Since the start of the pandemic, there has been a swirling question of if, not when, technology companies will return to in-person office work. However, that narrative has changed in recent months. The rapid rollout of vaccines has driven down COVID-19 case levels in the U.S., making a return to the office possible. Meanwhile, a growing number of companies and their employees are growing tired of working remotely since that's not an ideal situation for creating culture, mentoring, and innovation.
Because of that, several large employers, led by tech giants Google, Facebook, Amazon, and Apple, have started announcing their return-to-work plans for this summer, with most targeting Labor Day to get everyone back. That bodes well for office REITs (real estate investment trusts) focused on leasing space to technology companies like Kilroy Realty (NYSE: KRC) and Hudson Pacific Properties (NYSE: HPP). This upcoming catalyst makes both companies look like compelling buys this month.
Readying for the return
Kilroy Realty owns office and multifamily units across four West Coast cities. San Francisco is its biggest market, at 53.3% of its NOI, followed by Los Angeles (21.8%), San Diego (12.6%), and Seattle (12.3%). Given that heavy presence in those Pacific coast cities, it's no surprise to see that most of its major tenants are in the technology or media industries. Its 15 largest tenants are a who's who of the tech sector, including giants like Microsoft (4.3% of its annualized base rent), salesforce.com (3.5% of ABR), and Amazon (2.1% of ABR).
That focus on leasing space to technology companies has weighed on Kilroy's stock over the past year and a half. Overall, the office REIT has generated a -12.8% total return since the start of 2020. Pushing down its share price has been the concern that an increase in remote work among technology companies will negatively impact the occupancy levels and rental rates of its West Coast office buildings.
However, that hasn't seemed to be the case. For example, the company signed 206,000 square feet of new and renewal leases in the first quarter at cash rates 4.9% higher than previous rents. Meanwhile, its portfolio stood at 93.3% leased at the end of that period.
As more technology companies return to the office in the coming months, lease rates could continue climbing. On top of that, the company should benefit from the return of nonrental income sources like parking fees. Those catalysts should help take more of the pressure off of Kilroy's beaten-down stock.
Interest is picking up
Hudson Pacific Properties focuses on four major West Coast cities. Like Kilroy, San Francisco is its biggest market, at 61.6% of its ABR. It also has properties in Los Angeles (16.9% of its ABR from offices and another 6.3% from studios), Seattle (9.4%), and Vancouver (5.7%). Unsurprisingly, it has a tech-heavy tenant base at 37.9% of its ABR, led by Google at 8.6%. It also counts saleforce.com (2.5%) and Amazon (2.1%) among its largest tenants.
That tech-heavy focus has weighed on Hudson Pacific's stock since the start of 2020, as its total return during that time has been -19%. However, while concerns over occupancy and rental rates have weighed on the stock price, they seem overblown.
For example, the REIT signed more than 524,000 square feet of office leases in the first quarter at cash rental rates 2.4% above prior leases. That number was a bit deflated due to some large renewals at market rates and a lease expansion below market rates. After adjusting for those items, cash rent growth was 6.9% on its other leases. As a result of those lease signings, its stabilized portfolio ended the quarter 92.7% leased.
That quarter doesn't seem like an aberration. CEO Victor Coleman noted in the company's first-quarter earnings release that:
With a growing percentage of the population vaccinated and case numbers declining concurrently, companies are formalizing and even accelerating plans to return to the office. We are seeing this in our conversations with current and prospective tenants, and more broadly in the increase in tenant tours and requirements across our markets. Both our first-quarter leasing activity, in terms of volume, and our current leasing pipeline, that is, deals in leases, LOIs or proposals, are back on par with our long-term averages.
With companies accelerating plans to return to the office, they're also making sure they have enough space for their employees by securing leases. That increase in activity has Hudson Pacific back on track to where it was before the pandemic, which should help lift some of the pressure off of its stock.
The new normal might not look that different
There's been a lot of speculation about the role of offices as the pandemic subsides. While many thought remote work would be here to stay, that doesn't seem likely to be the case. Instead, most companies, even those in the tech sector, are planning for a nearly total return of in-office work. All this means Kilroy and Hudson Pacific could rebound in the coming months, making them compelling bounce-back candidates to buy this June.