Office REITs Recovering
In the US the latest economic recovery has been very different from previous recoveries for office REITs, as job growth has been lukewarm and didn’t produce the anticipated demand for office space. In its place, tenants are using space more efficiently, so they require less space as their headcount grows. For example, banks, legal entities, consulting firms and accounting companies have all been growing their employee base, but their overall real estate requirements have actually reduced.
During last year, office market fundamentals improved moderately. Overall vacancy dropped to 16.0% from 16.7% a year earlier, and direct asking rents were up 2.2%, according to Cushman and Wakefield. Likewise, office REIT portfolios showed little, if any, improvement in occupancy and rent growth. Due to their high quality assets and professional management, REIT-owned properties started with stronger fundamentals and had less room for improvement.
• S.L. Green (SLG) occupancy for Manhattan properties was 91.7% at year-end 2012 versus 91.5% one year earlier. Its suburban portfolio occupancy was 81.3% in 2012, down from 82.6% in December 2011.
• Total occupancy for Boston Properties (BXP), the largest office REIT, measured 91.4% at year-end 2012. This was down slightly from 91.7% one year earlier. BXP’s CBD properties, with 96.4% occupancy, are performing significantly better than suburban properties, with 83.6% occupancy. (Source: REITCafe)
Limited new construction has helped maintain balance in the office market. Pipelines are growing, though few markets have had strong enough recoveries to rationalize significant office construction. Cushman and Wakefield reported 4 million sqm of new construction underway at year-end 2012. REITs are well positioned to undertake development projects because they can raise inexpensive money on the secondary market or borrow from lenders with confidence in their track records. Some REITs are turning to development because they can achieve better returns than by acquiring existing properties at aggressive price levels.
• Kilroy Realty completed the redevelopment of two projects in Southern California in 2012. Two additional projects totalling 50,000 sqm, which were 70% pre-leased, were close to completion at year end. The company is increasing its presence in the San Francisco Bay Area and has another four buildings totalling 1.4 million square feet under construction.
• Boston Properties is developing eight office projects in New York, DC, San Francisco, and Boston totalling 250,000sqm. The buildings were 66% preleased at year-end 2012. The Company, along with Hines Interests, recently broke ground on the 130 000sqm San Francisco Transbay Terminal Tower, which is scheduled for completion in 2017.
REITs have expanded through acquisitions by taking advantage of the current low borrowing rates. In 2012, Boston Properties acquired four properties totalling 240 000sqm that were 93% leased, while S.L. Green acquired a fee interest in four properties totalling 81,000 sqm that were more than 90% leased. Kilroy acquired 14 buildings totalling 163 000sqm in 2012 and two additional buildings totalling 30,000 sqm located in Seattle in January 2013.
Office REITs have been sturdy so far this year. As a result of high occupancies, the largest REITs have experienced limited improvement in occupancy and rent growth. Like all REITs, across the board, they are continuing to use their balance sheets, taking advantage of low interest rates, to grow their portfolios through acquisitions and to some degree new construction.