• Sun. Dec 3rd, 2023

    New Challenges Emerge for Office REITs as Occupancy Levels Decline and Expenses Rise

    ByNuala Hafner

    Nov 20, 2023
    New Challenges Emerge for Office REITs as Occupancy Levels Decline and Expenses Rise

    The office real estate investment trust (REIT) sector has been facing significant challenges in recent times. Since the beginning of 2022, this sector has been grappling with a harsh bear market, marked by declining occupancy rates and increasing expenses. BofA Securities analyst Camille Bonnel has recently downgraded three of the weakest office REITs in the subsector due to their expiring leases and the resultant impact on cash flows.

    Highwoods Properties Inc., a Raleigh-based office REIT, is one of the companies that Bonnel downgraded. Highwoods Properties specializes in purchasing, leasing, and managing properties in smaller markets across the Southeast U.S. The company’s client base includes notable entities such as the federal government, Bank of America, and MetLife Inc. Despite its strong presence in the market, Highwoods Properties has been struggling lately. With a portfolio comprising 28.5 million square feet of leasable space, the company reported a lower Funds from Operations (FFO) of $0.93 per share in the third quarter of 2023 compared to $1.04 per share in the same quarter of the previous year. However, Highwoods Properties managed to beat revenue expectations and maintain a stable occupancy rate of 88.7%.

    Another office REIT that faced a downgrade is Paramount Group Inc. Based in New York, Paramount Group manages a portfolio of 17 properties in both New York City and San Francisco. The company reported lower-than-expected FFO of $0.21 per share in the third quarter of 2023. However, revenue figures performed better, surpassing analyst estimates. Despite these challenges, Mizuho analyst Vikram Malhotra disagrees with Bonnel’s downgrade, maintaining a Buy rating on Paramount Group.

    Hudson Pacific Properties Inc., a Los Angeles-based office REIT, is the third company that faced a downgrade. With 51 office properties and four studio properties, Hudson Pacific Properties focuses on centers of innovation for media and tech companies in the West Coast region. While the company reported FFO in line with estimates, its revenue fell short, leading to the downgrade by BofA Securities. Nevertheless, other analysts, such as Piper Sandler analyst Alexander Goldfarb and Vikram Malhotra, have expressed different opinions, proposing Overweight and Neutral ratings, respectively.

    Overall, the office REIT sector continues to navigate through tough times. Declining occupancy rates, expiring leases, and higher expenses pose significant challenges for these companies. Investors should carefully evaluate each REIT’s performance and seek expert advice before making investment decisions.

    Frequently Asked Questions (FAQ)

    What is a REIT?
    A real estate investment trust (REIT) is a company that owns, operates, or finances income-generating real estate. These companies pool capital from multiple investors to invest in a diversified portfolio of properties. REITs are required to distribute a significant portion of their taxable income to shareholders in the form of dividends.

    What are the challenges faced by office REITs?
    Office REITs are currently experiencing declining occupancy rates and higher expenses. Expired leases can result in increased leasing costs, negatively impacting cash flows. These challenges have contributed to the downgrade of some office REITs by analysts.

    Why are declining occupancy rates a concern for office REITs?
    Declining occupancy rates can impact the rental income generated by office REITs. With fewer tenants occupying their properties, REITs may struggle to maintain steady cash flows and meet their financial obligations.

    What should investors consider before investing in office REITs?
    Investors should carefully evaluate the financial performance, occupancy rates, lease terms, and client base of office REITs. Conducting thorough research and seeking expert advice can help investors make informed decisions and navigate the challenges of the market.