Vacancies are at record highs and tenants are handing back more workspace real estate, but for all the things going wrong in the national office market, one real estate investment trust is finding some silver linings.
Highwoods Properties executives say they are getting rid of free-rent concessions at some buildings, while still being able to hike rates and attract new deals. It is one of a handful of Sun Belt-focused REITs including Cousins Properties that have managed to maintain a stable base of tenants despite the turbulence shaking up larger, higher-profile markets across the country.
The Raleigh, North Carolina-based REIT has already signed more than 700,000 square feet of new, expanded and renewal deals since the start of the year, adding to the leasing momentum it began to pick up toward the end of 2023.
"While there obviously continues to be headwinds for the office sector, we're optimistic about the future," Highwoods President and CEO Ted Klinck told analysts on the company's earnings call Wednesday. He pointed to the landlord's "significant organic growth potential" within its existing portfolio, its pipeline of nearly $520 million of new developments and a strong balance sheet. That means the REIT won't have to raise new capital at a point when some competitors have been forced to deal with the impact of rising interest rates.
The company signed 698,000 square feet of leases in the final quarter of last year, the highest amount of quarterly leasing volume through all of 2023 and about 15% higher than previous fourth-quarter leasing averages. That helped push occupancy rates to an average of nearly 90% across Highwood's portfolio with a focus on office properties in suburban downtown areas in regions such as Nashville, Tennessee; Orlando, Florida; Atlanta; Charlotte and Raleigh, North Carolina.
"Return-to-work programs and mandates are raising the tide on physical occupancy," Brian Leary, Highwood's chief operating officer and executive vice president, said on the call. "This also goes with the fact that our customers are telling us one-on-one and via their leasing activity that they value the physical workplace."
Atlanta-based Cousins also reported a solid year of leasing as it raked in nearly 1.7 million square feet of new deals in 2023, a feat that has kept its portfolio stable at an average of roughly 90% over the past three years.
Patient and Ready
The developer's Sun Belt-focused portfolio — valued at more than $6.7 billion and spanning roughly 28.5 million square feet — is concentrated in areas that have largely avoided the pitfalls plaguing larger cities such as San Francisco or Washington, D.C. Those areas have faced some of the steepest declines in leasing activity as well as an even slower return among employees getting back to physical workspaces.
Even so, Highwoods is still navigating an office environment that has experienced a shaky and uneven recovery since the pandemic. The crisis has unleashed seismic shifts that are expected to have dramatic, long-term effects on the office market, helping to drive national vacancy rates beyond an unprecedented peak of 13.7%, according to CoStar data.
Within months of signing a major, 223,000 square-foot deal with Landmark Recovery in Franklin, Tennessee, the drug and alcohol treatment provider went back to Highwoods to revise the deal, conversations that resulted in modifying the lease to just 110,000 square feet.
Tenants collectively handed back more than 65 million square feet of office space throughout 2023, according to the data, bringing the total to over 180 million since the start of 2020 and far exceeding the reductions reported throughout both the Great Recession as well as the dot-com bust.
What's more, the leases that are being signed these days have shrunk considerably, averaging about 20% smaller than their pre-pandemic averages.
Current headaches aside, Highwoods executives said they remain committed to the office market and are "laying the groundwork for future investment opportunities" to position the REIT for what it believes is an imminent recovery.
"We believe this cycle will present us with opportunities by acquiring high-quality assets in high-growth markets," Klinck said. "We will be patient and we will be ready."