The pandemic cast a cloud on the future of office buildings. That has weighed heavily on real estate investment trusts (REITs) focused on owning office buildings.
While overall demand for office space remains uncertain, demand for high-quality office space in the Sun Belt region has grown stronger in recent years. That's benefiting Sun Belt-focused office REIT Cousins Properties (CUZ 7.12%). However, it has gotten lumped into the sell-off in the sector, which has caused its stock to sink more than 25% this year.
I think the market will eventually realize its mistake as it becomes clear that Cousins' strategy is delivering results. Because of that, I plan to buy more shares of the office REIT before it's too late.
Focused on the right locations
On Cousins' first-quarter conference call, CEO Colin Connolly shared key points showcasing two notable divergent trends in the office sector. First, the CEO pointed out that "the Sun Belt represents only 26% of the national office inventory and yet accounted for 58% of new-to-market leasing in 2021." Put another way, while only a quarter of the country's office space is in the Sun Belt, more than half the leasing activity last year was in that region. This metric demonstrates the strong demand for office space in that part of the country.
Several factors are driving the demand for office space in major Southern metro areas. A big driver is migration trends. Businesses have been relocating and expanding across the South due to the region's lower taxes, better business climate, and economic growth. Meanwhile, more people are migrating from higher-cost cities along the coasts to warmer, cheaper ones in the South, providing employers with access to high-quality workforces.
A tale of two office buildings
Another notable office trend Connolly pointed out on the call is that companies are increasingly favoring newer Class A office buildings. The CEO stated: "Over the past few quarters, buildings built since 2015 accounted for 62 million square feet of national net absorption. On the flip side, buildings built before 2000 accounted for negative net absorption of over 100 million square feet."
Office tenants are leaving older buildings in favor of newer ones because they typically have better layouts, more amenities, and improved air filtration systems, all features that office workers desire. Connolly noted that:
Culture, collaboration, mentorship, relationships, and trust all suffer in a permanent remote setting. To attract their teams to come together in person, more companies are shifting to exciting space and highly dynamic locations. The goal is to offer a more attractive daily experience than the convenience of the dining room table.
That's driving companies to focus on leasing space in higher-quality buildings to entice their workers back to the office.
The intersection of these office trends
Cousins Properties spent several years assembling a portfolio of trophy office buildings in the Sun Belt. This means it's starting to capitalize on growing demand for high-quality offices in the region. For example, the company signed 324,000 square feet of leases during the first quarter, with rates on second-generation leases coming in 15.4% above those on expiring leases for the same space. Overall, rents on new leases are 9% above their pre-pandemic level and 25% higher than the average for Class A office space in the country.
Meanwhile, the growing demand for office space in the Sun Belt region has enabled the REIT to develop new office properties. It's building over 1.5 million square feet of space across three projects in leading Sun Belt metros, and it has already pre-leased more than 90% of the space in two buildings.
In addition, Cousins has a large land bank to support up to 5.1 million square feet of additional new development in the future. That positions it for continued growth as more companies expand and relocate to the Sun Belt region. Because of that, it has a brighter future than most office REITs.
Well positioned for the future of office demand
There's no doubt that offices are evolving. Companies are increasingly favoring higher-quality buildings located in major metro areas in the Sun Belt region, which play right into the strategy of Cousins Properties. The market will eventually realize its mistake of lumping it in with all the other office REITs. I want to add to my position before that happens to take advantage of the current discount in its stock price before it goes away.