BXP, Inc. (BXP) Earnings Call Transcript & Summary

[Audio Gap] CEO Conference, I am Michael Bilerman. I am here with Manny Korchman. This session is for investing clients only. If media or other individuals are on the line, please disconnect now. Disclosures are up here and available on the web. Those in the rooms, you can go to liveqa.com, enter code Citi2020. Owen Thomas, I will turn it over to you to introduce everybody here. Doug, don't look so happy.

Yes. Owen Thomas. To my right is our President, Doug Linde, to my left is our CFO, Mike LaBelle, and to people to my right is Sara Buda, who's our head of IR.

So I'll turn it over to you, and then introduce the company and 3 reasons why investors should buy BXP stock today, and then we'll turn it over to Q&A.

Okay. So introduction on Boston Properties. I think as many of you know, we're the largest cap office REIT. That's still true despite the trading activity over the last 10 days or so. We are -- market focus is gateway markets in the United States on the coastal cities of Boston, New York, Washington, D.C., San Francisco and Los Angeles. To go to your question about what are the 3 reasons to own our stock, and specifically, what are some things potentially in those 3 reasons that are misunderstood or not well understood about Boston Properties. So let me just summarize by saying those 3 things that I want to spend a few minutes talking about are: first of all, our growth profile; second of all, the quality of the various aspects of our company; and third, the resiliency of our operating results. So let me get into those 3 areas and explain what I mean. So in terms of growth, we've given the market our projections for 2020 and the midpoint of that projection of FFO per share growth is 8%. I think the average office REIT last year grew at 3%. And at 8%, we are certainly amongst the leaders of our peer companies. By the way, that 8% is on top of our growth last year, which was an 11% growth in FFO per share. And again, the average was around 3%. So we have executed upon and have demonstrated a well above peer average growth profile last year and this year. Specifically, what is driving that growth? Part of it is same store and part of it is external growth coming from primarily development. Currently underway, we have $3 billion of projects, which represents 5.5 million square feet. This development pipeline that we currently have represents about 4% compound annual growth rate in our NOI between now and 2022. So we've given you a forecast for 2020. We think that growth can continue with our development pipeline. And then again, I think something that's not well understood or appreciated is we think that growth can continue even further. We've talked about in the nearer term, launching a handful of new projects that we have entitled. One is Platform 16, which is in San Jose, California. We will launch that in phases, but the whole project is 1.1 million square feet. We're in a joint venture with CPP on that project. And also, we just got 500,000 square feet of Prop M entitlement for our project at Fourth and Harrison in downtown San Francisco. And again, assuming the world doesn't completely fall apart, our anticipation is we would launch that project as well. Also, we have a 15 million square foot land bank under control in our company, which would lead to development down the road. Some of that land needs to be entitled. Obviously, we need to attract customers to that. We have additional projects that we're looking at, trying to see customers for, including 171 Dartmouth, which is at the Back Bay Station in Boston, 3 Hudson Boulevard, which is a major project in the Hudson Yards in New York. And in our new joint venture with Alexandria, we have over 200,000 foot lab building that could be a nearer-term start. So again, we've had strong growth this year and last year, and we have the potential for additional strong growth in future years. Second, I would talk about what is a key reason to own our stock is the quality of what we do. And I think the quality comes through in several areas. First, and very importantly, market selection. We are in, in our opinion, 5 of the most productive markets in the country for real estate investment and also 5 markets in the country that are some of the most difficult to operate in, where we are a market leader in most of them. I talked about what those 5 gateway markets were earlier, so I won't repeat it. These markets not only provide growth today, primarily from technology and life science customers, but they also provide protections from new development, and we can go into some specifics of that if you're interested. I would also talk about quality in terms of the types of assets that we own. If you look at our portfolio, we own some of the most notable office assets in the markets where we operate. And I won't go through a long list of those. The other thing, I don't think that's very well appreciated by the marketplace is our portfolio is getting younger. We are delivering over a $1 billion or plus or minus $1 billion of new developments every year, and we're selling somewhere between $300 million and $400 million of our older properties. So newer properties, they're full. They require less CapEx and it's more valuable, in our opinion, for shareholders. The other aspect of our quality, in our opinion, is our balance sheet. We have the highest rated. We have the highest credit ratings of any of our peer office companies. And as a result, we have access to all the major capital markets that are available to property owners and developers, that being the public and private debt markets as well as the public and private equity markets. And last, but not least, that I would mention in terms of quality is our operating teams. We're -- in most of the markets where we operate, we're either the largest landlord or the second largest landlord or the third largest landlord. We have a very deep team, which, by the way, we intend to showcase to all of you at our Investor Day this fall. But we have -- and also very strong leadership with industry leaders in all of our regions. And then the last thing I'd like to talk about in terms of why to own the shares is the resiliency of our income streams. As you know, we're an office company. We -- many of our assets are leased by customers on a long-term basis. Our current weighted average lease term with our customers is 8 years, and this has been rising. And it leads to less volatile outcomes in terms of our economics, particularly in times like this of uncertainty. Our debt maturities are spread. Our debt is relatively low, as I described earlier, and they're also spread equally roughly over the next 10 years. During the globe global financial crisis that we experienced about 10 years ago, we had rather minimal same-store losses for the reasons that I outlined. And then lastly, we had very strong diversification, which leads to resiliency. We're in 5 different markets that have different characteristics. Our customer base represents a broad swath of corporate America. We're not overexposed or underexposed to any specific industries and the largest tenant in our portfolio represents about 3% of our revenue. So again, the 3 reasons I outlined: growth, quality and resiliency.

Thank you for that, Owen.

So we start each of these sessions talking about ESG, which I know is obviously something that BXP takes very seriously. It obviously is an increasing importance to a lot of your stakeholders. What is one thing that BXP is doing to improve your ESG score over the next 12 months? So looking into the future.

Yes. So I'm going to turn it over to Mike who supervises this effort for us. But as you said, Michael, I just want to reiterate, ESG is very important to us. We have a sustainability department. I think we're a recognized leader in this space. Here we've -- I won't go through all the decorations, but we have quite a few of them. So let me turn it over to Mike.

Thanks, Owen. So yes, I think that we've been working on this ESG program for many, many years. So we feel like we're a leader. We're very good at it. We rank very highly. The Global Real Estate Sustainability Benchmark survey ranks us in the top 4% of nearly 1,000 companies globally in this area. We now have 4 of our 9 independent directors that are females, which I think is a very positive thing as well in this area, and we continue to reduce our energy intensity and our greenhouse gas emissions in line with our goals. We have 2025 public goals set for those things as well as waste and water reduction. So we've got a lot of things that we're working on. I would say goals for 2020 are really around green energy and figuring out and working on our strategy for reducing further our greenhouse gas emissions through green energy procurement and adding solar capacity to our portfolio. So we've got several places where we've been working on that to add our use of green energy. We also plan to develop Fourth and Harrison, which Owen described, which will be our first net zero development, and we hope to get started with that in 2020. And with respect to disclosures, we're working -- we've already complied with the SASB disclosures that came out a couple of years ago. And we're now working on TCFD, which is the latest disclosure requirements that are coming forth. And we've bulked up our 10-K that we just filed, and we're working on strategies to comply with the TCFD requirements over the next year. So a lot of different goals and objectives that we have in the E area. And I would say, we're also focused on the S area, in terms of disclosures around the social factors that we have.

So I would just add one comment, which is we don't take this as sort of a "check the box" kind of an approach to the business. Everything that Mike described and everything we're doing actually is geared towards cost reduction. So it actually makes sense to do these things. So when we put a solar array in one of our projects. And for example, Carnegie Center in Princeton, which we're doing right now. It will actually reduce our energy consumption, and we're entering into a power contract. So we're not actually putting any capital up to do that. And when we, for example, refurbish one of our chillers from a steam or natural gas to electric chiller, we're doing that because it's going to have a pretty significant payback over time. So every time we do something, we're thinking about what the return on cost is and how it's going to improve our operating results as well as doing the right thing for the environment.

Right. You mentioned it's the 3-year time to do the Investor Day, which is always a good sort of step. I think back 3 years ago, the focus was of the key development projects that you had going on, the entry in L.A. in terms of the hire and then eventually led to the deals. It was the famous bridge, that the bridge wasn't going to be blown up, we're going to get to the other side of growth, and that clearly has happened. A big focus on ESG and all those initiatives and where the balance sheet from a cost and funding perspective was. I think. And then the typical market stuff. What is the key thing -- things for this year's program that you're going to want to try to drill home with the backdrop of the uncertain economic and political environment?

Yes. Well, look, I think as you suggest, we are in a little bit of a time of uncertainty. We have this coronavirus matter that we don't know what the outcome is. And it's you know, it's interesting not -- I don't want to speak for everybody in the room, but none of us have a whole lot of experience with something like this. So we don't know what's exactly going to happen. And also, as you suggest, we have an election. So we will be watching all that as we come up with our programming for this event, which is going to occur at the end of September. But in general, I can tell you that I know the things that we are going to want to showcase. And I'm going to start with, I think, one of the most important things, and that's our team. You all and this group here assembled today, you see a lot of Sara and Doug and me and Mike as we spend a lot of time spending time with you trying to explain what we're trying to do. But we can't make any of this happen without the depth of the teams that we have in each of our regions. And we -- I think we had 45 different Boston Properties people speak at our last Investor Day, and you're going to see something like that again. And I actually think that's one of the absolute most important things about the Investor Day. But then to add to that, I would say, we want to talk about our markets and why is our market selection still makes sense. And which of those markets are doing the best and which are struggling and why, and why are we in those particular markets. I think we also want to spend some time on our development pipeline. It's very important. I talked about some of the projects in my introduction. We have a 15 million square foot land bank. We're going to get all of you for a day. We'll have some more time to get into some details. We clearly want to get into all that.

And then as you think about approaching development, which obviously has been a core competency of the company for pretty much ever. How do you activate projects with this uncertainty, right? And is that changing and does pre-leasing or joint ventures minimize enough of that risk to move forward and launch a new development?

Yes, I think it's a good question. And I think the key word that I would use is flexibility. So to execute these strategies in a way that provides us as much financial flexibility as possible. For example, let's take Platform 16, which is a project that we're right in the middle of making decisions around capital expenditures and launching. Well, the first thing we did is we shared our risk and upside with CPP. So we own 55%, they own 45%. That was a decision we took last year and we executed on. Second, we'd love to have a pre-lease, but the Silicon Valley market is not as conducive to pre-let developments as many of our other markets. So I believe that we will -- even though we're actively looking for anchor customers at this time, my guess is we will end up having to launch at least the first phase of this project on a speculative basis. If we do that, we'll commence the foundations for the first 2 phases, which include a garage. So that will be an incremental investment, and then we'll be able to take a look at the environment and decide if we want to take the next step, which would be to build the first phase of the project, which is around 400,000 feet. So we're incrementally making investments, giving us the flexibility to cease development if we think that's appropriate. I'll give you another example. The Fourth and Harrison project that we have is in San Francisco. Today, that obviously looks like a home run and a very favorable investment because we got our 0.5 million square feet of entitlements. But when we started with that site, which was, I think, Doug?

5 years ago.

5 years ago. We organized that as an option, we didn't purchase any land. We spent some money on predevelopment work, and we clearly spent a lot of our time on the project getting it entitled. But we made no financial commitment to it. And now that it's been entitled, we have every intention of purchasing the land and moving forward. But again, that structure as an option gave us financial flexibility, and we try to do that in all of our projects.

And then Boston Properties full equity, whether you're relying on a joint venture, like in the case of CPP to advance Platform 16, what do you think from a balance sheet perspective of how much equity you would need to keep your leverage in check to complete both the current projects, but the projects -- it's my Canadian, I just want to make you feel like you're hearing from Mort at some point -- to finish them?

Well, I think you've heard from Mike many times over, our focus is -- we look at our debt levels, and we've -- we're operating the company with a net debt-to-EBITDA of 6.5 to 7.5, and that's our target. And if we look like we're going to exceed those targets, then we would seek other sources of capital. And one of those would certainly be private equity, which is a lot of what we've been doing. We bought the Santa Monica Business Park with a partner. We're doing the Platform 16 with a partner. But that's when -- leverage is obviously a less expensive place to get capital. It's gotten even a lot less expensive over the last few days. That's what we've been doing the last few years, but we're going to stay within those operating targets.

So recently, I got a quote from Twitter CEO, Jack Dorsey, he said, our concentration in San Francisco is not serving us any longer. And his point was that he doesn't need to be at sort of that prime location necessarily, but sort of in the shadow cities. Is that the same approach you're thinking about sort of with San Jose and Oakland, if you sort of go with office there or do you disagree and think owning that Fourth and Harrison site is the right way to go?

I think the Fourth and Harrison site is a less risky development than Platform 16. It's in the city of San Francisco, in a city that's protected from new development through Proposition M, and it's an urban environment, and it's a unique opportunity. So look, I think in many of our cities, they can be expensive places to do business. And I do think companies look to find ways to move certain segments of their workforce out of those more expensive population centers to less expensive places. This isn't a new phenomenon. This has been going on, for example, in New York for 4 years, particularly at financial institutions. So I think we are experiencing some of that. But I certainly wouldn't call for the demise of San Francisco as a result.

You guys are certainly landlords of a lot of large tech tenants. Give us an update on what you're hearing from them about their growth plans and what cities that are most attractive today?

So I would say that the general consensus is that they want to go where they believe they can attract and recruit the smartest and most viable candidates, and those happen to be the cities that we currently operate in. The -- I'll just use an example of Google. I think Google has 26 million to 28 million square feet of current space in the Silicon Valley, and they are growing in the Silicon Valley. They are also growing in the city of San Francisco and there are rumors that they're purportedly going to take a couple of million square feet more there. Similarly, they've just expanded, as you know, in New York City, where they now have 5 million square feet, and they're expanding in Boston, where they're going to be up to 850,000 square feet. You can go on and on. And if -- I'll use Reston Town Center as sort of the Northern Virginia example. We've done a lease with Facebook. Google is expanding there. Salesforce.com is in the marketplace. Amazon is in the marketplace. Microsoft is in the marketplace. So the cities that we are operating in are pretty conducive to the kind of labor that is interesting to these technology companies. For sure, there are also tertiary markets from at least a real estate supply and demand perspective that they are going to. We don't traffic in those markets. So it's hard for us to understand the technology desirability of an Austin or a Nashville or an Atlanta relative to the markets that we're in.

Any new desires to go to any of those markets you just named?

Well, in terms of market selection, we're very happy and comfortable with the 5 markets that we're in, the one market that we do spend time on in terms of new entry is Seattle because we think that fits well into our gateway structure. Some of the other markets that are out there that are attracting tech tenants, like, let's say, in Austin or Nashville, again, we think they're fine cities. They -- we do think there's a lot of development that's going on in those cities. There are a lot of sites that are available. And also, there's also a scale issue for us. How much of the city would we need to own for it to make a difference in what we're doing?

And I'd go back to Michael's last question, which is talking about do we have the resources to do what we want to do in our existing platform. I think the nice thing about our business model and the nice thing about these 5 companies effectively that we own and control in the 5 core markets that we're in is that they're very entrepreneurial, and they find new opportunities for us to invest capital. And if we're struggling with finding the resources to do the transactions in those markets, I don't see a lot of rationale for us to try and expand our footprint and broaden our capital challenges.

If you think about New York, L.A., San Fran, it also has some of the most difficult affordability issues on the housing side. So I guess how do you balance this great demand that you're seeing? Can these cities continue to have the growth that they would like to have with that as a backdrop? And Owen, we sat together, listening to Doctoroff yesterday. Those are key concerns for those cities, right?

Yes. No, look, I think, I would call it attainable housing as opposed to affordable housing, which I think has a different definition. Look, there is no question that the cities that we are in are complicated. They're complicated from a regulatory standpoint, from a political standpoint. They're complicated from a development standpoint because a lot of it is upsizing existing buildings and things like that. So that being said, we think that's where talent wants to be. I mean, the -- take New York City, for example. There has, I think, been some outmigration of jobs on to the technology side from the Bay Area to New York because there is a depth of talent that Doug was talking about, and there is a fair amount of attainable housing. And though many of us that live there may not think it's that great when we use it, it has a pretty effective public transportation system. So -- and I think given the difficulty of developing in these cities, it gives us, what do we need to be successful? We build and buy assets, and we generally hold them. So what do we need to be successful? We need rent growth. Why do rents grow? Rents grow because there's good demand. It's an attractive place for talent. It's attractive place for businesses to locate. We think that's true. And the other thing you need for rent growth is you need to have some moderation of supply. And given the complexities that you outlined, the cities that we're in, albeit with some specific exceptions that we can talk about, they're difficult to develop in. And it gives us longer-term protections.

You talked a little bit of Hudson Boulevard, and obviously, there's been a dramatic amount of leasing that's taking place on the west side. Where do things stand currently? And has -- have any tenant discussions advanced far enough?

So I just -- I want to remind everybody that when we purchased the Hudson Boulevard site, we described it as a land investment, not as a development. And we sort of positioned it as a we're going to get in at a great basis. We're going to finish the platform. And then we expect to hold on to this land for a significant period of time. The last 18 months of leasing in the Hudson Yards has actually accelerated the opportunity set in front of us because there are relatively few large blocks of space available for tenants compared to where it was when we bought the site. And so there is an active dialogue going on with a handful of existing incumbent financial services companies and technology companies that potentially would either consolidate or grow in the city for being a lead tenant at the 3 Hudson Boulevard site. When you ask the question, "How much do we need to start?", it depends on who it is and where it is. So as an example, if a technology company said, "We want 400,000 square feet at the base of the building.,” and we think that technology company is going to grow, we might do that deal. If an accounting firm said, "We need 500,000 square feet and we want to be in the middle of the building.,” we might not do that deal because that might not be enough. I'm just -- it really is a question of who and where.

And what's the earliest, I guess, that this could start?

So we're working now. We're moving forward, and we're still doing the foundation so that we could have somebody in place in 2024, if there was a lease expiration need in '24. Some of the tenants are looking for leases that early, and there are some other tenants that are looking for more like the 2027 contract.

Right. Because everything you're doing now is what you would be doing and then once you couldn't save any additional time...

Effectively.

And it's a -- it would be a late 2024 start or earlier 2024 start?

That wouldn't be a start. That would be a finish.

Finish, right, sorry. That's what I meant. Finished by end or early?

Middle of '24.

Middle.

I thought you were saying that otherwise it could be 2027. Did I hear that right?

I'm saying there are some tenants who have a need in '27. So if a 1 million square foot tenant came to us and said, " We'll take this much space," and this is the rent and we think it's in a successful transaction, we might delay starting the building for 24 months because we wouldn't want to line up the commencement of their lease with the completion of the building.

Is there questions from the room? All right.

So Doug, I know you love talking about specific leases and specific tenants. So I've got 2 questions for you on that front. What's going on with Under Armour? If you can update us there, we'll start with that.

Sure. So Under Armour was pretty clear on their conference call that they had taken a charge for the lease that they have with us at the General Motors Building, 767 Fifth Avenue, but they also said, "We have a lease, and it's a 15-year lease, and we're going to be obligated to pay rent through the term of that lease." So at the moment, Under Armour has said what they've said, and nothing else has happened.

So you now -- so you just now wait. They haven't fully -- at what point do you enter into -- are you shopping the space? Do they shop the space, what?

It's Michael's idea. [ If the door has been ] open to change the deal, [ if it's not beyond there ].

So the only thing that has happened is that Under Armour has said to us, if you were going to hire a broker to market the space, who would it be? And we've given them some suggestions. That's the only physical thing that's happened.

And how much capital had they already thrown into that store? Are they not really fully..

So they haven't done anything.

Nothing.

So you'll recall that this has been sort of a...

The temp space.

One of the challenges of our bridge, which you described was we knew that we were going to be able to lease the space to Under Armour, but Apple unfortunately, made the decision to expand their store, which is obviously a great thing for the property. But they needed to be someplace while that store was being retrofitted, and they took the space that Under Armour was going to go into. Obviously, Under Armour agreed to that because they wanted to delay the decision as to what they would be doing. And we've now come to the point where Apple has moved out. It's a beautiful Apple store inside. And Under Armour hasn't done anything from a capital perspective.

And you have sublease rights, right? You would have to approve any sublease?

We have very strong rights.

Very strong rights.

And then the other space, 680 Folsom, where Macy's is closing...

Yes. So macys.com announced that they were moving there, that team, if you will, down to Atlanta. And we're presuming that, that's going to happen relatively quickly. They have hired a broker to lease that space, and we were told as of last week that there were a number of active proposals that were outstanding. And that they were going to make a decision as to which way they were going to go immediately and that there would likely be a tenant in the building very soon.

How do you underwrite, let's say, Under Armour said, "You know what? We just want to get out. We don't want to sublease. We'll just pay you 15 years of rent." And then how do you look at a re-tenant situation, do you bake that as a onetime gain? Do you average that into a new lease? How do you -- because I remember, at 250, right? You had the Al Jazeera, right, which they never built out the space either. And you've got a big lease term fee out of that one.

I think we're going to -- we'll make that decision if they were to actually come to us with the -- if they wanted to give us a full cash payment of all the rent obligations for the next 15 years. I think we'd have a hard time saying no to that.

But you could hold them up to, can't you, right? You do have the hard rights. I mean, some negotiation.

We have really...

I started for you at full payment of 15 years.

So we'll see. I mean, we're thoughtful about these kinds of opportunities.

We're going to put in a foosball table and just play foosball.

Did you look at Oceanwide in L.A.?

We were part of probably the teams that thought hard about the Oceanwide development at first admission, and we ultimately were not the successful bidder.

Other questions in the room?

I'd like to know how you manage the risk of over renting in your portfolio because you signed long-term leases with fixed escalators or CPI-linked escalations, where we own new market rents and move up and down based on where it's supplied. So how do you manage that in your portfolio?

So I'm not sure I quite understand the question. But we have long-term contractual leases with contractual escalations at all times.

Sir, my question -- sorry, just to make it clear. So at the end of the lease, the rent that you're receiving per square meter per square foot could be way above market value?

Yes. I mean, that's a truism. And in fact, that's what we're seeing in Washington, D.C., and I think I used this as an example on our last conference call. So we have a tenant that is currently paying on a net basis somewhere in the low 70s, and we're renewing that tenant at a rent of $58 a square foot on a net basis when their lease expires in 2021. So that happens in some markets when you have annual escalators of 2.5% or 3%, and the markets don't grow at those rates. On the other hand, in San Francisco, where rents have been going up by double digits for a number of years, our typical mark-to-market is somewhere between 40% and 50%. So when the rent rolls over at $70 a square foot, and we re-let the space at $100 a square foot, we're doing it very well. And net-net, across our portfolio, we have a positive mark-to-market each and every quarter and have had for, I think, the last 2 decades of operations across the whole portfolio, not on individual building leases.

And in 2019, the cash mark-to-market on all the second-generation leasing that we did was a positive 27%. So it's pretty significant.

Right. Any other questions in room? Good. We can wrap it up.

Will there be more or fewer office companies in the public sector a year from now?

I always say fewer and I've been right.

Will Boston Properties merge with Alexandria or Vornado?

We just started with a building in South San Francisco so...

And then how about Vornado? No? All right. Well, what will same-store NOI growth be for the office sector overall, not Boston Property-specific in 2021? And for reference, 2020 guidance is what, Manny?

4.5%

4.5%. So 2020 is 4.5%, 2021 is...

I usually say, 3%, 3.5%.

10-year treasury a year from now?

I always say, up 50 to 75 basis points and I've been wrong every year.

But that's what you're going to continue to say?

75 because...

I mean, if we go down 75, it would be pretty low.

Plus 50 would be the same as it was like 2 weeks ago. I'm going to say plus 75.

In what year will the U.S. enter a recession?

Honestly, it could be now.

Okay.

I'm not going to call it, but I think that's a possibility.

Okay. And if it's not now, it will be?

Next year.

Okay. All right. Thank you very much.

Thank you.