Real estate investment trusts (REITs) aren't get-rich-quick investments. Instead, these companies build wealth slowly by investing in commercial real estate that generates rental income and benefits from appreciation. Because of those two factors, REITs have become enriching long-term investments compared to stocks.
However, not all REITs have track records of creating superior shareholder value. With that in mind, here's a closer look at whether office REIT Highwoods Properties Trust (NYSE: HIW) has what it takes to enrich its investors who hold for the long haul.
Getting rich slowly
Any investment can grow into a $1 million payday if it can generate a high-enough return for an extended period. For example, $10,000 invested in an S&P 500 index fund has historically grown into $1 million in about 46 years, assuming a historical rate of return of around 10%. Meanwhile, a higher-returning investment could turn that same $10,000 initial investment into $1 million even faster.
Thus far, Highwoods Properties hasn't generated market-beating returns. Since its initial public offering (IPO) in 1994, the REIT has produced an average annualized total return of 9.3%, underperforming the S&P 500's total annualized returns of roughly 10.7% during that time frame.
A look at Highwoods Properties' millionaire-making potential
While Highwoods Properties has underperformed the market since its IPO, that doesn't necessarily mean it will continue doing so in the future. Until a few years ago, Highwoods' total returns had outpaced the broader market. Unfortunately, the company has trailed off since then due to two notable headwinds.
First, the company has been undergoing a market rotation strategy, pivoting out of slower-growing office markets by selling properties to expand into faster-growing ones in the Sun Belt region. For example, in late 2019, the company unveiled its plans to enter the Charlotte, North Carolina, market while exiting Greensboro, North Carolina, and Memphis, Tennessee.
Meanwhile, it recently agreed to acquire a portfolio of office properties in the Sun Belt markets of Atlanta and the cities of Charlotte and Raleigh in North Carolina, which the company intends to finance with additional non-core asset sales. Highwoods is making these moves due to the rapid expansion of those Sun Belt markets, as more companies move into the cities to take advantage of their better business climates.
Highwoods believes moving into the Atlanta, Charlotte, and Raleigh markets will enable the company to benefit from higher rent growth in the future than if it stayed in Greensboro and Memphis.
However, though a net positive for its balance sheet, this capital recycling strategy of selling assets to finance acquisitions had a neutral impact on its funds from operations (FFO) per share. With FFO stagnant, the stock hasn't had reason to rise.
Meanwhile, Highwoods is facing some near-term issues and uncertainty from the pandemic. For instance, it's not yet clear how companies will utilize office space in the future. With remote work and hybrid office solutions likely to rise, companies might not need as much space, which could impact occupancy and rental rates at Highwoods' properties.
However, given its focus on lower-cost Sun Belt markets, the REIT could avoid the same level of impact felt by office REITs focused on high-cost coastal gateway cities that are experiencing the most significant effect from the pandemic.
Instead of a headwind, the pandemic has been a tailwind for the Sun Belt region. Companies are increasingly moving to this area's large metro areas due to better affordability and business climates. Because of that, Highwoods' strategy has the potential to pay off over the long run as the company could benefit from above-average rent growth.
Meanwhile, the company has substantial long-term growth potential, including several development projects currently underway that should boost Highwoods' net operating income (NOI) once completed. On top of that, it has significant future development potential thanks to its vast land position: The company has the space to invest $2.2 billion to add more than 5.6 million square feet of additional office space across its markets.
What's more, Highwoods could sell additional non-core assets and utilize its strong balance sheet to give it the financial flexibility to make more acquisitions across the Sun Belt region. If it can make investments that grow its FFO per share and dividend at healthy rates, the REIT could get back on the road to outperformance.
Solid, but likely unspectacular
Highwoods Properties Trust has done a decent job creating shareholder value over the years. While it has gotten off track in recent years, its market-rotation strategy could set it back on the right course, potentially leading the office REIT back to producing solid total returns in the years ahead as companies continue expanding their office presence in the fast-growing Sun Belt region.
However, that might not be enough to deliver superior performance compared to the S&P 500, especially over several decades. Unfortunately, while Highwoods has compelling upside potential, it doesn't look like a millionaire-making REIT.