Buy-rated office REITs

Declining vacancy rates and rising rents will boost these select real estate investment trusts.

By TheStockAdvisors Jan 28, 2013 12:22PM
Office buildings reflecting clouds low angle view Skip Nall Digital Vision Getty ImagesBy Royal Shepard, S&P Capital IQ equity analyst, The Outlook

Office building owners faced significant challenges in 2012. A slow economic recovery and modest new job creation combined to limit demand for new space. In addition, long-term leases in many local markets were often renewed at rental rates below those previously in place.

We expect moderately better operating conditions for office REITs in 2013, driving an average increase in funds from operations (FFO) per share of about 4%.

For the coming year, Standard & Poor's Economics estimates that the U.S. economy will add about about 2.2 million jobs, up from a gain of 1.9 million in 2012. At the same time, we believe the level of new construction will remain modest in most markets.

In our view, real estate developers, including REITs, will pursue new projects only after securing leases from prospective tenants. The net result, in our estimation, will be a gradual decline in vacancy rates nationally and an average rent hike of 2% to 4% on new leases.

We expect the strongest markets to be ones benefiting from new job creation, particularly in the energy, technology, and life sciences industries. However, many suburban markets, in our view, are still suffering from excess supply and will lag large urban centers.

S&P Capital IQ has "buy" recommendations on three REITs that we expect to benefit from 2013 industry trends.

Boston Properties (BXP) is a large-cap office REIT focused on supply-constrained urban business districts. The trust has significant holdings in San Francisco and Boston, major markets recording positive job growth in the technology and life sciences sectors.

SL Green Realty (SLG) is an office REIT concentrated on the New York City market. Despite some contraction in the financial services sector, it is experiencing strong demand from technology and media-related tenants. In addition, we expect recent acquisitions to contribute to its 2013 earnings growth.

Finally, we recommend Highwoods Properties (HIW), an office REIT focused primarily on secondary markets in the southeastern U.S., including Nashville, Raleigh, and Atlanta.

We believe Highwoods will benefit from strong regional population growth as well as less intense competition from large industry players.

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