2023-09-06 16:16:05 ET
Summary
- Highwoods Properties is an office REIT focused on high growth markets in the Sunbelt region.
- The tenant mix is very traditional, putting HIW in danger of low occupancies due to the work from home trend.
- I present my article on HIW, issuing a hold rating.
Highwoods Properties ( HIW ) is an office REIT with a focus on the Sunbelt market, which makes the REIT quite interesting, especially if you have no interest in investing in legacy markets such as New York City or San Francisco.
The last time I wrote about the company was back in May when I concluded that the stock was riskier than its peers such as Boston Properties ( BXP ) or Kilroy Realty Corporation ( KRC ), because its tenant mix was very traditional, in the sense that it would likely continue to suffer in light of the ever-present work from home.
Little has changed with regard to how Americans work over the past four months, but the stock has increased by nearly 20%, outperforming the S&P 500 by a factor of two. Clearly, I was wrong, and following the company’s Q2 earnings , I want to take a closer look at the company to make sure I didn’t miss anything.
Before diving into the numbers, I want to reiterate the REIT’s focus on high growth markets in the South. In fact, 95% of NOI is generated in the so-called Sunbelt which has 2.5x the population growth and 2x the jobs growth compared to the national average. Both of these are very important to maintain occupancy.
Recent Results
The REIT’s occupancy currently stands at 89% which is significantly above the average occupancy in its market. This is a result of high quality, mostly A-Class space, which the company owns and operates. This seems to be in line with what I think is the general consensus here on Seeking Alpha which calls for quality office to get stronger during this crisis, while lower quality and older space suffers. It is also in line with the findings of a CBRE study which found high quality office space to have positive net absorption since the pandemic, while lower quality space has suffered occupancy drops.
Revisiting the tenant mix, little has changed as finance and banking accounts for the largest (18%) portion of rent-roll, followed by legal and accounting services at 16%, insurance at 12% and healthcare at 9%. The issue is that unlike Life Sciences, for example, a lot of these can be done from home, which means that many of the tenants may want to downsize their space as their respective lease agreements mature. Still, on a tenant-by-tenant basis, the company is quite well diversified with the top 10 tenants accounting for no more than 22% of NOI.
In terms of guidance, management expects occupancy to remain around today’s levels for the rest of the year, but expects no NOI growth this year (guidance range is +/- 1% YoY growth), suggesting that in order to maintain occupancy, they may have to offer somewhat discounted rents. This is somewhat expected given a tenant mix that is likely to want to downsize, still, HIW can leverage the fact that at least their space is high quality.
While medium-term growth is likely to be very low, the REIT maintains a pretty solid BBB rated balance sheet with a reasonable level of leverage at 6x EBITDA and an average weighted interest rate of 4.3%, which is around the 10-year treasury yield. The company also has no debt maturities until 2025, which significantly decreases risks related to high interest rates.
Overall, I would characterize HIW as a portfolio of high-quality assets in growth markets. The problem I believe is that those assets mainly appeal to tenants that are at high risk of downsizing as a large portion of their employees can do their job remotely. That’s why I don’t see significant growth in FFO over the next couple of years. On the flip side, I don’t expect a significant fall in FFO either, as the balance is fairly conservative and the REIT seems to be able to maintain occupancy for now.
Valuation
My view is largely consistent with consensus, which calls for flat FFO until 2025, when it could reach $3.76 per share. Today the stock trades at just 6.2x FFO, which is way below its historical average of 12.4x.
Of course, I’m not suggesting here that the stock will return to that average anytime soon, perhaps ever. But the stock doesn’t appear very expensive relative to history. Relative to peers, we can look at BXP and KRC which trade around 8.3-9x FFO and have similar quality properties with higher exposure to legacy markets on both coasts. General market sentiment dictates that legacy markets should be riskier so if anything, I would expect those REITs to trade at a discount relative to HIW. But the opposite is true.
Recently I published an article on BXP and issued a HOLD rating. In the case of HIW, the valuation seems more appealing, but the risks discussed last time are still present, which is why I’m hesitant to initiate a position here. Therefore, I reiterate my HOLD rating for the stock.
For further details see:
Highwoods Properties: Likely To Remain Stagnant