Highwoods Properties, High-quality Real Estate for a Discount

Key Points

• While the U.S. housing market has taken its biggest dive since the housing crisis in 2008 within states like California and New York, some states have gained strength in migration patterns and inflationary trends
• Highwoods Properties is taking advantage of new residents and businesses adding to the pent-up real estate demand in these hot regions, finalizing some large acquisitions in Dallas, TX. 
• Dissecting the portfolio's NAV per share offers an opportunity for investors to own a share of this real estate at a 7.3% cap rate while other comparable properties are valued around 3-4% cap rates. 

Private equity real estate funds, crowdfunding platforms, and syndicators all seek to justify their high fees and bonuses to investors by convincing them that only they can deliver the results they promise. Ultimately, purchasing real estate is not much different from analyzing a business, which, in turn, is similar to analyzing a stock. Under this realm, what is the value proposition of owning shares in Highwoods Properties NYSE: HIW?

Starting with understanding where real estate valuations are, the overall U.S. housing market has declined in value by $2.3 trillion USD, otherwise the largest dive since the housing crisis in 2008. However, it is important to understand which markets were the most affected and if others were not. 

Although rising interest rates will impact real estate costs and demand across the board, certain markets such as Florida, Texas, Georgia, the Carolinas and Tennessee have experienced such a significant influx of new businesses and residents that recent interest rate increases appear to have had little to no effect on real estate valuations.

Conversely, states that saw an exodus of similar agents - such as residents and businesses - like New York and California experienced the largest drops in their real estate valuations and, in some cases, rental rates. These are trends that analysts believe will be long-standing, with certain states offering greater benefits through no state taxes, higher business incentives, or better lifestyle qualities. Therefore, investors may benefit from owning a share of real estate portfolios that focus on these regions.

Inflation and rents, a love story

Inflation will be a sticky high reading for the foreseeable future, as do economists think. As inflation affects incomes and costs of goods across the board, renters are sure to confirm that their housing costs also increase at a similar, if not hotter, rate. 

Highwoods Properties may have the ultimate trifecta of real estate working for its portfolio since they have focused its acquisitions on residential and office-based real estate in high-growth states. As stated in the latest investor presentation, their properties have achieved an average occupancy rate of 91.1% with a compounded annual growth rate of 4% in the rents charged, compared to the national average of 2.5% rent growth.

The further comparison reveals that while average national real estate markets are poised to experience 0.6% population growth or influx into properties, Highwoods' portfolios are expected to see 1.5%.

The third leg of their trifecta is valuations. Given that most of the portfolio is office-based, cap rates have risen on their properties (in other words, rents remained steady while building valuations compressed) due to entrenched beliefs that employees may never return to in-person work in offices. While these beliefs may be true for some industries, HIW's renters are not among those adopting a fully remote work environment; thus, these valuations may be a little too conservative for their properties.

Portfolio Composition and values

The latest development deals are only part of the story, looking to add an additional $40-$60 million USD in stabilized net operating income (NOI) to the portfolio. HIW has a formidable collection of high-growth income properties, which are mostly stabilized. According to their latest financials and presentation, the net asset value (NAV) per share is $50 or a 46% discount given today's stock prices.

Taking the NAV of $50 per share and an NOI yield of 4% (interchangeable with a 4% cap rate) would indicate where the portfolio of properties should be trading as a real estate investment trust or REIT. The stock is currently trading at $27.19 as of this morning, which translates to a 7.3% cap rate and an equivalent yield for shareholders.

Looking at the portfolio's valuation, funds from operations (FFO) is a commonly used metric to value real estate, like EPS for a stock. The 2022 FFO came in at $3.75 per share, thus placing HIW stock at a 7.25x multiple to FFO currently. 

Manageable debt and buying ranges

The overall portfolio carries a Net Debt / EBITDA ratio of 5.9x, which is a little richer than the usual norm for REITs of 5.0x. However, the debt has no maturities until the fourth quarter of 2025, when most new projects/acquisitions are expected to have achieved their stabilized NOIs, thus normalizing this ratio down to a more attractive level.

But wait, there's more... This stock is trading near its COVID pandemic lows, reaching a very strong support level between $25.50 and $26, currently showing very strong bullish divergences in weekly RSI and Stochastic indicators. If all of this was not enough, analysts are targeting a consensus price of $31.71 on top of the current 7.3% cap rates (yield) for investors, certainly worthy of a budget for these high inflation periods.