Morgan Stanley Identifies Stocks to Buy and Short in the Office Space Sector
Introduction
Morgan Stanley has named three stocks to buy and three to short as it revealed a cautious stance on the global office space sector. The Wall Street bank forecasts an oversupply of office space that could last more than a decade amid headwinds from the rise in working from home, increasing capitalization rates, and expensive refinancing challenges. However, the bank acknowledged that not all office real estate faced the same predicament, with variations across regions in debt levels, density, and occupation rates. According to the bank, there is a widening gap between class-A prime assets — such as modern buildings with green credentials in prime office locations — and the rest of the property market.
“Based on historical demand levels (which is not a given post-pandemic), it would take 5-13 years for the global office market to return to pre-COVID occupancy levels,” said Morgan Stanley analysts led by Ronald Kamdem in a note to clients on July 24. “However the class A prime assets can recover in half the time as the rest of the market as they take an outsize share of demand in our view.”
Stocks to Short
The U.S. office real estate market, in particular, faces unique challenges related to higher vacancies associated with work-from-home trends, sharp interest rate hikes, and regional bank weaknesses, according to the analysts. Reflecting that view, Morgan Stanley said shares of Office Properties Income Trust and Vornado Realty Trust face significant downside to the current share price. The Wall Street bank expects both stocks to decline by more than 35% over the next 12 months. “Fundamentals this cycle are worse than the [global financial crisis] in terms of occupancy, subleasing activity, and secular challenges from office utilization stalling at 20-55%,” the analysts warned. The bank also noted that a viable path to lower debt, positive earnings growth, and signs of a fundamental bottom are required for a more positive outlook.
Stocks to Buy
Morgan Stanley also identified stocks it said were undervalued, pricing in a significantly worse trading environment than is likely to be the case. The bank’s analysts said the most promising regions are Hong Kong and the U.K., with these areas preferred over Singapore and continental Europe, respectively. It expects shares of Hongkong Land, Derwent London, and Keppel REIT to rise by more than 30% over the next 12 months. Shares of all three property companies are also traded in the U.S. “HK has been pricing in one of the highest implied cap rates across the global office markets. While this could be justified by a slightly higher vacancy increase, we see limited further rental and occupancy downside from here (due to reopening) and the leverage is much lower compared to other regions,” the analysts added.