate Office Index was down 55.4% compared to the end of 2019. It underperformed the broader Dow Jones Equity All REIT index, which declined 11.7% during the same period.