Highwoods Properties Stock: Up Since Trough, But Still A ‘Buy’ (NYSE:HIW)

Writer’s Discover: This text was first printed on iREIT on Alpha in July 2023.

Pricey subscribers,

I’ve reviewed Highwoods (NYSE:HIW) a number of instances prior to now, some in blended articles, and a few in particular articles to the corporate. Because the firm has gone up within the final 1-2 months, I’ve seen good RoR for the corporate. The overarching thesis – each in upside and danger – hasn’t materially modified, however I imagine the most recent outcomes and the most recent tendencies are a affirmation that issues are removed from as unhealthy because the bears would have you ever imagine.

Due to that, I feel a case may be made as to why it’s extra fascinating right here to put money into the corporate once more.

With regards to Workplace Properties, my picks are the 4 that I view as the very best high quality.

They’re, in no explicit order right now, Alexandria (ARE), Boston Properties (BXP), Highwoods Properties, and Kilroy (KRC).

I personal all three corporations in my portfolio – and I’ve zero intention to vary that.

Right here is why Highwoods Properties stays a strong essential decide for me.

Highwoods Properties – The upside is plain, if Workplace stays enticing

Highwoods Properties is a REIT with an fascinating geographical publicity for its properties – that means it primarily focuses on the enticing southeast with publicity in areas like Nashville, Atlanta, Raleigh, Tampa, and Orlando, which collectively account for round 80% of the corporate’s general geographic mixture of properties.

The corporate tends to deal with, as a lot as its geographical publicity permits this, the highest general actual property markets. With its deal with Raleigh, Nashville, Charlotte, Orlando, Atlanta, and Tampa, it focuses on 5 out of the ten 2022 high actual property markets on the market. Take particular discover of the truth that their precise impacted east or west-coast publicity is actually fairly minimal in the case of geographies which have been receiving flak for his or her present tendencies.

Highwoods is extraordinarily targeted on rising actual property markets and has outpaced or averaged the annual progress in actual property by markets for the previous 10 years.

That’s not to say that the corporate hasn’t had challenges with components of its portfolio. However the core flaw that bears have right here stays the idea that Highwoods doesn’t react to this (or different workplace REITs). That is demonstratively false.

REITs all the time have a really shut eye on their asset working performances, and so they regularly rotate/divest/make investments to make sure that their asset portfolio stays at a top quality and as resilient as they will presumably make it.

That’s the reason lately, in Could 2023, the corporate bought over $40M of non-core belongings in a tough market, most of which is able to go in the direction of shoring up an already iron-clad steadiness sheet with a BBB ranking.

The 95%-sunbelt is without doubt one of the main arguments right here, with 85% of the NOI in high markets. HIW has one of many strongest market tendencies on the market when it comes to demographics, hire, and absorption.

This portfolio is now beneath 90% occupancy – at 89.6%. That is nonetheless going sturdy with a 4% hire CAGR and fewer than a 20-year common asset age and a 6 WALT. Within the so-called “flight to high quality”, Workplace REITs have been pressured to speed up inclinations of non-core or non-attractive belongings. These belongings have been “advantageous” to carry and advantageous to finance in a greater market – such because the market 1-2 years in the past – however they’re steadiness sheet poison on this setting.

Nevertheless, what I would like you to deal with is the diploma of outperformance statistically related to HIW within the setting.

The corporate has very spectacular diversification going to finance, authorized, insurance coverage, healthcare, tech, manufacturing, and a mixture the place no single section has greater than 18% and solely 3 have greater than 10%. By way of buyer diversification, no buyer has greater than 3.8% of ABR, and the highest 20 is at 28%.

Whereas the outlook vary does comprise the likelihood for a decline in NOI progress on a same-property foundation, the corporate might on a historic foundation see 1-2 years of this with out impacting what I view because the strongest tendencies within the workplace REIT house.

By way of fundamentals, the corporate has 42.4% debt + prefs as a % of gross belongings, bringing to us to a sub-6.0x web debt/EBITDAre at a weighted fee of 4.3% and a securitization proportion of beneath 10% with 82.5% unencumbered NOI. This leverage has gone down from what was above 6.5x 13 years in the past post-GFC, to round 4.7x in 2016, however by no means above 6x once more since.

Maturities? None till 2025. No $500M+ maturities till 2028, and the corporate nonetheless has almost $800M readily available as of the 1Q23 interval. The inclinations of $40M are additionally solely the start of what HIW intends to do, which involves a $400M disposition plan for 2023E. HIW has a confirmed monitor file of enticing market exits whereas offering constant FFO progress.

Keep in mind that I’m on no account arguing that there aren’t dangers to HIW. Occupancy will little question be a future driver of efficiency, and that is what truly declined in 1Q23. But it surely’s equally vital to notice, that these declines didn’t come from all markets. Nashville and Charlotte, as an illustration, did extraordinarily effectively with 95%+ occupancy stats.

The traders who think about the inventory dangerous converse to the corporate’s decrease leasing fee – round 250,000 much less on common in 1Q along with a 5-7% FFO drop on this 12 months. Then there are the “bears” on workplace, that count on a 25-40% workplace out of date fee within the subsequent 2030-2040.

Let’s simply say that should you as an investor are bearish on workplace demand, you shouldn’t be investing in workplace REITs. I as an investor think about it unlikely that workplace demand will collapse – I think about it probably that workplace renters could have larger calls for on the areas they hire going ahead – however this advantages a web high quality landlord corresponding to HIW.

My core argument is that even within the case of “Workplace oversupply”, Highwoods manages among the finest properties in the marketplace, and paired with the corporate’s lively administration and their deal with higher-quality markets versus almost collapsing markets, the end result at this valuation will likely be optimistic for traders in a 3-5 12 months timeframe.

Why Highwoods is about to outperform over 3-5 years sooner or later

Highwoods and its administration know precisely what is occurring available in the market, and they’re righting their ship in a really tough setting. That this will likely be workable with out some form of damaging influence is unattainable, as I see it. We are going to see corporations, together with HIW, reporting stresses all through their organizational construction because the seams and limitations of the corporate – each financially and in any other case – are examined.

However stress is how organizations are hardened. Stress and hassle is the answer to fragility, as a result of organizations, like people, have to “change or die.”

Once I have a look at these kinds of REITs, I’m asking myself if they’re altering quick sufficient or if they’re attempting to do every part as earlier than and sticking their heads within the sand.

Highwoods is the previous.

It turns into a query of whether or not the valuation rightly corresponds to the elemental improve in danger.

And let me simply say that my reply to that exact query is a agency “no”.

You argue that HIW is on no account justified to commerce at its historic premium on this market.

I agree with that.

You argue that HIW ought to positively commerce at a reduction to replicate the ratcheted-up danger that we’re seeing from each macro and micro.

I agree with that as effectively.

So what Highwoods be value?

How about half its historic premium?

As a result of should you forecast at 7.5x P/FFO, that nets you an annualized RoR of 13-14% primarily based on present estimates of damaging ahead FFO progress charges.

So even at a despairing form of valuation, ignoring most every part the corporate has to supply, together with an 8% dividend that is coated by a 52% post-5.7% FFO drop Payout ratio that was not reduce within the dividend, that is the upside you are getting.

Me, I purchased shares even cheaper, at nearer to twenty bucks per share, which has already seen progress.

Personally, I imagine that Highwoods given its publicity and high quality is value much more. And when you, should you, settle for that premise, then your potential returns begin trying comparatively insane.

First off, no premium. I do not count on web progress for the subsequent few years. So a 10-11x P/FFO is actually essentially the most I’d count on out of HIW, even in a slowly recovering market.

Nevertheless, that 11x P/FFO is when the corporate, even at $25/share, begins touching triple-digit ROR.

The factor is although, at a spread from virtually 6x P/FFO to upwards of 11x P/FFO, which I view because the realistically impacted and discounted vary for HIW, there’s a very low probability of a long-term lack of capital on this funding. And that is what I search for once I make investments.

I’m not saying that I will go 10-15% in Workplace REITs. My general portfolio allocation is and can stay beneath 5% in whole. Nevertheless, essentially the most distressed and “hated” sectors are the place the very best bargains may be made – if you already know what to search for, and if you already know your danger/reward issues.

I do – and it’s best to as effectively.

A few of the analysts and fashions that estimate a good worth for Highwoods put the corporate as excessive as $40-$52/share in the long run. I would not have a difficulty with this goal – not in the long run. The corporate can be thought of to be one of many highest-quality workplace REITs nonetheless round, with the exceptions of specialty workplace REITs like Alexandria (ARE) the place I personal even bigger stakes.

I don’t observe one mannequin or method to a tee – I as a substitute use a number of fashions and valuations, attempt to discover their flaws, after which influence accordingly. That’s the reason my goal is decrease than $50/share right now. Nevertheless, I think about any valuation beneath $40/share to not accurately account for this firm’s strengths exterior of this setting.

And should you argue beneath this, you are both arguing that the downturn will final for a really very long time, or that the corporate won’t survive the downturn in any respect – I think about each of those stances to be flawed, as I imagine the downturn could final maybe 2-4 years, however not.

HIW is presently being valued at round 0.58x its NAV. The near-20-year imply for this a number of is 0.92x. I do not even have to argue for that 0.9x+ – I can simply say they need to be valued at 0.75x, and it’d nonetheless be a major upside at a mean the corporate has by no means held for any prolonged time period – not even within the GFC.

For these causes, I view the corporate as being materially enticing right here, and right here is my thesis on Highwoods properties.

Thesis

• Highwoods Properties is without doubt one of the 4 strongest Workplace REITs that I put money into, and I think about it to be one of many workplace names one ought to deal with as a conservative investor within the house. The mixture of portfolio and geographical high quality along with confirmed administration experience and FFO progress will maintain the corporate within the face of great ahead stress on this economic system.
• The eventual upside to the corporate as soon as issues normalize inside a 3-5 12 months interval is at least double digits on an annual foundation, with full normalization having the potential to ship triple-digit progress.
• For these causes, I view HIW as a “BUY” right here and set a value goal of $42.5/share for the long run.

Keep in mind, I am all about :1. Shopping for undervalued – even when that undervaluation is slight, and never mind-numbingly large – corporations at a reduction, permitting them to normalize over time and harvesting capital positive aspects and dividends within the meantime.

2. If the corporate goes effectively past normalization and goes into overvaluation, I harvest positive aspects and rotate my place into different undervalued shares, repeating #1.

3. If the corporate does not go into overvaluation, however hovers inside a good worth, or goes again right down to undervaluation, I purchase extra as time permits.

4. I reinvest proceeds from dividends, financial savings from work, or different money inflows as laid out in #1.

Listed below are my standards and the way the corporate fulfills them (italicized).

• This firm is general qualitative.
• This firm is basically protected/conservative & well-run.
• This firm pays a well-covered dividend.
• This firm is presently low-cost.
• This firm has a practical upside primarily based on earnings progress or a number of growth/reversion.

The corporate fulfills each certainly one of my standards, making it a “BUY” right here.