Real estate investment trusts (REITs) are income investments, so the rising interest rates over the past couple of years have been a big headwind. Why take on the risk of loss that comes with a stock purchase when you can get a CD with a 5% yield?
The answer is that the income a CD pays won't increase over time like the dividends being paid by Alexandria Real Estate Equities (ARE -1.29%) and Kilroy Realty (KRC -2.10%). That's the foundation of the story, but there's more to know about these two office landlords.
1. Alexandria owns a very special type of office
Alexandria gets lumped into the office REIT subsector, which is appropriate. But it doesn't really own the type of offices that most of its peers own. Alexandria's portfolio is centered around medical research facilities. These assets are usually a combination of laboratory space and more traditional office space. It is a very specialized type of property and demand remains quite strong, noting the REIT's occupancy of 93.7% and rental rate increases of around 33% through the first three quarters of 2023 on renewing leases.
But Wall Street doesn't see that nuance right now. Indeed, traditional office properties still suffer from the fallout of the pandemic-era work-from-home trend, which is why Alexandria's stock currently trades more than 40% below where it was at the start of 2020. And yet its dividend was just increased in December, which suggests that the company is doing just fine.
In fact, its funds from operations (FFO) payout ratio is around 55%. That's a pretty modest number that leaves material room for adversity before the distribution would be at risk. To be fair, office landlords usually have lower payout ratios (office properties tend to be more expensive to operate than other assets), but there's no reason to fear Alexandria is going to cut its dividend. Meanwhile, the dividend yield is near 10-year highs at around 4% or so even after a recent rally in the stock price. There's still time to invest here if you can stomach swimming against the current.
2. Kilroy is right in the thick of it
If owning Alexandria is like swimming against the current, Kilroy is something akin to jumping into the deep end. This office REIT is largely focused on traditional office space (though it is increasing its exposure to medical research assets) located on the West Coast (it has a small position in Texas, as it essentially followed its tech customers to the state). The work-from-home trend has been a major headwind, with Kilroy recently highlighting that its vacancy rate was 14%. Only that's better than the average for the company's markets of 19%.
The differentiating factor here is that Kilroy tends to operate modern, well-located assets with plenty of amenities. These are A-rated properties that businesses and their employees want to be in. In hard times, companies tend to upgrade into assets like the ones Kilroy owns. In good times, companies may have to fight to get into them. Yes, times are tough today in the office sector, but Kilroy is fairly well-positioned. That includes both the quality of its assets and the markets it serves, which are still some of the most vibrant technology regions in the country.
At 5.4%, Kilroy's dividend yield isn't nearly as high as it was before its recent stock rally. But the shares are still over 50% below where they were prior to the pandemic. It seems like Wall Street is starting to recognize that this high-quality office landlord isn't in as bad a shape as some once feared. Notably, its FFO payout ratio was just a touch under 50% in the third quarter, which is very robust.
Still well off the highs
The big attraction here with Kilroy and Alexandria is that, even after a bump up in their stock prices, they remain well below their pre-COVID-19 high-water marks. Both of these office REITs have handled this difficult period fairly well, and there's no particular reason to believe they are going to stumble anytime soon. Risk-averse investors might want to tread with caution, but those willing to take a contrarian view will likely see that there's still some value here even as the broader REIT sector bounces back.
