“Long-suffering” US office S-REITs have exhibited nascent signs of recovery, says UOB Kay Hian (UOBKH) Research analyst Jonathan Koh. Leasing volume has picked up and tenants are more willing to commit to larger and long-term leases. Physical occupancy is trending higher as more companies demand employees return to working at the office, he adds.
According to CBRE, leasing volume increased 11.5% y-o-y to 51.5 million sq ft in 3Q2024, reaching 86% of pre-pandemic levels. Tenants from the finance and legal sectors remain active, while tech companies have started to return to the office market. Net absorption increased 87% q-o-q to 4.3 million sq ft, marking the second consecutive quarter of positive net absorption.
Tenants have shown more confidence in signing long-term leases, according to CBRE. The average size of leases for at least 10,000 sq ft has also grown sequentially for the second consecutive quarter to 29,875 sq ft. Availability of sublease space has shrunk to 4.1% of total inventory, compared with a peak of 4.7% in 2Q2023. Vacancy rate for prime office space improved 20 basis points q-o-q to 15.5%.
Koh notes a “turning point” for offices with early signs of expansion as tenants shift from “contraction to stabilisation mode”. Downsizing activities are normalising as adjustments to hybrid work arrangements have largely taken place over the past four years, he adds in his Jan 13 report.
According to Jones Lang LaSalle (JLL), many tenants have reached their targeted office footprint with office space per employee stabilising at 146 sq ft in 3Q2024, down 9% from pre-pandemic levels. Some tenants have started to expand; smaller tenants looking for 10,000 to 20,000 sq ft of office space are driving leasing volume.
See also: Manulife US REIT reports 9.3% drop in portfolio valuation, warns of FY2024 loss
US trends
The US federal government is taking the lead to return to a five-day work week, providing the impetus for the private sector to do likewise, says Koh. “Successful implementation of the work-from-office model by large corporations, such as Amazon, JPMorgan and AT&T, paves the way for other companies to switch to the same model.”
According to Placer.ai, which monitors office attendance by tracking signals from mobile phones, physical occupancy recovered to 83.2% of pre-pandemic levels in October 2024, up from 72.3% in January 2024.
See also: Prime US REIT added into S-REIT Benchmark Index
However, some companies downsized prematurely and will need additional office space to accommodate more employees returning to the office, notes Koh. “The work-from-office momentum would lead to higher physical occupancy and underpin the recovery in demand for office space.”
Koh also notes a “migration to the South” within the US. “Growth markets in the Sun Belt have outperformed with leasing volume increasing 9.4% q-o-q in 3Q2024, reaching 96% of pre-pandemic levels. Relocations out of gateway markets to lower cost Sun Belt secondary markets have picked up.”
Chevron, SpaceX and X (formerly Twitter) announced plans to relocate their headquarters from California to Texas in 3Q2024. Foot Locker plans to relocate from New York to Tampa.
Sun Belt beneficiaries
Among the three US office S-REITs, Koh picks Keppel Pacific Oak US REIT (KORE) and Prime US REIT (PRIME) as beneficiaries of growth in Sun Belt markets, as their assets there accounted for 52% and 38% of their portfolio valuations respectively.
Manulife US REIT (MUST), however, is notably absent from Koh’s report. It is also missing from UOBKH’s table of all S-REITs. MUST, which is in the midst of divesting assets to fulfil a “recapitalisation plan” and pay off debt, reported a 9.3% drop in portfolio valuation on Jan 10.
See also: Prime US REIT eyes turnaround with divestment, US$550 mil credit facility
According to Koh, “overwhelmingly attractive valuations beckon” among US office S-REITs, which are trading at a 2026 distribution yield of 22.5% and average price to net asset value ratio (P/NAV) of 0.31 times.
In comparison, US office REITs listed on the New York Stock Exchange (NYSE), such as Boston Properties (BXP), Cousins Properties (CUZ) and Vornado Realty (VNO), trade at an average distribution yield of 4.06% and P/NAV of 1.60 times, notes Koh.
Still, Koh has adjusted his target prices on KORE and PRIME lower to reflect higher US government bond yields, which have risen due to expectations of continued strong growth for the US economy. “We also adjusted our risk-free rate higher from 4.00% to 4.75%. Thus, we are correspondingly using higher cost of equity (COE) at 10.5% for KORE (previous: 9.75%) and 11.75% for PRIME (previous: 11.0%),” notes Koh.
KORE occupancy ‘to remain above average’
Koh thinks KORE’s portfolio occupancy will remain “above industry average”. Management has cautioned regarding known vacates at Westmoor Center in Denver (100,000 sq ft) and The Plaza Buildings in Bellevue (40,000 sq ft) in 2025.
Portfolio occupancy is expected to hover sideways at 88% to 89% in 4Q2024, and take a small dip in 1Q2025 before recovering back to 88% to 89% by end-2025.
Management expects rental reversion to range from negative 5% to positive 5% in 2025. Physical occupancy improved 3 percentage points (ppts) q-o-q to 73% in 3Q2024.
Koh is maintaining “buy” on KORE with a 32 US cent target price. “KORE provides 2026 distribution yield of 19.0% and trades at P/NAV of 0.29 times.”
PRIME’s enhancements
PRIME completed the enhancement for Waterfront at Washingtonian in October 2024. Amenities provided include a tenant lounge, conference centre, cafe, full-service gym and wellness room. The “iconic” 14-storey office building with a lakefront view is adjacent to Rio Shopping Center, which provides a broad mix of restaurants, shops and entertainment options, says Koh.
Occupancy at Waterfront at Washingtonian increased 7ppt to 40% with 22,000 sq ft of new leases signed in 3Q2024.
PRIME is expected to sign leases for another 35,000 sq ft by end-2024, further improving occupancy to 50%.
Management is reportedly in talks with a global insurance company for 100,000 sq ft of office space, and notable leasing discussions are underway at Park Tower in Sacramento and Village Center Station 1 in Denver, notes Koh.
PRIME is in advanced negotiation with a government agency for 105,000 sq ft at Park Tower, which could bring occupancy back to 90%, up from 68% in 3Q2024. The deal is expected to close in 1Q2025.
PRIME is also engaging a financial services company for 60,000 sq ft at Village Center Station 1.
Koh is maintaining “buy” on PRIME with a target price of 33 US cents. “PRIME provides attractive distribution yields of 2.3% for 2025 and 25.9% for 2026. The stock trades at a depressed P/NAV of 0.32 times.”
Prior to the midday break, units in KORE were trading flat at 20 US cents, while units in PRIME were trading 0.1 US cent higher, or 0.62% up, at 16.3 US cents.
Units in KORE have slipped 46% over the past year, while units in PRIME have declined 20% over the same period.
Charts: UOB Kay Hian Research
