It’s Time to Take a Look at Office REITs

One of the hottest topics of conversation on Wall Street, and among my colleagues like Tim Plaehn and Tim Melvin here at Investors Alley, is the state of the U.S. commercial real-estate market (CRE).

The story on Wall Street, as articulated by media outlets such as Bloomberg, is that a $1.5 trillion “Wall of Debt”—mortgages due before the end of 2025—is approaching for commercial property owners.

As a result, office and retail properties’ valuations may fall by as much as 40%.

This theory involves property owners being unable to refinance because their property values have fallen so much. Also, lenders—mainly local and regional banks—may be in trouble when property owners default on commercial mortgages.

Keep in mind that commercial property mortgages are almost always adjustable, so rising interest rates hurt property owners with sometimes significant increases in the cost of servicing their debt. And the CRE industry is highly leveraged and interconnected. So, the potential is there that if things go wrong, unexpected and very bad things could happen.

But let’s move away from the gloom and doom and look at the actual state of the commercial property market.

Because the reality is much better than the headlines would have you believe…

Yes, stresses are rising, but they are mostly confined to a small slice of the market: low-quality, or Class C, properties. (There are three classes of office buildings: Class A, Class B, and Class C.) For the overall commercial real estate market, vacancies and delinquencies are above pre-pandemic levels, but are not soaring higher. That’s due to the fact that the U.S. economy still remains strong.

Office REITs

Despite these economic strengths, Wall Street fears about the CRE have created an investment opportunity in a very obvious place: the office real estate investment trusts (REITs)—the companies that actually own office properties.

Even if dividends are included, office REITs have lost half or more of their value since the start of the coronavirus pandemic! Stock market participants have made a collective judgment that profits at these REIT are going to drop by half, even though these firms mainly specialize in high-end properties.

But has the market—as it often does—overreacted? Will conditions really be all that bad for these companies?

Here’s the investment angle… as revealed in…

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