Analyze this: PiperSandler’s Alex Goldfarb on trouble in REIT-land

Wall Street is going to test some of commercial real estate’s biggest players this year, and it’s Alex Goldfarb’s job to call the winners and losers.

The PiperSandler veteran is one of the most recognizable REIT analysts on the street.

Whether he’s taking Newmark’s Barry Gosin to task for his latest splashy investment, or sending out a note dishing on his “Lunch with Laz” (Eastdil Secured’s David Lazarus), Goldfarb is an important player in REIT-land.

And those publicly traded companies face a bumpy road ahead, with talk of a commercial real estate “recession” and a Federal Reserve chair hellbent on controlling inflation.

In REIT-land for the longest time it was accretive to refinance, and now it’s not.
Alex Goldfarb, PiperSandler

The FTSE Nareit stock index, a benchmark for U.S. REITs’ performance, is down roughly 20 percent over the past year, compared to a drop of about 8 percent for the S&P 500.

Goldfarb talked with The Real Deal about how rising interest rates are squeezing commercial landlords, what investors are telling REIT managers and what it’s been like covering the industry and its people for 20-plus years.

This interview has been edited and condensed for clarity.

Boston Properties’ Owen Thomas said CRE is in a recession, but even in the broader economy people disagree on what is and isn’t a recession. You cover a variety of companies, so what’s your big-picture view for 2023?

Commercial real estate is generally in a good position, meaning we don’t have excess supply, but the trends that we had last year and that emanated from Covid remain in place.

So industrial is strong, retail is strong, pure-play Sun Belt apartments are strong. But the major coastal gateway markets are lagging. We’re in this white-collar recession. 

Powell the other day said higher-for-longer is the mantra. It means that he is gonna really hit hard on interest rates and that’s a headwind in the REIT space because they’re going to be facing higher sustained rates. 

But the market doesn’t believe he’s going to be that hawkish, and that’s forcing him to be more aggressive. Where do the REITs think rates are going to go?

Right now you’ll get a bunch of CEOs going, “If I had known where rates were gonna go, I would’ve issued a ton [of debt] a year or two ago.”

But from a balance sheet management perspective, having big lumpy maturities creates its own problems. I don’t think any company has ever gone broke having a well-laddered maturity schedule.

But I would say that between financing costs, NOI growth and Cap-ex, Cap-ex is the biggest issue because that determines whether your property survives or dies. In that sense, it doesn’t matter what the financing costs are.

Who has big maturities coming up? In a recent note you flagged this $1.8 billion preferred-equity position that Vornado has to refinance out of its retail joint venture.

That was brilliant to do the JV back in 2019, but if that were to get refinanced today the value probably gets cut in half. Street retail has found a floor, but the negative marks of peak rents rolling off will continue and the recovery of office is going to take a lot. So they have a lot they’re working against.

In REIT-land for the longest time it was accretive to refinance, and now it’s not. 

And they’ve got this huge plan to redevelop the Penn Station area, yet it seems Wall Street just wants companies to make sure they turn a profit each quarter. Is there a disconnect in REIT-land between what managers are doing and what investors want?

It’s challenging for investors because most of them run dedicated REIT books, so they have to be invested in REITs. And you say, where can I invest and where do I not want to be? A lot of people have just written off office. You still have people who are hesitant on malls. And if I’m not investing in office, I need to go somewhere, right? 

The point is that you’re investing by elimination. You’re saying what areas do I just not feel comfortable investing in and then you whittle it down.

You’ve got some office landlords out there who are starting to accept the impact Covid has had on their portfolios. When you think about the five stages of grief, who’s at acceptance and who’s in denial? SL Green’s been really pushing for the return-to-office. Are they in denial? 

SL Green is most certainly not in denial. If you look at how they’ve run the portfolio — move it to really focus on Grand Central and exit lesser-tier assets — they are a solid team. The reason that we have them as a neutral and not an overweight is because it’s a tough environment and the outlook is not consistent with earnings acceleration.

If you think about how they run the portfolio, there’s not one thing that they are doing that you would disagree with. Now you can say, hey, they shouldn’t be going for a casino license. If you’re SL Green and you have good relations with the governor and the mayor and you’ve got a building in Times Square, that’s a good opportunity for it. 

I think they recognize that returning to the 1970s-style of Times Square is not in the city’s best interest. And we have too much office, right? You need to repurpose that office for other uses and this is a great way to do it. 

I noticed that they’re calling themselves an asset manager now. Boston Properties calls itself a “premier workspace provider.” Is everyone trying to get away from an association with offices?

Listen, BXP does own a portfolio of really top-tier office. So that title is accurate. SL Green is still a real estate company.

What’s this white-collar recession doing to apartments?

Suburban is fine but the coasts and major markets are having issues. What I think is happening on residential is that price point matters. For the longest time REIT investors would focus on rent-to-income, and that’s misleading. What we believe is more important is overall affordability to the market. Meaning you want your apartments priced sort of in the middle or maybe a little bit below average for the overall market because that widens the pool of potential renters.

I give EQR and AvalonBay a lot of credit for realizing that they need to diversify their product type and geography because that’s a tough decision for companies to make. 

I think about these companies always building or owning the best Class A buildings in a city, which cater to the high-income renters.

I think what the REITs have learned is that it’s okay to have a few marquee buildings, but you don’t want to have many of them because you push yourself too far into that band.

The other thing is if you’re at the super high end, you get pricing power for the first year or two, then some shiny new toy gets developed and that attracts all the renters. So your building no longer has pricing power but it’s not old enough to be a discount.

“Companies know that some analysts ask softballs, other ones ask the harder ones.”
Alex Goldfarb, Pipersandler

A lot of these REIT CEOs have been around for a long time. Who’s working on succession plans and paving the way for the next generation?

I would say Mike Schall at Essex [Property Trust], because he’s retiring this month. 

AvalonBay had Bryce Blair and then it went to Tim Naughton and now it’s Ben Schall. I give them a lot of credit in that respect because they used to only promote internally, but my belief is that the board realized they needed fresh ideas and outside DNA. 

So I think a number of REITs have done well in cultivating the next generation, and then there are others that have had long tenures that have either been good or sometimes bad. I think most people would say we all love [Vornado’s] Steve Roth. I think everyone is ready for him to move on and if [Michael] Franco is the man, have Franco take over.

When I listen to the earnings calls I can tell you’ve got a rapport with these execs. You often get in near the top of the queue and ask good questions. How does that system work? 

Some companies legitimately take it first come first serve. Some companies know that some analysts ask softballs, other ones ask the harder ones. Not surprisingly, some companies may put the harder questions towards the end.

I think one thing that’s important is you can’t take your [place in the] batting order personally.

Are there any companies where you’re really proud of your batting order and others where you’d like to see it improve? 

I’m not gonna say. Because like anything, one day you’re batting first and the next day you’re DFL.