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High-Rise REIT Gets a Better View: Opinion

NEW YORK (TheStreet) -- With rates hovering near all-time lows, investors have been searching for securities that will provide them with higher income without a significant amount of risk. REITs have become a popular way of achieving these goals as they have been a source of consistent and stable income based off a diversified business with repeatable results.

One such REIT that warrants investor consideration is SL Green Realty (SLG), as it has been a dominant REIT in its focus market, Manhattan. SL Green Realty is New York City's largest office landlord and is the only fully integrated REIT that is focused primarily on acquiring, managing and maximizing value of Manhattan commercial properties.

As of June 30, SL Green owned interests in 71 Manhattan properties totaling more than 39.2 million square feet. This included ownership interests in 27.4 million square feet of commercial properties and debt and preferred equity investments secured by 11.8 million square feet of properties. SL Green also owns 385 residential units in Manhattan encompassing approximately 0.5 million square feet.

In addition to its Manhattan investments, SL Green holds ownership interests in 32 suburban assets totaling 6.9 million square feet in Brooklyn, Queens, Long Island, Westchester County, Connecticut and New Jersey, along with four development properties in the suburbs encompassing approximately 0.5 million square feet.

The following table lists their property location, size and occupancy:

It is worth noting that investments in the New York Metropolitan area also include investments in Brooklyn, Queens, Long Island, Westchester County, Connecticut and New Jersey, which are collectively known as the Suburban assets.

In order for a REIT to generate consistent and stable income, the properties in the portfolio must have favorable operating statistics.

As the table above (courtesy SNL Financial) shows, SL Green's properties have occupancy levels consistent with the industry. The only weak point is the retail sector, which is under industry occupancy rates by more than 2%.

The focus on New York City has, at times, painted this REIT with a financial brush, since Manhattan has one of the largest finance industries. A look at SL Green's top 10 tenants should help put an investor's mind at ease.

The top 10 tenants account for 32% of SL Green's rent and are primarily strong investment grade, which shows the tenant diversity of this REIT as well as the ability of these tenants to pay their rent.

Ultimately, portfolio occupancy and tenant diversity have to lead to income and growth of income. SL Green, while positioned in one of the most competitive markets in the U.S., has been able to grow net operating income at approximately 4%.

While income growth is important, it must translate into a solid financial profile from which the REIT can comfortably and consistently make dividend payments to investors. SL Green has been able to grow funds from operations and make comfortable dividend payouts from these funds. In the last quarter, the dividend payout ratio was 13%, giving the company significant financial flexibility to both grow and continue to pay dividends.

As with any investment, there should be growth drivers present to ensure increasing profitability and a growing income stream available to investors. The primary driver for SL Green is the recovering employment fundamentals in New York City and its impact on market rents. As the following graph shows, New York is second only to Houston in employment recovery, having recovered more than 125% of jobs lost at the trough of the decline.

And when we compare employment to rents, the growth driver emerges. The following graph will help visualize the activity.

Performance for the equity has been decent, but has not kept up with the REIT space due to its office focus, which has underperformed most REIT sectors.

Unfortunately for income investors, even with the requisite growth drivers in place, the conservative nature of this REIT has kept the dividend yield low, currently yielding 1.20%. This yield, arguably lower than the rate of inflation, is one of the reasons income investors have not been drawn to SL Green. Fortunately, there is another alternative that should give income investors a reason to invest in this REIT -- a newly issued preferred stock.

On August 8, SL Green issued $200 million of Series I cumulative redeemable preferred stock. The preferred stock has a rate of 6.50% and pays dividends quarterly on January, April, July and October 15.

The bottom line is that SL Green is well positioned to continue to benefit from growth in the New York City area and has the financial wherewithal to continue its growth and acquisition of properties for its portfolio. While the REIT is attractive fundamentally, the dividend yield on the common stock is nothing to write home about, which makes the Series I preferred stock the "preferred" way to generate higher income with this high-rise REIT.





At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Research conducted by Rubicon Associates. Mr. Michael M. Terry, CFA is the Founder/Principal of Rubicon Associates LLC and has nearly 20 years of experience in the investment management industry focused on the analysis, investment and management of fixed income and preferred stock portfolios.

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