Following a few years of underperformance relative to the S&P and a late 2018 plunge, REITs are off to a quick start in 2019. Senior REITs Analyst Haendel St. Juste actually sees the potential for a competitive performance versus the S&P 500 Index this year but, of course, not all REITs are made the same. Even within subsectors, companies will have to battle it out. 

In this article, we take a look at office real estate – a sector that continues to undergo a great deal of secular change – to understand how one part of the REIT kingdom stands to fare in the coming year. 

Office Space Squeeze

In just a short period of time, we’ve seen a significant shift in the way companies use office space, particularly by those who operate out of big cities such as New York. Having reduced square footage per employee and with the work-from-home trend continuing to rise in popularity, these companies are simply no longer in need of vast amounts of office space. Lower demand doesn’t bode well for office REITs overall, but St. Juste suggests that the sector isn’t a monolith. “You have to play the market, company to company and balance sheet to balance sheet,” he said in a recent interview with Commercial Observer

Indeed, St. Juste approaches the office sector as a "stock-picker's arena,” meaning events and catalysts are often company-specific and cash flow dynamics will tend to drive individual performance. Stronger and more tangible cash flow growth will be key differentiators and indicators for outperformance in 2019.

The Theme is Risk

Without an overriding theme for the sector, it’s hard to gauge which companies are best positioned in the battle for growth. But companies that can take advantage of the current “goldilocks” economy – a stable state of low unemployment and steady GDP growth in which neither inflation nor recession are on the horizon – could stand to gain the most. Though the office subsector as a whole is buoyed by low rates and the “not too hot, not too cold” economy, the stable environment has been a particular boon lately to smaller caps, which have been outpacing their larger counterparts the past few months. The steady backdrop, St. Juste explains, supports a “risk on” psychology for investors who are now willing to take on more perceived risk in their pursuit of higher returns. 

A Favorable Economy Does not Favor REITS Equally

Today, the office subsector appears to have favorable demand drivers including modest GDP and employment growth along with low rates. Paired with low supply, this environment should support office fundamentals near-term. But not all will perform equally and different geographies, local economies, demographics, and industry dynamics will be at play. Each company must be evaluated on its own merits, making an analyst’s job that much more difficult, but (hopefully) that much more rewarding.