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Most large office REITs, or real estate investment trusts, concentrate on major gateway cities along the coasts. Office space in these regions tends to always be in high demand, enabling these landlords to steadily grow their rental rates.
However, the business environment in many of these cities is growing less favorable as rental rates, taxes, and regulations continue rising. That's leading a growing number of companies to move south, where they're finding more business-friendly environments.
Two office REITs focused on this Sun Belt business migration trend are Cousins Properties (NYSE: CUZ) and Highwoods Properties (NYSE: HIW). That makes them compelling office REITs for investors to consider buying this May.
At the crossroads of two major trends
Cousins Properties currently owns about 20 million square feet of Class A office space across the following Sun Belt markets:
- Atlanta: 35% of its net operating income (NOI)
- Austin, Texas: 27%
- Charlotte, North Carolina: 12%
- Tampa, Florida: 8%
- Phoenix: 8%
- Dallas/Fort Worth: 6%.
- Houston: 4%.
Those markets represent 6 of the 10 cities with the most in-migration last year.
In addition to focusing on the fastest-growing markets, Cousins concentrates on owning the highest-quality office buildings, which tenants highly desire. CoStar (NASDAQ: CSGP) estimates that demand for Class A office space should grow at a 2.7% average annual rate through 2024, compared to 0.4% for lower-quality space.
Those two factors should drive higher rental rates at Cousins' existing properties when current leases expire. It should also enable the company to continue developing additional office buildings. The REIT currently has 1.5 million square feet of development projects underway in Phoenix, Atlanta, and Austin, 77% of which it has already leased.
Meanwhile, it has an extensive land bank in Atlanta, Austin, Charlotte, Dallas, and Tampa that could support up to 5.2 million square feet of additional office development. That gives it lots of room to keep growing as it benefits from steadily rising demand for office space as more businesses relocate and expand in the Sun Belt region.
Shifting its portfolio to the southeast
Highwoods Properties ended 2020 with more than 25.9 million square feet of primarily Class A office space across the following fast-growing secondary markets:
- Nashville: 22% of its revenue
- Atlanta: 20%
- Raleigh, North Carolina: 19%
- Tampa, Florida: 13%
- Pittsburgh: 8%
- Orlando, Florida: 6%
- Richmond, Virginia: 6%
- Charlotte, North Carolina: 4%
- Noncore markets (Greensboro, North Carolina, and Memphis, Tennessee): 2%.
Those cities included 5 of the 11 best real estate markets in 2021. Overall, more than 75% of its revenue comes from fast-growing markets.
The company has been slowly repositioning its portfolio to focus on those fast-growing Southern markets by exiting other cities and entering or enhancing its presence in its target markets. It left Kansas City via several deals in 2016 and launched a market rotation plan in 2019 to move out of Greensboro and Memphis and into Charlotte. Meanwhile, it recently signed an agreement to acquire more office assets in Charlotte, Raleigh, and Atlanta, which it will finance through additional noncore asset sales.
Highwoods has an extensive development pipeline to continue expanding in its core markets. The company entered 2021 with five projects in Raleigh, Tampa, and Nashville under construction. It expects to invest $503 million to build 1.2 million square feet of space, 79% of which it has already preleased.
Meanwhile, Highwoods has a vast land bank across all its core cities -- enough land to build more than 5.6 million square feet of additional office space, representing $2.2 billion of total investment potential. When combined with rent growth from its existing buildings, Highwoods has lots of growth potential as more companies relocate and expand into lower-cost secondary markets in the Southeast.
These office REITs have a bright future
Companies were relocating and expanding in the Sun Belt region long before the pandemic. However, that event has accelerated more migration because governments in many Sun Belt states have taken a much more business-friendly approach. This means office REITs focused on the region should thrive as demand for space in their buildings continues to grow, enabling them to steadily increase rent and develop additional properties.
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