Come back to the office… or go find another job.
That’s what IBM told its managers earlier this year. It wants to put an end to remote work.
Making return-to-office mandatory is a trend that’s been playing out for more than a year. Company executives have been pushing employees to return to the office, at least a few days each week.
Some companies – such as UPS, Boeing, and JPMorgan Chase – are taking it a step further, telling workers to show up five days a week.
According to a survey by accounting firm KPMG, 64% of CEOs believe offices will be back to pre-pandemic attendance by 2026.
These are signs that the office sector is starting to stabilize.
But as I’ve been telling you these past few months, not all offices are created equal. And some are thriving while others remain empty.
Today, I’ll give you an update on the latest trends in the office sector. And I’ll show you how to play the rebound as workers head back to the office.
Not All Office Spaces Are Created Equal
If you like the hustle and bustle, show up on Tuesdays. Want a quiet place to work? Come in on Fridays.
Data from the building security company Kastle Systems shows that office occupancy ranges from 35% to 63%, depending on the day of the week.
But more and more people are starting to come back to the office. In the last few weeks, office occupancy reached a record high since the start of the pandemic.
Expect that trend to continue as more companies force employees to return to the office.
Since the end of 2019, office-based jobs have increased by 6.3%. But over that same time, companies have reduced their office real estate by 6.1%. In some cases, companies have suddenly found themselves with not enough office space.
But companies aren’t looking for office space in the same places they used to.
Demand for offices in “gateway” cities like San Francisco and New York has increased by 2.6% since June. Meanwhile, demand for offices in secondary markets like Austin and Nashville is up 8%.
During the pandemic, many people moved out of the big cities and into the Sunbelt. Now, that’s where the jobs are and where demand for offices is highest.
Another big trend in the office sector is the “flight to quality.” Companies are looking for newer, more modern buildings that keep employees happy and comfortable while they’re at the office.
Offices built after 2015 have seen a net increase of 127.3 million square feet of leased office space since the pandemic hit. Meanwhile, older offices continue to lose tenants.
Newer offices are not just getting fuller… They’re also getting pricier.
In fact, the rental rates for trophy office properties are 13.3% higher than they were pre-pandemic.
Supply vs. Demand Is Creating an Opportunity
It’s clear that demand for new, high-end office buildings is rising. But what about supply?
Office construction has dropped off a cliff.
Over the past three years, new office construction averaged 9 million square feet every quarter. But the latest reports show that has dropped off to just 1.2 million square feet.
That’s a level not seen since the Financial Crisis. And it means that record low numbers of new offices will be available in the coming years.
On top of that, developers have been getting rid of old offices at record rates. Last year, over 24 million square feet of offices were demolished or converted into other types of real estate, like apartments. That’s more than double the pace seen from 2013 to 2019.
And this year is on track to reach a similar amount of office space disappearing.
The imbalance in office supply and demand caused by the pandemic is rapidly reversing. And when it reaches the tipping point, office rents and prices will start heading higher.
That’s why it’s a good time to consider investing in an office real estate investment trust (REIT) like Highwoods Properties (HIW).
Highwoods owns a portfolio of 28.5 million square feet of office properties. The average age of its offices is 20 years. That’s well below the average age of buildings across the office REIT sector – 34 years.
It means Highwoods has more of the new, modern offices that are in high demand.
And Highwoods’ portfolio is focused on offices in secondary markets in the Sunbelt. Its offices are in cities like Raleigh, Nashville, Atlanta, Tampa, Charlotte, and Dallas. These are the areas that are seeing the most jobs and demand for offices.
Highwoods yields 8.4% and trades at 10.6x adjusted funds from operations (AFFO). AFFO is a financial metric used for REITs that shows how much cash flow is available to shareholders. Highwoods has historically traded at 19x AFFO, which means it’s at a 55% discount right now.
There will be winners and losers as America reevaluates how much office space it needs. If you’re interested in investing in the sector, Highwoods is one of the higher-quality names with a portfolio of modern properties that will attract more tenants and command higher rents.
And now is a good time to consider buying, while shares are cheap and before the sector starts to turn around.
Happy SWAN (sleep well at night) investing,
Brad Thomas
Editor, Intelligent Income Daily
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Source: Wide Moat Research