Office real estate investment trusts (REITs) are still feeling the impact of the coronavirus pandemic. But you shouldn't give up on names like Boston Properties (BXP -1.09%), Kilroy Realty (KRC -1.11%), or Cousins Properties (CUZ -1.43%). Things are tough today, but this trio has what it takes to survive.
The really big problem
It's not hard to understand why 2020 was a challenging year for office REITs, with nonessential businesses shut and employees being asked to work from home. Thus, vacancy rates rose for most office REITs, and the headwinds are far from over. For example, industry bellwether Boston Properties, with a market cap of $17 billion, has seen its occupancy continue to fall in 2021. At the end of the third quarter, occupancy for the REIT sat at 88.4%, down from 90.1% at the end of 2020. This was at a time when other hard-hit sectors, such as retail, have already started to see occupancy rates rebound.
A big part of the problem is that the work-from-home shift forced employers to do something materially different. And the process actually worked out fairly smoothly, thanks to advances in technology. Going back to full-time office work for all employees seems unlikely because working from home helps save employers money and, at least for now, helps keep employees happy. That's potentially bad news for office REITs.
However, a permanent shift to work from home seems unlikely. There are benefits to having people working together in a communal space that simply can't be fully replicated via videoconference calls. And the value of socializing with coworkers could increase as the world gets a better handle on the coronavirus.
However, it probably pays to focus on the largest, best-positioned office landlords just the same, given that they probably will be able to adjust to the changes that are taking place now and in the future, as the world learns to live with the coronavirus.
Some names to consider
Boston Properties is the industry leader, with a focus on major cities like namesake Boston, New York, and Los Angeles, among others. As noted above, occupancy remains a trouble spot as the business world continues to adjust to shifting trends. However, it is unlikely that big cities will completely fall out of favor, given the social, work, and entertainment benefits that come along with these centralized locations.
In fact, major city apartment occupancy is on the mend already. That suggests people are moving back to the places where they work. With exposure to virtually all of the key U.S. urban office markets, Boston Properties will eventually benefit as employees return to the office, in whatever form that takes.
Kilroy is largely a West Coast office REIT. That means that it is highly reliant on the technology sector, which you might assume would be the first to embrace a permanent shift to work from home. However, some of the biggest tech companies are still leasing and buying offices. So the demise of the tech office seems unlikely.
Meanwhile, Kilroy has been expanding into new markets, buying assets in Texas, essentially following tech companies as they shift some of their operations away from the high-cost West Coast area. So it is already adjusting to the changes taking place around it, and that should bode well for its long-term future.
Cousins Properties is a bit different from the two other office REITs because it focuses on secondary urban and suburban markets like Nashville, Tennessee; Phoenix; and Tampa, Florida. There are two things of note here. First, the portfolio is heavily concentrated in the Sun Belt, which has seen strong migration from colder areas of the U.S. for years. That trend is likely to continue.
Second, assuming that employees who have moved away from big cities are happy with their new locations, office demand in less developed areas is likely to increase as companies consider having more office "hubs" in the mix. Cousins will be there to benefit. It's worth noting that Cousins was able to eke out 0.2% year-over-year rent growth in the third quarter versus declines for the broader office sector. That's a sign of strength that shouldn't be ignored.
No easy answers
There's no question that the office sector is facing an uncertain future today and that where it goes from here is an open question. That said, it is far from clear that the office is dead. If anything, it is much more likely that the way offices are used will just change. That suggests that the best-positioned office landlords are the names to watch.
Boston Properties is probably the best option for investors who focus on portfolio diversification. Kilroy is a solid technology play that's already shifting its portfolio to accommodate demand trends. And Cousins seems like it is positioned perfectly to take advantage as people continue to move to warmer states, regardless of the pandemic.
What's critical is that none of these office REITs cut their dividends in the face of the pandemic, with Cousins and Kilroy actually increasing their quarterly payments. This is not a sign of an industry that's dying, but it is a sign that you shouldn't count these office REITs out just yet.