Highwoods Diversified For Long-Term Stability

CNN financial guru Ali Velshi is engaged to Philadelphia portfolio manager Lori Wachs who works for Delaware Investments, a division of Lincoln National (NYSE:LNC). While she manages several growth funds at Delaware, it was Christopher Beck's Mid-Cap Value fund at Delaware that caught my attention.

All in the Family
One of the fund's top holdings is Highwoods Properties (NYSE:HIW), a Raleigh-based REIT specializing in suburban office space. Generally, I don't spend a great deal of time analyzing real estate businesses and I've only written two or three stories about REITs; it's just not my thing. But its business model is intriguing. (For a related reading, check out Find Fortune in Commercial Real Estate.)

A Change of Plans
Highwoods got its start in 1978 and went public 16 years later in 1994. It's the largest commercial real estate owner and operator in the Southeast, with 35.4 million square feet. The office market contributes 84.5% of its annualized revenues, with retail and industrial making up the remainder. Its top five office markets are responsible for 62% of its office revenues and are a key component to its future growth. Stagnating in mid-decade, management undertook a new strategic plan in January 2005 that focused the company's business model, with laser-like precision, on its core suburban markets. It sold about $800 million in non-core assets (at a 6.8% cap rate) and, more importantly, it moved up-market, increasing its Class A office space from 38% in 2004 to 61% today, which changed the composition of its portfolio by almost half - achieving tangible results.

Highwoods' Top Competitors

Company	Market Cap
Highwoods Properties (NYSE:HIW)	$1.45 B
Cousins Properties (NYSE:CUZ)	$439.49 M
Duke Realty (NYSE:DRE)	$2.01 B
Liberty Property Trust (NYSE:LRY)	$2.47 B
Data as of May 20, 2009

Sufficient Diversification
Raleigh, Atlanta, Nashville, Kansas City and Richmond generate over half of Highwoods' total revenues, with an office occupancy rate of 90.0%, which compares favorably to 85.2% for the average in the five markets. Adding to its success, only two customers account for more than 3% of revenue and one is a group of 31 federal and state agencies under long-term leases. You couldn't ask for better clients. Overall, its total portfolio has an 89% occupancy rate, which isn't bad considering the current economy. According to commercial real estate sources, vacancy rates in the top office markets in America range from a low of 9% in Boston to 20% in Phoenix. In 2009, this will only get worse. Add to this $500 billion in mortgages coming due in the next two years and real estate investors have to be nervous. Mortgages that once were renewable at 70-80% loan-to-value ratios will now drop to the 50% level, forcing owners to either add cash to the mix or simply sell outright. Neither is very palatable.

Bottom Line
Highwoods' first quarter funds from operations (FFO) beat expectations by two cents, 70 cents versus expectations of 68 cents - this, despite a worsening commercial real estate market. What are the company's debt obligations in 2009? It has $117 million maturing in 2009 and feels its full-year FFO guidance of $2.53 to $2.72 is more than adequate to meet its current responsibilities. Given the state of the economy, I'd be careful about an investment in commercial real estate at this point, although Highwoods is as good a place to start as any. (Read Add Some Real Estate To Your Portfolio to learn more about this topic.)