SL Green Realty Could Soar If These 2 Things Go Right

Shares of SL Green Realty (NYSE: SLG) have tumbled more than 35% in the past year and are down almost 40% over the last five years. Manhattan's largest office landlord has struggled due to higher interest rates (REITs are highly rate-sensitive) and sluggish demand for office space since the pandemic.

While SL Green Realty has battled headwinds in recent years, the office REIT stock could soar if the following two things go right.

Image source: Getty Images.

The 10-year finally starts to fall

Interest rates have a massive impact on commercial real estate investments. Higher rates increase interest expenses, cutting into the cash flows produced by commercial real estate, leaving less money to distribute to investors. Elevated interest rates also make lower-risk fixed-income investments such as bonds more appealing to investors. That weighs on the value of yield-focused investments, such as commercial real estate.

The Federal Reserve has been lowering the Federal Funds Rate over the past few years. While that has reduced short-term rates, it hasn't had much impact on longer-term rates:

Target Federal Funds Rate Upper Limit data by YCharts

As that chart shows, while the Federal Funds Rate has fallen from its peak of around 5.5% to 3.75%, the 10-year Treasury (a key long-term interest rate benchmark) has remained stubbornly high. That's due to many factors, including elevated inflation and high federal deficits. If the inflation rate finally falls to the Federal Reserve's target of around 2%, the 10-year could start to descend. That could provide a significant boost to the value of commercial real estate and SL Green's share price.

The office market enters a new growth phase

Office demand has remained lackluster since the pandemic. Companies have been reluctant to make long-term commitments to office space because their space needs are uncertain amid remote and hybrid work. As a result, office vacancies have been on the rise, rental rates have been stagnant, and investor demand for office buildings has been weak.

However, there are some signs of life in the office sector these days. JLL's latest U.S. office dynamics report showed that the leasing activity in the fourth quarter hit a new post-pandemic high, and annual leasing grew 5.2% year-over-year. Large-scale transactions surged 15% as more companies committed to long-term leases. Additionally, office sales volume has risen for seven straight quarters and grew 35% last year. Meanwhile, distress in the sector is declining, and there are very few new office projects under construction. These factors drive JLL's view that the office market is entering a new growth cycle. If these positive office market trends continue, SL Green Realty's stock should rally.

Shifting from headwinds to tailwinds

Elevated interest rates and lackluster office market fundamentals have put significant downward pressure on SL Green Realty stock in recent years. However, if those headwinds shift into tailwinds, shares of the office REIT could soar.

Matt DiLallo has positions in SL Green Realty. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.