Despite competition, debt concerns, SL Green outlook “stable”: Fitch

While affirming SL Green Realty’s default rating and providing an outlook of “stable,” credit ratings agency Fitch raised issues with the real estate investment trust’s relationship to debt and noted “concerns” about the Midtown Manhattan office leasing market.

Fitch affirmed SL Green’s rating of BBB- last week, citing credit strengths including a “high-quality New York office portfolio,” a growing pool of unencumbered assets and a “strong, albeit relatively concentrated tenant base.”

But the ratings agency said that optimism was balanced by its take on an “uncertain” Midtown office leasing environment, which it believes is “somewhat dependent on the growth of large financial institutions” and supporting industries like law and accounting firms. It also noted SL Green’s dependence on just a handful of large tenants.

Financial services tenants account for 33 percent of SL Green’s base rental revenue, Fitch said, noting the potential effects of both “a downturn in space demands” from such tenants and “emerging competition” to Midtown landlords from developments like Hudson Yards and Brookfield Place.

In addition, SL Green “continues to incur significant costs in the form of tenant improvements, leasing commissions and free rent incentives as tenant inducements,” the ratings agency said, adding that such conditions had “placed pressure on the company’s fixed charge coverage.”

Despite such headwinds, however, SL Green has “maintained strong leasing volume and has improved occupancy,” Fitch said.

SL Green depends on its top tenants more heavily than its key rivals do, Fitch added. SL Green’s top 10 tenants represent just over a third of its annual base rent. In comparison, rival Manhattan office landlords Vornado Realty Trust and Boston Properties’ top 20 tenants comprise 28 percent and 30 percent of annual base rent. SL Green’s largest tenant is Citigroup, which is responsible for 10.5 percent of the REIT’s annual cash rent.

Fitch also said that SL Green’s ratings were hurt by its ratio of unencumbered asset value to unsecured debt, which is “weaker when compared to similarly-rated companies.” However, it noted that SL Green’s Midtown Manhattan assets “are highly sought after by secured lenders and foreign investors,” which helps insulate the REIT from further risk.

“Midtown Manhattan office assets consistently trade at lower capitalization rates and are more liquid and financeable in economic downturns than typical office assets, bolstering the contingent liquidity of the company’s portfolio,” the ratings agency said.

As far as specific aspects of SL Green’s business, Fitch said the REIT’s leverage “will temporarily increase from historic levels due to the recent acquisition [for $2.6 billion] of 11 Madison Avenue,” which it is largely funding with proceeds from asset sales. That leverage is expected to decline after these buildings are sold.

The ratings agency also said it expects Citibank to exercise a $2 billion purchase option to acquire its headquarters at 388-390 Greenwich Street in Tribeca, and noted that while SL Green’s equity commitment for the One Vanderbilt office tower in Midtown remains “uncertain,” the company has stated that it may consider joint venture alternatives on the project “to reduce its exposure.”