Investors are turning their backs on this particular market. Find out whether or not you should as well.

Wednesday: The Independent Investor FROM THE DESK OF MILES EVERSON: Hi! We’re excited to share another investing insight in today’s “The Independent Investor!” Every Wednesday, we bring you insights about the world of investing because we believe this activity can help you achieve wealth creation and attain financial freedom in the process. Today, we will talk about the current state of office real estate in the U.S. Continue reading below if you want to know whether this market is worth investing in or not. CEO, MBO Partners Chairman of the Advisory Board, The I Institute

Investors are turning their backs on this particular market. Find out whether or not you should as well. The prevalence of remote and hybrid work setups have led many companies to rethink their office leases. After all, what’s the point of renting huge spaces if people will only work at the office a few times a week? Landlords had to deal with this reality as occupancy rates in 2023 significantly declined. Even though most landlords were able to stay afloat after battling high interest rates and low occupancies last year, some are losing hope that demand for office spaces will rebound anytime soon. In light of this, investors, pension funds, and lenders are turning their backs on office real estate investment trusts (REITs). The question is: Should you avoid REITs as well? To answer that question, let’s take a closer look at the state of real estate occupancies and REITs first. A REIT is a firm that owns, operates, or finances real estate properties that generate income. Patterned on mutual funds, REITs gather the capital of numerous investors, making it possible for the latter to earn dividends from real estate investments without having to buy any properties. A few years ago, REITs typically had little problems refinancing their debt since their businesses were backed by real estate assets. Lenders were more than willing to keep financing REITs since they can always collect the assets as collateral. However, this has changed due to the emergence of remote and hybrid working setups. While the number of full-time remote employees has declined, hybrid working setups have kept employees from spending all of their workweeks in their respective offices. As a result, return-to-office rates have stalled for most of 2023. Additionally, according to data from Scoop Technologies, 62% of U.S. businesses allowed employees to work from home a few days per week in the fourth quarter of 2023. With office demand showing no signs of returning to pre-pandemic levels, it’s no surprise investors and lenders are turning their backs on REITs. Douglas Emmett, a renowned name in the REIT space perfectly illustrates why lenders and investors are avoiding office real estate. The office REIT firm holds most of its properties in Los Angeles, a region where demand for office space is significantly decreasing. As a result of the uptick in office vacancies and decline in demand, the value of Douglas Emmett’s properties have gone down considerably. For the past 15 years, the company’s Uniform return on assets (ROA) has hovered around 3%. When remote and hybrid working setups took off during and after the height of the COVID-19 pandemic, Douglas Emmet’s Uniform ROA dropped to 1% and has remained at that level over the past 2 years. That’s a clear indication that the firm’s cash flows are clearly falling. Douglas Emmett’s credit risk outlook doesn’t look good either—a telltale sign that the company would likely struggle to meet its obligations moving forward. Let’s use the Credit Cash Flow Prime (CCFP) analysis to understand the risks the firm is facing. In the chart below, the stacked bars represent Douglas Emmett's obligations each year for the next five years. We then compare these obligations with the company's cash flow (the blue line) as well as its cash on hand at the beginning of each period (the blue dots). The CCFP shows the company will experience challenges in meeting its financial obligations in the next few years. It also has consistent debt maturities moving forward. This means while Douglas Emmett might be able to resolve its credit issues in the near future, the risk of default is not far-fetched. — Nearly half of office leases signed before the COVID-19 pandemic haven’t expired and once this happens, many businesses will likely rent fewer spaces than they are currently occupying, regardless if they are renewing or relocating. This simply means the office real estate sector will continue to deal with lower occupancy rates in the next few years. So, circling back to our question earlier, our answer is this: We think it’s best to stay away from the REIT space for now. Hope you’ve found this week’s insights interesting and helpful.     The iPhone 14 is one of Apple’s most powerful phones to date. What is new about it? Learn more about the status of Apple’s stocks nowadays in next week’s article!