Summary
- In the post-pandemic world, companies may need to offer more incentives to bring workers back to the office.
- Some companies are getting it right and are seeing strong demand for their office space.
- These three Office REITs are aligned with current workspace trends.
This article was co-produced with Cappuccino Finance.
I'm in the process of writing my new book, REITs For Dummies, which I should have finished in a few more weeks. I'm working 7 days a week to get the manuscript finished, and I spend most of my time working in my office.
This week I plan to focus on the office sector and explain how the pandemic brought many changes to our lives and how we do work. Work from home ('WFH') became more common and zoom and teleconference became a much bigger part of corporate culture.
While the pandemic may have accelerated the WFH movement, other factors — such as employees’ commutes and workforce demographics — could have a greater influence on the long-term impact of hybrid work arrangements.
Employees facing long commutes from the suburbs may embrace a popular post-pandemic employer policy: in the office two or three days a week and at home the rest of the time.
In large gateway cities, where a high percentage of workers rely on public transportation — which many may not be comfortable using for health reasons — this hybrid work arrangement may mean work from home has a lasting impact on how much office space tenants need.
As seen above, in a post-pandemic world, most employees prefer to work remotely at least one day a week.
One interesting development of the post pandemic work environment is that companies now have to offer bigger incentives for workers to come in to the office. Companies have been updating their offices to include nicer amenities like break rooms and refreshments, and a more comfortable environment (chairs, sofas, and other furniture).
At the same time, some work simply cannot be done from home or a remote location. Pharmaceutical research, laboratory work, and biotechnology jobs are examples where workers need an office space, and the need for these workspaces are only growing at this point.
These three office REITs in this article are positioned to take advantage of this paradigm shift in office space environment and the growth of the pharmaceutical and biotechnology industries.
They have a solid business model and strong portfolio, and they also have a strong balance sheet and financials to support their operation and growth in the future.
Alexandria Real Estate ( ARE )
Alexandria Real Estate is a REIT that develops dynamic urban cluster campuses and vibrant ecosystems for innovative companies. Most of their tenants are multinational pharmaceutical companies, biotechnology companies, life science companies, and U.S. government research agencies.
Their development projects generally consist of the ground-up development of generic and reusable facilities, permanently changing an office, warehouse, and shell space into a more specialized office/laboratory, agtech, or tech office.
Alexandria reported earnings a couple of days ago, and it was a great one. Their FFO per share grew 8.5% YoY, and they further strengthened their balance sheet. Also, Alexandria deployed the second highest amount of capital ever in their history (second only to 2021) and substantially increased their footprint.
The growth in life science, pharmaceutical, and biotech has been great for Alexandria’s whole portfolio.
Following the strong FFO growth in the past 5 years (6.94% per year, 5-year CAGR), their dividend growth has also been strong. The dividend growth rate for the past 5 years has been 6.47%, and I expect the growth to continue well into the future. Alexandria’s current 3.1% dividend yield is pretty safe at this point, demonstrated by a cash dividend payout ratio of 58.36% and FAD payout ratio of 55.65%.
Alexandria has a strong and flexible balance sheet to support their growth plan. They have $5.3 B liquidity available to them, and the weighted average remaining debt term is 13.2 years. The net debt and preferred stock to adjusted EBITDA ratio is at 5.1x, and 99.4% of their debt is at a fixed rate.
Alexandria is fairly valued right now , but I believe that the company is nicely aligned with current trends in the sector and is a solid long-term investment.
Highwoods Properties ( HIW )
Highwoods Properties is a REIT that owns, develops, acquires, leases, and manages properties in the best business districts of Atlanta, Charlotte, Nashville, Orlando, Pittsburgh, Raleigh, Richmond, and Tampa.
Their properties are concentrated in the high-growth sunbelt region, and they have a presence in 6 of the top 10 real estate markets (as ranked by the Urban Land Institute).
Their properties are in high demand (>90% occupancy), and their rent has been growing steadily in the past decade (4.0% per year, CAGR since 2013).
Highwoods has been doing a great job at maintaining a strong balance sheet. Their debt and preferred stock are only 40.2% of gross assets, and net debt to EBITDAre is at 5.6x. The weighted average interest rate of their debt is at 3.7%, and there are no debt maturities until 2025. The credit rating from Moody’s and S&P are Baa2 and BBB at this point.
I expect the portfolio of Highwoods to continue to grow as their pipeline is very strong. They have $476 M worth of development in-process (1.4 M square feet), and they still have a total of $3.9 B of potential development projects in their land banks.
Backed by a strong balance sheet, liquidity, and operation, I expected continued strong growth.
The valuation metrics of Highwoods demonstrate that they are undervalued right now. The current P/AFFO of 11.99x and P/FFO of 7.93x are almost 30% below their 5-year average. At iREIT, we calculate a 19% margin of safety at the current stock price.
We rate Highwoods Properties a “Strong Buy” at this point , based on an attractive valuation and dividend, the good geographical distribution of the portfolio, and strong fundamentals.
Kilroy Realty ( KRC )
Kilroy Realty Corporation is a REIT that owns, develops, acquires, and manages premier office, life science, and mixed-use assets in the United States. Their assets are primarily consisting of class A properties in the Los Angeles, San Diego, San Francisco, Seattle, and Austin areas.
Kilroy reported solid earnings earlier this week. Their revenues grew 8.9% YoY, and they recorded FFO of $139.9 M ($1.17 per share), which represents 11.4% growth compared to the last year. They have a total of $1.7 B of liquidity available to them, comprised of $290 M of cash and equivalents, $300 M from unsecured term loan facility, and $1.1 B of unsecured revolving credit facility.
Their solid AFFO growth in the past 5 years (3.39% per year, 3-year CAGR) has supported strong dividend growth. Kilroy’s dividend has grown 5.14% in the past 5 years. Their dividend is safe too, as demonstrated by a cash dividend payout ratio of 41.31% and FAD payout ratio of 51.34%.
Valuation metrics show that Kilroy is undervalued at this point. The current P/AFFO of 15.59x and P/FFO of 8.93x are about 50% lower than their 5-year averages. The equity rating trackers of iREIT shows a margin of safety at 32%, giving the stock an overall “Strong buy” rating .
Risk…
The Federal Reserve just announced yet another rate hike, and Chairman Powell said it would be premature to claim victory against inflation. He strongly suggested that Federal Reserve will keep a hawkish stance until inflation is considerably lower than now. He even mentioned that he doesn’t anticipate any rate cutting this year.
As long as the Federal Reserve maintains its hawkish stance, I don’t expect the bull run to gain a lot of steam. Also, high borrowing costs will prevent the real estate market from gaining significant momentum.
High tech companies are announcing rounds of layoffs, and it may have a short-term negative impact on Office REITs. The REITs in this article are focused on high end office spaces, so cost cutting from high tech companies could have a negative impact on their occupancy and rent rate. Therefore, the investors should pay close attention to the technology sector’s performance.
Conclusion
The pandemic environment has introduced a lot of changes to our lives, and the office and work environment changes are one of them. Many people now want to work from a remote location, and the companies are trying to figure out a way to balance their needs with workers’ demands. Not surprisingly, companies have to offer greater comfort and amenities to give incentives for work forces to come back to the office.
But there is still a need for office space. Many companies would prefer to keep an office environment. Also, some work simply cannot be done at home. Research and development activities of the pharmaceutical industry is one great example of work that cannot be performed remotely.
The Office REITs listed in this article are ones that are well positioned for the changing trends in the sector. They will be able to meet the different demands of companies and employees, and should see continued demand for their office space. These REITs provide work places for essential laboratory activities for pharmaceutical and biotech companies, or upscale office space in areas with strong demographic trends.
Recent earnings show that these REITs are seeing high demand, and their attractive valuations make this a good time to take a closer look!
Author's note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.
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Who's Buying These Office REITs?