Real estate investment trusts (REITs) focused on office buildings are bouncing back this year as some pandemic-related headwinds fade. The average office REIT generated a more than 15% total return through the end of June after delivering a negative 18.4% total return last year.
West Coast-focused office REIT Hudson Pacific Properties (NYSE: HPP) has joined that rally, with its shares up more than 17% this year. Here's a look at whether the office REIT still has room to run or is running on empty.
The case for buying shares of Hudson Pacific Properties
While Hudson Pacific's stock has been in rally mode this year, shares of the office REIT are still down about 25% from the start of 2020. That decline comes even though the company's office and studio portfolio has held up relatively well during the pandemic, with a strong rental collection rate in the upper 90% range.
While the loss of parking revenue and lower rental collection from storefront retail tenants in its office buildings put some pressure on funds from operations (FFO), it only declined by 6% on a per-share basis after excluding some special items.
Meanwhile, the company's results have improved in 2021. Same-store office and studio cash net operating income (NOI) rose 2.6% and 6.4%, respectively, during the first quarter. In addition, leasing activity has improved -- the REIT secured more than 524,000 square feet of office leases in the first quarter -- with rental rates up 2.4% on a cash basis.
Hudson Pacific's CEO Victor Coleman noted that "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." That suggests companies expect offices to remain central to their operations in the future.
Hudson Pacific is also firmly focused on growth. It used the cash from its studio deal with Blackstone Group (NYSE: BX) to purchase a high-quality office building in Seattle leased to Amazon. Even after that deal, it has about $1 billion of liquidity, giving it significant financial flexibility.
The company's using that flexibility to pursue a more than three million-square-foot development pipeline -- 40% of which is studio-related opportunities -- and value-add office and studio acquisition opportunities. Those investments could enable Hudson Pacific to grow its FFO at a healthy rate in the coming years.
The case against buying shares of Hudson Pacific Properties
The biggest concern with buying any office REIT these days is the uncertain future of the office. Many companies -- especially those in the technology sector -- plan to allow more of their employees to work remotely in the future, including entirely offsite or as part of a hybrid model.
Given the West Coast's tech-heavy office market -- 40.1% of Hudson Pacific's office rent comes from the sector -- there's concern this trend could impact leasing activity in the future, weighing on occupancy levels and rental rates.
Further, even companies that had planned to return to the office following the rollout of vaccines are having second thoughts as the delta variant causes case counts to rise. For example, Apple planned to start bringing employees back to the office three days a week beginning in September but has delayed that until October, given the recent surge in new cases.
If more companies push back their return, it could put additional pressure on office REITs, potentially impacting leasing activity negatively.
Finally, Hudson Pacific's focus on the West Coast is a concern, given the migration of businesses to states with better business climates in the Sun Belt region. Several California-based companies have relocated or expanded to the Sun Belt to take advantage of lower tax rates and fewer regulations.
Because of that, office buildings across the region are benefiting from higher rental growth rates. That trend recently led rival West Coast office REIT Kilroy Realty (NYSE: KRC) to acquire an office tower in the Austin, Texas, market, which is benefitting from the migration of tech companies to Texas. If tech companies continue to leave the West Coast, it could put additional pressure on occupancy levels and rental rates.
An interesting bounce-back candidate
While Hudson Pacific's stock has rallied this year, it hasn't fully recovered to its pre-pandemic level as some uncertainties remain. However, its office properties have held up well and are in demand.
On top of that, the company has an interesting studio joint venture with Blackstone and lots of upside potential as it puts its liquidity to work on new development opportunities and acquisitions. Those factors make Hudson Pacific look like a compelling office REIT to buy for those seeking a way to play the sector's recovery.