The pandemic has had a significant impact on the office sector. With so many employees working remotely, demand for office space has declined, weighing on rental rates.
However, many companies are calling their employees back to the office this year. That's starting to revive the office sector. We saw evidence of this in the first-quarter results of several office-focused real estate investment trusts (REITs).
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Collaboration is drawing tenants to secure more office space
Hudson Pacific Properties (HPP 1.36%), an office REIT focused on providing real estate solutions to technology and media tenants primarily along the West Coast, saw strong demand for office space in the first quarter. The company leased 500,000 square feet of space, pushing its in-service office portfolio to 91.1% occupied and 92.3% leased. Rents on renewal leases were 12% higher than prior rates.
CEO Victor Coleman stated: "Our unique focus and specialized expertise in serving the growing tech and media industries yielded strong results during the first quarter, with notable leasing success across our world-class, amenitized, collaborative and sustainable office and studio space." Coleman noted that tenant activity is accelerating, which "further expanded our leasing pipeline."
Meanwhile, the company is looking to start two new office developments in the near term. It recently purchased the Washington 1000 development site in Seattle for $85.6 million. It plans to begin construction on a new 546,000 square-foot office tower later this year at an estimated cost between $340 million and $360 million.
In addition, it's advancing a 450,000 square-foot office building in Vancouver. These new development projects suggest the company expects office demand to continue growing in the coming years.
Skyscraping rental growth rates
Kilroy Realty (KRC 1.17%), an office REIT focused on the West Coast and Austin, is also seeing strong demand for space in its office buildings. The company signed 183,000 square feet of new and renewal leases in the first quarter, with rents on renewals jumping 32.9% above prior rates. These agreements improved its stabilized portfolio to 91.3% occupied and 93.1% leased.
The most noteworthy lease was with Nuro, an autonomous-delivery-vehicle company, which extended and expanded its lease for Kilroy's 1290-1300 Terra Bella Avenue property in Mountain View, CA. The new lease totals 114,000 square feet, more than doubling Nuro's original 56,000 square-foot lease. That agreement brought the property to 100% leased.
Kilroy Realty also took a step to start a new development project, agreeing to buy a 2.9-acre development site in Austin. The company paid $40 million for a site fully entitled for a 493,000 square-foot office development. Kilroy plans to start that project as soon as the middle of this year.
Office demand in the Sun Belt is red hot
Highwoods Properties (HIW 2.61%), an office REIT focused on the best business districts of fast-growing office markets across the Sun Belt region, also saw strong rental growth in the first quarter. The company signed 658,000 square feet of second-generation leases, including 391,000 square feet of new leases, pushing its occupancy level to 91.1% by the end of the quarter. The REIT achieved 14.9% rent growth on a weighted average term of 6.4 years on leases signed during the quarter.
CEO Ted Klinck commented on the quarter by stating:
We have once again reported strong financial and operating results. The consistency of our performance prior to and throughout the pandemic validates the resiliency of our portfolio, platform, and strategy. In the first quarter, we posted meaningful FFO [funds from operations] and same property cash NOI [net operating income] growth. In addition, as demonstrated by the signing of 391,000 square feet of new second-gen leases, our leasing activity was healthy with lengthening average lease terms and accelerating GAAP rent growth.
Based on our strong first-quarter results and healthy business trends across our markets, we are pleased to update our outlook, which includes an increase in FFO, same property NOI growth, and year-end occupancy at the respective midpoints.
Highwood Properties sees the potential to announce between $100 million to $250 million of new development projects this year, though it didn't unveil any in the first quarter. One reason it sees the potential of moving forward on new projects is its success in leasing its current pipeline.
The company leased 23,000 square feet of first-generation leases in the quarter, bringing its existing $283 million, 615,000 square-foot pipeline to 55% pre-leased. That pipeline includes 2827 Peachtree in Atlanta, which the company and its joint venture partner started building during the quarter.
Offices are coming back into style
There had been a lot of concern that the pandemic would permanently affect demand for office space as more companies give their employees the freedom to work remotely more often. However, while there will be remote work in the future, companies highly value having their employees come into the office at least some of the time. That's driving a recovery in demand for office space.
This trend bodes well for office REITs, which should continue to see rising rental rates and enough demand to support additional development projects.
