Office REITs Are Getting That Small Town Feeling: Gadfly

Office REITs Are Getting That Small Town Feeling: Gadfly

(Bloomberg)—If you're reading this column at work, chances are your neighbor can read it, too. Open floor plans -- in which everyone you work with can see, hear, talk and snoop on everybody else -- have come to dominate office layouts.

But office space isn't keeping up with the increase in office jobs, so more workers are being stuffed into tighter spaces. While that shortage can make work relationships uncomfortable, it has benefited landlords who are enjoying escalating lease and rental prices. It's also a potential boon for companies that build corporate offices -- especially if they're located in cities that are expecting office employment surges.

Office vacancy rates and absorption rates (the amount of new and existing space already filled) are nearing pre-recession levels. Yet office construction is still less than half what it was in 2008, according to commercial real estate services firm CBRE. Nationwide office rental asking prices rose 4 percent in 2015, while cities including San Jose, San Diego, San Francisco, Orange County, Oakland and the non-California standout Greenville, South Carolina, saw double-digit rent increases.

About 70 percent of offices now have the most obvious hallmarks of open plans -- low or no partitions, according to the International Facility Management Association. But that layout preference makes older buildings less desirable since their design typically can't accommodate the airy, open spaces now in vogue. Yet as you can see from the chart below, most current office inventory is from the 1980s and earlier.

All of this further buttresses the need for new office construction, a trend that should benefit office REITs, particularly those with leasing and development strategies in the Sunbelt.

According to the 2016 commercial real estate outlook from PwC, a consultancy, future office growth will be concentrated in secondary and tertiary markets.  The largest REITs, such as Boston Properties, Vornado Realty Trust and SL Green Realty Corp, focus on the big six markets, where demand is perennial, high barriers to entry and limited building space check competition, and international investment offers lots of liquidity.

Highwoods Occupancy Rate

93 Percent

But anticipated market slowdowns in the big six markets have put those REITs in a bit of a rut lately, even though their underlying assets have performed well, according to Bloomberg Intelligence analyst Jeffrey Langbaum. REITs exposed to smaller markets have rosier expectations. The chart below shows that a number of high-tech, low-cost cities in the Sunbelt rank near the top for one-year and two-year office-job growth -- and may be the best places for REITs to target.

REITs with substantial exposure to cities in booming Sunbelt markets have had higher returns than their big-city counterparts over the last year (which has been a rocky period for REITs overall). Large Sunbelt REITS include Equity Commonwealth, Piedmont Office Realty Trust and Highwoods Properties.

Highwoods, which has properties in cities like Orlando, Tampa, Raleigh and Nashville, has seen greater total returns during the past year than any other comparable REIT in the same North American cohort tracked by Bloomberg Intelligence. According to Highwoods CFO Mark Mulhern, its properties are enjoying an average occupancy rate of 93 percent (an all-time high), thanks in part to big companies moving their Internet and technology departments to cities where the cost of living is lower than San Francisco or New York.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story: Rani Molla in New York at [email protected] To contact the editor responsible for this story: Timothy L. O'Brien at [email protected]


© 2016 Bloomberg L.P

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