Highwoods Properties: Office REIT Struggles with Supply, Weakening Demand

Highwoods Properties (HIW) is an office REIT that once held a spot among my preferred real estate plays in the sector. A few years back, I rotated out of the position, watching from the sidelines as the office market softened. The stock has since drifted lower, a trajectory that reflects the broader headwinds facing mid-tier office assets in the Southeast and Midwest.

The company reported second-quarter funds from operations (FFO) per share of $1.20, flat year over year, on total revenue of $207.5 million. Same-property cash net operating income (NOI) slipped 0.9% from the same period last year, dragged down by a 70-basis-point drop in occupancy to 86.7%. Leasing volume came in at 1.1 million square feet, with weighted-average lease terms of just over five years. The market remains anemic: new lease starts were down 12% from the year-ago quarter, and renewal activity accounted for roughly half of the quarter's total leasing.

The bulk of the weakness is supply-driven. Atlanta, Raleigh, and Nashville – three of Highwoods' top markets – have all seen a wave of new office construction over the past two years, much of it built-to-suit or speculative by well-capitalized developers. That extra square footage has pushed vacancy rates in those cities above 20%, forcing landlords into lease concessions. Highwoods reported average tenant improvement costs of $6.50 per square foot per year on new leases, up from $4.80 a year ago. Free rent periods have also crept higher, to an average of 11 months on a five-year lease.

On the demand side, tenants are shrinking footprints rather than expanding. Highwoods' retention rate was 65% in the quarter, down from 72% a year ago. The company cited several large tenants that renewed at smaller spaces, including a major law firm in Atlanta that cut its square footage by 30% while extending its lease by only four years. Management told analysts that the large-block leasing environment – deals above 50,000 square feet – has slowed to a crawl, with most tenants deferring decisions until they see clearer signals on return-to-office trends.

Highwoods' balance sheet is moderate. Debt to undepreciated book capitalization stood at 47%, within the company's 50% self-imposed limit. The portfolio has $1.2 billion of total debt with an average maturity of 4.5 years. However, with interest rates staying high and cap rates widening, the company's cost of equity remains too high to issue unsecured debt at a spread that makes sense. Highwoods hasn't bought back stock since 2022, and management said there are no plans to do so this year.

The dividend, now at $0.50 per share per quarter, yields about 7.8% on the current share price of $25.60. FFO covered the payout at a 78% ratio, leaving a slim cushion. The company does not provide specific guidance for the remainder of 2025, though it noted that the leasing pipeline entering Q3 is 20% below last year's level.

What would have to shift before I consider initiating a new position: a clear inflection in occupancy – say, a 100-basis-point improvement in same-property occupancy over two consecutive quarters – plus stabilized or falling tenant improvement costs. Neither condition looks imminent. The next meaningful catalyst is the company's Q3 earnings report in October, when the 2026 leasing budget and capital allocation plan will be announced.

The office REIT sector has historically lagged during periods of supply-side adjustment. Highwoods is not the worst-positioned name in the space – its southern markets benefit from job growth and lower cost bases relative to gateway cities. But the gap between demand and supply is still too wide to justify a premium. I will stay patient.