The office market is changing. Corporations used to locate their headquarters or major regional offices in coastal gateway cities like New York, Boston, and San Francisco because that's where they could find the best talent. However, businesses and workers have been slowly migrating out of those cities to more affordable ones in the Sun Belt region, which also boasts better weather and fewer regulations. That's fueling fast-paced growth in several large Southern cities.
Office REIT, or real estate investment trust, Highwoods Properties (NYSE: HIW) wants a bigger piece of this action. That recently led it to acquire apartment REIT Preferred Apartment Communities' (NYSE: APTS) office portfolio. Here's a closer look at why this deal makes so much sense for Highwoods.
The next phase of the rotation
Highwoods Properties focuses on owning Class A properties in fast-growing secondary markets. It had investments in the following cities:
- Charlotte, North Carolina
- Greensboro, North Carolina
- Memphis, Tennessee
- Nashville, Tennessee
- Orlando, Florida
- Raleigh, North Carolina
- Richmond, Virginia
- Tampa, Florida
However, it's been rotating out of Greensboro and Memphis to expand its presence in faster-growing cities in the Sun Belt. It's also been selling other noncore properties to redeploy those proceeds into better ones.
This asset rotation strategy recently led the company to strike a deal to acquire Preferred Apartment's office portfolio. It's investing a total of $769 million to purchase the portfolio, which includes:
- Four Class A office properties in Raleigh and Charlotte with more than 1.6 million square feet of space.
- One mixed-use redevelopment site in Atlanta that could eventually feature 300,000 to 600,000 feet of office space and more than 300 multifamily units.
- A mezzanine loan related to a recently built office building in Atlanta.
- A multi-building creative office project in Atlanta.
The company deemed the last two assets as noncore to its strategy. Because of that, it plans to eventually monetize them to help finance the portfolio acquisition. In addition to that, Highwoods intends on selling $500 million to $600 million of other noncore assets, especially those in Greensboro and Memphis, to fund the transaction.
Why Highwoods sees a bright future in these Sun Belt cities
This portfolio is attractive to Highwoods because the properties are in some of the fastest-growing real estate markets. For example, Charlotte has enjoyed 6.3% compound annual rent growth since 2013, driven by the ongoing relocation and expansion of businesses in this major metro area, keeping office vacancies below the national rate. Those businesses are bringing high-paying jobs, which are drawing more people to the city. Further, these jobs aren't ideal for working from home, meaning companies will need more office space as they continue expanding.
Raleigh is also benefitting from a healthy office market. Overall, rent has grown at a 4.4% compound annual rate since 2013, while vacancy has remained below the U.S. average. Driving that growth is the migration of several large technologies and life sciences companies. For example, just recently, Apple (NASDAQ: AAPL) unveiled plans to invest $1 billion to build a new campus and engineering hub in the region. That move could spur even more tech companies to set up shop in Raleigh.
Meanwhile, the Atlanta acquisition gives it some long-term optionality. It could build a future mixed-use project on the site with office space and multifamily units. That would enable it to benefit from the continued migration of business and people to the fast-growing metro area.
Overall, the deal will increase the company's revenue from Raleigh from 18% to 21%, making it the biggest contributor. Meanwhile, revenue from Charlotte will double from 4% to 8%.
Shifting to a red-hot region
Highwoods sees a bright future in fast-growing Sun Belt markets, which is why it's steadily pivoting its portfolio to those cities. This deal with Preferred Apartments perfectly aligns with its strategy, as it will enable the company to boost its presence in three of the fastest-growing cities in the Southeast. It believes this strategy will allow it to create more value for shareholders in the future, making it look like a potentially attractive way to play the Sun Belt migration trend.