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Various Rating Actions Taken On Eight U.S. Office REITs On Secular And Cyclical Headwinds

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Various Rating Actions Taken On Eight U.S. Office REITs On Secular And Cyclical Headwinds

Overview

  • Fundamentals in the office real estate market are deteriorating, pressured by longer-term secular headwinds from remote working and near-term cyclical risks from a slowing economy and weaker job growth. Following a portfolio review of the rated office REITs, S&P Global Ratings took several rating actions.
  • We affirmed all ratings on the following issuers: Boston Properties Inc., Brandywine Realty Trust, Highwoods Properties Inc., Kilroy Realty Corp., Piedmont Office Realty Trust Inc., and Vornado Realty Trust.
  • We placed all ratings on Hudson Pacific Properties Inc., including our 'BBB-' issuer credit rating, on CreditWatch with negative implications.
  • We also lowered the issuer credit rating on Office Properties Income Trust to 'BB' from 'BBB-' and the issue-level rating to 'BB+' from 'BBB-'.
  • The rating outlook is negative on Boston Properties, Brandywine, Office Properties Income Trust, Piedmont Office Realty Trust Inc., and Vornado Realty Trust.
  • The rating outlook is stable on Highwoods Properties Inc. and Kilroy Realty Corp.

NEW YORK (S&P Global Ratings) March 31, 2023--

We expect office assets to underperform other real estate property types over the next two years given expected pressure to net effective rents and occupancy levels. Growth for the rated office REIT sector will likely be muted overall, with relatively flat to slightly negative NOI growth projected in 2023 given our expectation for leasing activity to remain slow, with office landlords wielding limited pricing power.

The office sector also has relatively higher debt leverage than other property types given heightened development exposure, adding to the downside risk if lease up is slower than expected.

Despite demand pressure, we expect the flight to quality will widen the bifurcation between class A and class B properties over the next year and allow owners of class A real estate to gain share and outperform the overall market. Our rated REITs generally own class A properties and should outperform the broader market.

The U.S. economic weakness in 2023 is expected to soften the job market later this year. Businesses will also likely need to trim payrolls, as seen in interest rate-sensitive sectors, as demand dries up in other industries. The recent banking sector disturbance will likely further add to a softer jobs market. We expect the current 3.6% unemployment rate to peak at 5.4% in the first half of 2025 before starting a gradual decline.

We also expect the technology sector slowdown to curb demand for office space because technology has been a key demand driver due to robust growth. While we believe office REITs operate with healthy tenant bases that span diverse industries, the recent job cuts in the technology sector, coupled with a deteriorating job picture as the economy slows, will likely pressure demand for office space.

Still, office REITs benefit from the long-term nature of leases and well-staggered lease expiration profiles. As such, they are relatively well positioned to avoid a material disruption to cash flows caused by the cyclical and secular headwinds.

Tightening access to capital will hinder growth and increase refinancing risk. Aggregate debt maturities for our rated office REITs are $4.1 billion in 2023 and $3.7 billion in 2024 as of Dec. 31, 2022, representing 6.9% and 6.4% of office debt maturities, respectively. We expect weaker fundamentals and rising rates to pressure valuations for office assets over the next year. As debt maturities approach, refinancing costs will be significantly higher, and we expect credit metrics to deteriorate given higher debt costs and weaker earnings, with coverage ratios expected to decline meaningfully as issuers refinance their maturing debt at higher rates. Given a largely unencumbered asset base for the rated REITs, refinancing with secured debt could be an option, but loan to value will likely be lower than current levels and an increased use of secured debt could put unsecured debtholders at a relative disadvantage. Asset sales could take longer to execute and delay the receipt of proceeds earmarked for debt reduction given tightening lending conditions and capital markets volatility.

Related Criteria

Related Research

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Ratings List

Ratings Affirmed
Highwoods Properties Inc.
Highwoods Realty L.P.
Issuer Credit Rating BBB/Stable
Kilroy Realty Corp.
Kilroy Realty L.P.
Issuer Credit Rating BBB/Stable
Ratings Affirmed; Outlook Action
To From
Boston Properties Inc.
Boston Properties L.P.
Issuer Credit Rating BBB+/Negative BBB+/Stable
Brandywine Realty Trust
Brandywine Operating Partnership L.P.
Issuer Credit Rating BBB-/Negative BBB-/Stable
Piedmont Office Realty Trust Inc.
Piedmont Operating Partnership L.P.
Issuer Credit Rating BBB/Negative BBB/Stable
Vornado Realty Trust
Vornado Realty L.P.
Issuer Credit Rating BBB-/Negative BBB-/Stable
Downgraded
To From
Office Properties Income Trust
Issuer Credit Rating BB/Negative BBB-/Negative
CreditWatch Action
Hudson Pacific Properties Inc.
Issuer Credit Rating BBB-/Watch Neg BBB-/Stable

Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at www.standardandpoors.com for further information. Complete ratings information is available to subscribers of RatingsDirect at www.capitaliq.com. All ratings affected by this rating action can be found on S&P Global Ratings' public website at www.standardandpoors.com. Use the Ratings search box located in the left column.

Primary Credit Analysts:Ana Lai, CFA, New York + 1 (212) 438 6895;
ana.lai@spglobal.com
Michael H Souers, Princeton + 1 (212) 438 2508;
michael.souers@spglobal.com
Alan Zigman, Toronto 1 (416) 507 2556;
alan.zigman@spglobal.com
Diandra J Prutton, San Francisco 917.231.4054;
diandra.prutton@spglobal.com
Hannah Gray, San Francisco + 212-438-0244;
hannah.gray@spglobal.com

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