Debt issued by publicly traded commercial real-estate investment trusts (REITs) has defied expectations by experiencing a significant rally in the early months of 2024, despite the challenges faced by the office sector.

For years, shopping centers were deemed undesirable investments, says Alex Snyder, a REIT-focused portfolio manager at CenterSquare Investment Management. However, with the shift towards remote work in the post-pandemic era, the term “office” has now become a dirty word.

While office vacancies continue to rise in many cities and landlords struggle with higher borrowing costs, Snyder points out that there is emerging optimism surrounding office-REIT debt. Unlike property-specific debt issued by the same borrower, office-REIT debt is backed by the entire company, making it a potentially more secure investment option.

Snyder explains, “Would I buy debt issued from 2015 to 2020 on a single-asset at par? There is no way. Would I buy corporate-office debt at a discount? Absolutely.”

The Changing Landscape of Office-REIT Debt

To illustrate this evolving landscape, take a look at the graphic below. It displays the trajectory of corporate-bond spreads for six major office REITs since the Federal Reserve’s significant interest rate hikes began in early 2022.

Boston Properties Inc., one of the leading players in the office sector, offers an interesting case study. In January, the five-year bond spreads for this office giant compressed to approximately 90 basis points above the benchmark 10-year Treasury rate. This is a notable decrease from the roughly 105 basis points seen in early 2022, as reported by BondCliQ.

Boston Properties specializes in top-tier office buildings located in major cities. According to BondCliQ data, the company currently has around $11 billion in outstanding corporate bonds. Bonds with a maturity of five years or less have been trading with average yields of approximately 5% to 5.5%.

This unexpected rally in office-REIT debt suggests that there may be untapped opportunities for investors in this sector, particularly in corporate-office debt. While challenges persist for traditional office real estate, the broader perspective presented by office-REIT debt offers a fresh outlook and potential rewards for those willing to explore this market.

Risk Assets Rally as Fed Signals Rate Cuts

Risk assets have experienced a rally following Federal Reserve Chairman Jerome Powell’s announcement in December that a pivot to rate cuts was likely in the near future. Both the S&P 500 index (SPX) and the Dow Jones Industrial Average (DJIA) have surged above record levels set two years ago.

Surprising Wave of Bond Issuance by REITs

In addition to the market rally, the new year has brought an unexpected wave of fresh bond issuance by Real Estate Investment Trusts (REITs). Even office landlords with exposure to cities slow to recover from the pandemic have participated.

According to Informa Global Markets, the first three weeks of January witnessed $5.8 billion in corporate-bond issuance from REITs. This figure surpasses the supply seen in January for each of the past four years.

Kilroy Realty Corp.’s Strong Pricing

Among the issuers was Kilroy Realty Corp. (KRC), a REIT that primarily focuses on Class A properties in Los Angeles, San Diego, and the San Francisco Bay Area. Through a 12-year bond deal with a coupon rate of approximately 6.25%, Kilroy Realty Corp. successfully borrowed $400 million.

Snyder, an industry expert, commended this accomplishment by stating, “That’s really strong pricing.” It is especially impressive given the ongoing uncertainty surrounding office-property debt and the lack of bond issuance from office REITs throughout the past year.

Dow Jones Equity REIT Index Performance

Despite a slight decline of 1.5% in the year so far, the Dow Jones Equity REIT Index (XX:DJDBK) has witnessed a remarkable increase of over 18.6% in the past three months, as reported by FactSet.

No Immediate Comments from Kilroy Realty Corp. or Boston Properties

At the time of writing, Kilroy Realty Corp. and Boston Properties have not responded to requests for comment.

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