Low occupancy on office REITs amid high rent, more dispositions in Q2

Earnings metrics for US office real estate investment trusts are nearly in line with those of the first quarter, although more than half of REITs showed better profitability during the second quarter, according to an S&P Global Market Intelligence analysis.

Median rent at its highest, occupancy rate at its lowest

In the second quarter, the median rent across US office REITs went up by 0.4% from the previous quarter and by 1.9% year over year, to $51.23 per square foot per year. In comparison to pre-pandemic levels, the median rent climbed 14.3% from $44.80 per square foot per year during the fourth quarter of 2019.

Paramount Group Inc. still had the highest average office rent at $90.50 per square foot per year during the second quarter, a 0.2% increase from the previous quarter. Office REITs with the second- and third-highest average office rents per square foot per year were Vornado Realty Trust and Boston Properties Inc. at $85.83 and $78.01, respectively.

During the second quarter, Cousins Properties Inc. had the highest increase in average office rent, posting a 12.2% quarter-over-quarter hike to $38.65 per square foot per year. This "exceptionally strong" average rent, was also "the second highest quarterly level in the company's history," said Cousins Properties' Executive Vice President of Operations Richard Hickson on the REIT's earnings call July 28.

Michael Colin Connolly, Cousins Properties' president, CEO and director, is optimistic that the REIT can continue to maintain its lease rates.

"When you look at our net effective rents over the last year compared to 2019, our overall net effective rents continue to track meaningfully upwards."

"[W]hile we've seen the leasing costs go up, both in the form of — perhaps a slight uptick in free rent and a larger uptick in tenant improvement allowances, we've been able to more than offset that with driving rental rates."

Highwoods Properties Inc. also enjoyed a higher average rent during the same period, with a 2.0% increase from the previous quarter to $31.58 per square foot per year. During a July 26 earnings call, the REIT's President, CEO & Director Theodore Klinck admitted that there would likely be pressure on occupancy and net effective rents, "until the office market regains its footing."

Despite that, Klinck remains confident over the long term as the REIT's Sun Belt portfolio is located within the region with the "strongest demographics and job growth."

"Our purposeful diversification, whether it be by market, by industry, by customer or by lead size, should enable us to deliver resilient operational performance, which has been among the strongest in the office sector over the past several years," Klinck added.

On the other hand, Kilroy Realty Corp. posted a 0.5% quarterly decline in average rent to $63.46 per square foot per year. Boston Properties Inc. and Douglas Emmett Inc. also saw quarterly drops in their average office rents by 0.4% and 0.1%, respectively.

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Concurrently, the US office REIT median occupancy rate continued to fall in the second quarter to 87.0%. On an annual basis, the median occupancy rate was down 1.3 percentage points and nosedived 6.0 percentage points compared to the fourth quarter of 2019, just before the COVID-19 pandemic.

Franklin Street Properties Corp. still had the lowest office occupancy rate during the second quarter at 73.3%, albeit a slight improvement from 71.5% in the prior quarter.

It was followed by Equity Commonwealth at 82.0%, a 40-basis-point hike from the previous quarter. Executive Vice President and COO David Weinberg said during the REIT's July 27 earnings call that the company is more actively preparing spaces for lease, on top of having been more aggressive on terms.

"In terms of leasing, we continue to see a range of deals with some tenants giving back space, some looking for short-term extensions and others more comfortable committing to term," according to Weinberg.

In contrast, Peakstone Realty Trust had the highest occupancy rate during the quarter at 97.0%, a 1.2-percentage-point decline from 98.2% in the previous quarter.

Corporate Office Properties Trust reported the second-highest occupancy at 94.9%, followed by Vornado Realty Trust at 91.9%.

Property dispositions spiked in Q2

There has been more transaction activity by US office REITs during the second quarter, following a weak first quarter.

Most of these transactions leaned toward property dispositions, which surged to $2.98 billion from $584.7 million in the first quarter. SL Green Realty Corp. drove the majority of dispositions during the second quarter, selling its 49.9% stake in Park Avenue 245 at a $2.00 billion valuation on June 2023.

Alexandria Real Estate Equities Inc. also sold $701.0 million worth of properties in the second quarter. "Alexandria has been able to make great progress towards reaching our value harvesting goals. At quarter end, we had closed $701 million of sales, including the 15 Necco sale announced last quarter and have another $175 million pending for a total of $876 million, which is a little over halfway to our midpoint guidance," according to Alexandria's CEO and co-Chief Investment Officer Peter Moglia during the REIT's July 25 earnings call.

Property acquisitions, on the other hand, fell during the second quarter, posting only a total of $100.5 million as compared to the $516.8 million reported during the first quarter.

Funds from operations, recurring EBITDA

Operating funds from operations (FFO) for 11 office REITs declined quarter over quarter, while eight REITs had sequential gains and two remained unchanged during the second quarter.

In contrast, more office REITs saw improvements in recurring EBITDA during the same period. Thirteen office REITs reported gains in EBITDA, while nine reported quarterly losses.

Gains in recurring EBITDA across all office REITs are more evident when compared to their year-ago and pre-pandemic levels. However, more REITs still have lower operating FFO compared to their year-ago and pre-pandemic levels.

Market Intelligence defines operating FFO as FFO adjusted for extraordinary items or other nonrecurring items at the discretion of the company. Office REITs sometimes refer to this as normalized FFO or core FFO.

Office REIT stocks fare well below pre-pandemic levels

US equity REIT stocks continued to underperform compared to the broader market during the second quarter. Office REIT stocks, in particular, were still among the worst-performing REIT stocks across all property types, with the Dow Jones US Real Estate Office Index losing 1.1% for the quarter.

As of Aug. 18, the Dow Jones US Real Estate Office Index was down 50.6% compared to the end of 2019. It also underperformed the broader Dow Jones Equity All REIT index, which posted an 11.6% decline during the same period.