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

Great. Thank you and good morning to those who are in attendance virtually for this fireside chat through Wall Street Webcasting. My name is John Guinee at Stifel. And we have with us Owen Thomas, CEO of Boston Properties; Mike LaBelle, CFO of Boston Properties; and most important, Sara Buda, VP of IR at Boston Properties. The usual format is that we ask Owen to provide an overview of Boston Properties, what you're all about, big picture of the facts and the figures. And then I have a series of questions, and hopefully, some questions will come in over the transom. So with that, Owen, do you have a couple of minutes of comments?

Sure, big picture. John, first of all, thank you for having us. It's a pleasure to be here or be on the phone with you and everyone that's tuning in. So just a quick overview on Boston Properties. We are a publicly traded real estate company, organized as a REIT. We are the largest market cap that focuses primarily on office buildings, although not exclusively. We are -- we have a wider geographic focus than most of our peer companies in the public space, although we are very targeted on 5 markets today, and those being Boston, New York, Washington, D.C., Los Angeles and San Francisco. We have aspiration for Seattle, but we're not there yet. So we're focused on the gateway markets in the country. We are very focused on quality. So we own some of the well-known, highest-quality buildings in each of our markets, things like the Salesforce Tower in San Francisco and the GM building in New York and the Prudential complex in Boston, for example. We have very high-quality balance sheet. We're the highest rated of all our -- of all the office companies in the public space. We're obviously in the S&P 500. And I think also very importantly, we are -- in addition to being an owner and an operator of real estate, we're also a developer. And often the ways that we are creating value for shareholders is at the property level, either building new buildings from scratch or taking older properties and fixing them up and leasing them and creating value. So John, that would be my introduction.

Great. Thank you. I forgot to mention that Owen and I were, long ago, at University of Virginia. Not together, I think I was about 6 years in front of Owen. And Owen and I did drive through the Shenandoah Valley a couple of days ago on my way back to Baltimore, where Owen grew up. Spectacular place. Let me ask the first question everybody always asks. You've answered this so many times, Owen, you probably could do it backwards. The top line news in office with COVID-19 is work from home equals less office demand. We all know it's not that simple. We all know there are many, many pros and cons, many, many issues going on regarding secular change for office demand, whether it actually results in increased demand in certain locations, decreased demand in others. What markets, what property types will benefit from any COVID impact? Can you sort of drill down a little bit, peel back the onion a little bit more than just work from home equals less demand?

Yes, delighted to. So John, I'm going to answer in a fairly -- a little bit of a complicated way, but I'll do it quickly, and then you might want to drill down on various pieces. So the first thing I think you have to do to respond to that question is to divide our future into 2 phases. One is the virus phase, while we're dealing with COVID-19, and then after the virus is gone. For whatever reason that occurs, people feel safe, and we can all return to work and return to the new normal. So I think you have to think about those 2 phases separately. And then I would mention related to those 3 phases, there actually -- or those 2 phases, there are 3 trends that are impacting office real estate today. So let's skip the COVID-19 phase, and let's go to the new normal when everyone is back in the office. What are the 3 things that are the 3 forces at work? Well, first of all, we're -- we have had -- we'll have had a recession. So we will be recovering from that recession. And every recession that we have does have a negative impact on office space demand. It comes back, and we're in the markets that we're in because they go up cyclically. Each cycle, the rent highs are higher and the rent lows are lower, but we will be dealing with a recession. So that's number one. Number two is, I do think that -- actually, I'm going to mention 4 things. The second is the customers that are going to be growing. And as we have seen from stock price performance and the importance of all the digital tools that we're dealing with, technology companies and also life science companies are doing very well, mostly through this pandemic. We would anticipate that they will continue to do well in a lot of our portfolio, both existing assets and new developments are geared towards that customer base. So I think that's important. Then third, you mentioned the work-from-home phenomena. There is no doubt that all of us have been able to accomplish our tasks and do reasonably well in this remote environment that we're dealing with. But I do hear from business leaders, and you hear from business leaders that are speaking publicly about this, the physical interaction of employees is important to companies for building culture, mentoring employees, creativity and all those kinds of things. And so I don't think that companies are going to forego the office going forward. All of our customers are engaged with us, trying to figure out how to return to their offices as quickly and as safely as possible. But I do think in the types of buildings that we have, which are premium buildings in premium cities, I do think a lot of the workers that work in those buildings are going to want to work from home for part time, whether it be a day a week, couple of days a month, something like that. But I think they're going to want to do that on their schedule, and they'll continue to want their own office or workstation. And I think if you're going to save a lot of space on temporary or part-time work from home, you really have to schedule that time out of the office, and you have to put people not in a fixed work station but in a rotating workstation. And I'm not sure how much of that will go on in the buildings that we have. And then the last trend that I want to mention is spacing. So you, John, you and others would ask us frequently over the last 5 or 6 years, what's been the impact of densification on the demand for office space. And clearly, with the COVID-19 virus, there is no densification going on, it's the reverse. Our customers are spacing out. During this virus phase, they're taking out workstations to make their employees more safe. So I think the question is, after the virus leaves us, what's going to happen. And our view is, clearly, densification is going to reverse, and we'll see how much of a demand driver that is. So we've got a lot of, as always, with real estate and with office, you've got a lot of competing trends that are going on, but those are the big ones.

Great. You signed a few big leases recently. The one that comes to mind is Microsoft, 400,000 square feet at Reston Town Center. Can you refresh us on the details and also talk about any thoughts Microsoft may or may not have about changing their layout and their density and that sort of things, if they've shared that with you?

Yes. So we were in discussions. Well, let me just step back for a second. We did announce off the quarter cadence a couple of weeks ago that we had signed around 870,000 square feet of leases in April and May, which we were very pleased about. The big one, John, is the one you're asking me about, which is Microsoft. And this was a requirement that they had that we started working with them on in 2019. And they are coming into one of the biggest rollover exposures that we had in our portfolio in Reston Town Center. So that's terrific because that was a near-term rollover that we needed to address. We basically stuck on pre-pandemic terms. There was no change to the deal or nothing material. There is always lots of little things moving around with the requirement of that size, but there was nothing kind of material related to the pandemic. We are -- I'm not aware that they are yet making major changes to their plans as it relates to the COVID-19 virus that could very well be going on. Right now, what we're seeing with our customers is that they are doing things on -- I would say, on a more temporary basis. So they're going into their existing space and just literally pulling out workstations so people are separated. They're not spending the money to rebuild the space in a different format. And I do think, increasingly, we will see customers like Microsoft and others that are doing new leases that have not built out their space yet to be thinking about what the virus means, even when it's gone, and how should they be laying out their space from a density standpoint.

Great, great. Owen, you had mentioned earlier that you're a developer, and you have very, very good teams throughout the country. Can you highlight some of the development that's going to be delivering this year and next year, the good, the bad and the ugly?

Yes. So stepping back from all of it, right now, I'll define the development as what is underway and what are we working on. So what is underway is about 5.3 million square feet. It is $3 billion in total investment. About half of -- rough justice, about half of that investment has already been made. These projects, the commercial component of them is 73% pre-leased. And those projects will be delivering over the next 3 years, and they add 3% to 4% of external growth to our FFO per share. Some of the projects that I would highlight are, we're doing a 1 million square foot building that is substantially pre-leased by Fannie Mae at Reston Town Center, and that's one of the largest nongovernment leases ever signed in the State of Virginia. We're building -- we own a half interest in it. We're building the Marriott headquarters in Bethesda, Maryland. We're building a major facility in Boston at 100 Causeway over the North Station. Again, almost fully leased to Verizon. We're doing a major building for Google in Kendall Center. We have a project in Brooklyn called Dock 72, that is pre-let partially by WeWork that we own a 50% interest in. And we're doing a project at 2100 Pennsylvania Avenue in Washington, D.C. that is substantially pre-let to WilmerHale. So those projects are underway. They're going to be delivered. We're certainly on track to deliver them on time. And then behind that, John, we've got about a 15 million square foot land bank of projects that are in all kinds of different phases of readiness for development, but a couple that are near -- and these projects, most of them, we're just waiting to start until we find an anchor tenant. So we have a project in Downtown San Francisco that's entitled now. We have Prop M allocation. The first phase is about 0.5 million feet in Central SoMa, and we're ready to go with that project, again, subject to pre-letting. Platform 16 is 1.1 million feet in San Jose that we can build in phases, again, waiting for a pre-let commitment. 171 Dartmouth, which is an office building over the Back Bay Station in Boston. Again, we're ready to go with that project. We're working on the foundation structure. We want a pre-let before we start. We own a 25% interest in 3 Hudson Boulevard, which will be the next major building built in the Hudson Yards. Again, waiting for a pre-let. So -- and there are others, I just won't give you all that detail. But so again, development is an important part of what we do. It's a key growth driver, and it has been a key growth driver for shareholders over time.

Great. Okay. You brought up WeWork. Everybody wants to know about co-working and WeWork. Any thoughts on that business and WeWork in particular?

Yes, sure. So this has been an important, I would call it -- what I'd call the shared workspace business has been, I think, an important innovation in office real estate that occurred last cycle. And the co-working operators were very significant net absorbers of space in the last cycle, and that was a plus for what we do because it tightened up market conditions. Now let's go to the pandemic. The pandemic could not be much of a worse environment for the shared workspace business because you've got 2 things going on at once that are a headwind: one is recession, and as companies and individuals cut costs, it's a headwind for co-working, it's a headwind for office landlord; but second, and maybe even worse, is a notion of spreading out because a lot of the business model of co-working is, the product is sold by the seat, not the square foot and density is important. That's the whole concept behind it is that you're working together and collaborating. And so that's created a very difficult environment for the business for this whole virus phase. But John, I would say, I certainly and we certainly believe in the shared workspace business for the long term because we think there is customer demand for it that's durable. I think individuals are going to continue to be interested in the product. Small business will continue to be interested in the product and larger enterprise customers will also be interested in procuring a small component of their space on a flexible basis. And I think we'll be prepared to pay a premium for it. So long term, I think it's here to stay, but the various operators in the business are definitely going to go through challenges during this pandemic period. We have an important relationship with WeWork, and they definitely have challenges for the reason that I mentioned, but they have several billion dollars of capital on their balance sheet. They have the backing of SoftBank, and they have new leadership, and they have -- and they are executing on their plans.

Owen, I would just add that co-working, as a whole, for Boston Properties is a pretty small part of our portfolio. The overall is about 2% of our revenues. And the biggest client we have, as Owen just mentioned, is WeWork. That is about 1.25% of our revenues.

Mike, thank you for chiming in. That gives a couple of things: one, it gives Owen a little bit of a break; and two, when we did this last year, we had Doug Linde with us, who did an excellent job. And at the end of the fireside chat, Sara was getting very agitated, and Sara broke in, love her, and said, "You know, John, you need to talk about growth. We've got FFO growth in the bag now." So let's pretend Sara is giving me the evil eye and wants me to really focus on BXP's growth. And Mike, you're the guy to answer that question.

Well, thanks for the lay-up, John. Look, Owen talked about the development pipeline already, which is, again, 73% pre-leased. So it's well pre-leased, and we'll -- upon stabilization, it delivers over the next 3 years, and it's going to deliver about a 3% CAGR to our current NOI. And the existing portfolio, right, that generates about $3 billion of revenue, we -- our leases in the existing portfolio are below market. Many of our markets have seen strong rental growth over the last 5 to 7 years, particularly Boston, San Francisco and L.A., and that's about 65% of our portfolio. So as leases roll, particularly in those portfolios, we've got a good amount of growth with the mark-to-market that will be positive. So that's a tailwind even if rents moderate. Because if we enter a recession, which we expect, you would anticipate some moderation of rental rates. In those markets, there is plenty of cushion for us, which is very positive. In the New York, Washington market, it's a little bit more flat mark-to-market. But again, the vast majority of the portfolio is in these markets that we think are going to continue to do well, given that they're focused on technology and life sciences, which are both industries that we think will continue to grow and do well.

Mike or Owen or Sara, if we were having this conversation in February, what would you have said you thought your mark-to-market was portfolio-wide? And how would you answer that question today?

Well, I think we would have said that our mark-to-market as a portfolio is probably plus-10%, something like that. With regard to rental rates today, I think it's too early to indicate where they've gone. There hasn't been enough transactions to really demonstrate a decline. We signed 870,000 square feet of leases that, to be fair, we started negotiating the economics for those leases before COVID. But they were signed after COVID, and there was an opportunity for those clients to come back to us and try to negotiate the pricing there. And there was little, if any, degradation. On the major leases we did, there was none. There was 1 or 2 that had a 1% to 2% kind of hit because the client just felt like they had to get something, but it was really immaterial. We've seen 2 transactions: one in San Francisco and one in Boston in the last 30 days. That would indicate about a 5% to 7% potential reduction. But again, that's only 2 transactions. So I think we will see how this rolls out. I think that the markets that we're in, particularly Boston, San Francisco, West L.A. and Reston, Virginia, are in very strong shape going into this. Not a lot of new development occurring. So there is not a lot of speculative development. So I think that those markets are going to fare much better and might not see much of any degradation in rents.

John, if I could jump into this for a second. So I want to just mention 2 things. One, just adding to Mike's description of growth opportunities, this is the hardest thing to underwrite, but our expectation is that this crisis will create some new investment opportunities for us. Maybe beyond the development, maybe acquiring underleased properties. Usually, when you have a recession like these things become available for whatever reason. Last cycle, Boston Properties got involved in the GM Building and 200 Clarendon and 100 Federal Street and Bay Colony. And we don't know what the future holds, but that's definitely another potential growth opportunity for us. And then the other thing I would like to mention, you didn't ask us about this, but I'm going to take some license here and say something else, which is, look, I do think our company is going to grow, and we have and will continue to provide a good growth opportunity. I think the story on our stock right now, however, is value. Our look through cap rate right now is, I haven't checked in a couple of days, but it's probably around 6.5%. Mike, you might want to correct me on that.

Yes...

Buildings in our space were -- before the pandemic, were trading in the 4% to 5% range, and interest rates are 80 basis points lower today. So the cap rate seems way high. The look-through price per square foot is zip codes $700 a square foot, Mike. I think if you -- if we got all our lands for free, I'm not sure we could replace our portfolio for that. And then as I look at kind of how stocks and real estate have performed during this pandemic, there's been the group that's kind of benefited and been resilient and their stocks have performed reasonably well. And then there's the group that's really been challenged because of the customer base, like hotels and retail. And it feels like even though we've been pretty resilient, we're collecting 97% of our office rent, 93% of our total rents, leasing 870,000 square feet of space in April and May on and on and on. Even though we are more resilient, our stock seems to be trading more like the group that has had more challenges. So even though we're -- we are -- we feel great about our growth prospects, I think a lot of the story about our stock today is value.

You know, Owen, you just answered my next 2 questions. Thank you. Let me ask a tangential question about that. You have a long and successful career on the private side. When this all shakes out, how -- talk about the cost of capital for the private players versus BXP and the REITs. Right now, at wherever you are, $100 a share, a 6.5% cap rate, I would imagine you're relatively disadvantaged, but I don't know for sure. Talk a little bit about the private/public market arbitrage and where you see the cost of capital shaking out for the private side?

Yes. So we talked a little bit about office REITs, John. You would know better than I, but they're probably down 30% this year. Look through cap rates, at least in our case, or maybe 150 high, 200 high, something like that relative to what the market was. If you go to the private side, there is an index called the NCREIF Index that a lot of private investors just benchmark off of. Office values went up 1.2% in the first quarter. Now that is not going to stick, and I do think office values on the NCREIF Index will come down this year. But it just shows you the large difference between the private market mark and the public market mark. Now let's go to where building values are. There have been very few, if any, trades of assets like we own since the pandemic started, but we are starting to get more and more inquiries and calls about buildings that may come out. And there is a view that if there is a high-quality building in an innovation market, in other words, one driven by tech and life science, and there is not a lot of leasing risk that the valuations for those assets probably haven't gone down very much, and where the values will be more impacted on the private side or for assets where there is leasing risk. Where there's the rollover, tenant moved out, tenant went out of business, there is some leasing challenge. That's where I think the values will come down. So how do we navigate in that market? Look, we -- clearly, we think there are going to be some opportunities of these underlet properties that will come out later this year. And we -- as we have done in the past, we continue to speak with private equity sources of capital to help us, one, extend our dollars more, but also to be more competitive as we get into this phase of the crisis.

Great. Okay, okay. Unfortunately, I can't see any questions coming in. Technology is good, but not great right now. But probably more important than that is Sara is very good at pointing out things that we probably should be talking about that we aren't talking about. So Sara, if you're still on the line, are there a couple of things you think we should be talking about in the last -- next few minutes?

No. I think what's important is what we're hearing from tenants. I think that's where we get the most questions from investors, and I think Owen covered a lot of it. But I do think it's worth mentioning that as we speak now and as I sit in Boston, Massachusetts, which is one of the first regions to open up, how we're preparing for re-occupancy in our leadership in health security might be worth touching on, Owen, if you have a minute.

Yes. No, I think that's a good idea. I did -- John, we spent most of our time on the post-virus phase. So during this virus phase, honestly, what we're spending a lot of time on is getting our buildings ready for customers because we're all focused on creating a safe environment for everyone as they return to work. And it started in Boston, and we hope New York will open partially in the next few weeks, and D.C. as well, and then California probably in July. We put together a health security task force. We used outside medical experts. We came up with a strategic plan for all of our customers. That -- by the way, that document is on our website, if anyone is interested in it. And our goal is to make sure that the landlord is not an obstacle in any way for people feeling safe about coming back to their workplace. And I think we will be able to accomplish that. The issues that we're getting into, obviously, are cleaning and disinfection, air and water quality, spacing in the elevators and in the lobbies, PP&E, wearing a mask, also temperature screening in certain buildings and then communication. So that's been a big focus. And as Sara said, kind of going back to this work-from-home discussion, we're -- none of our customers are saying, "You know what, we're good. We don't need an office anymore." That's not happening. They're all engaged with us, trying to figure out how quickly can they come back to the office, and how do they create for their workers a safe work environment. And I think you will see a slow return to the office over the summer and particularly, in the fall, and it's going to be governed by government regulation on occupancy. It's going to be governed by employer policy on occupancy, and how they want to manage their teams. And I think it's also going to be governed by public transportation because I do think that's also a choke point for many people is their level of comfort or discomfort in riding public transportation, while we have an environment where there is still a fair amount of virus around.

Good, good. Okay. Two last questions for you on that. The cost, who absorbs that cost, the additional operating costs that you just summarized? And then second, when you look at Downtown San Francisco, Platform 16, 171 Dartmouth, 3 Hudson, when you're having your design meetings, are there any discussions yet on how those buildings, big picture design may change as a result of all this?

Yes. It's a good question. So first, on the cost. So there are 2 types of costs, capital costs and then operating costs. The capital costs we generally own modern or well-renovated properties. So we have very limited capital costs. There are thermal screening equipment that we're buying for certain buildings, but that's not in the scheme of what we do, not material capital outlay. The bigger issue is the operating expenses because if you think about it, you're going to have extra cleaning protocol. You're going to have more people in the lobby doing the sequencing for the customers. And also, you're going to have greater power needs because we're going to be running the air handling at higher levels. And a lot of our response is certainly in terms of cleaning and thermal screening and things like that is based on customer demand. So we've engaged with all our customers on what they want. I mean we're clearly following CDC guidelines, and in some cases, our customers want more than that. So we think the cost of that, John, is probably in the neighborhood of $1 to $1.50 a square foot a year. And those costs would be escalated, just like any other operating costs in the buildings. And then going to your question about new development and changes in design. I don't -- we're not seeing much change in the base building design. I think what you're going to see, again, we're building brand-new modern facilities with all modern equipment, appropriate light and air spaces and all that type of thing. I think where you're going to see change is what the customers do within our spaces. We're the -- as you know, we're the base building owner, and we lease space and then our customers actually lay it out the way they want, buy the furniture and lay the space out the way they want. And I think that's where you're going to see the changes and where the densification is going to change.

Okay, okay. We ran a couple of minutes over. I have one very important question, and this is for Mike LaBelle. When will the Red Sox start playing in Fenway Park again?

That's an excellent question. I hope that they actually are going to figure out a way to have these teams play in their home park sometime before the end of this summer, instead of all play in one single location. But I certainly hope that both the Red Sox and the concerts will be played at Fenway Park again because it's a wonderful spot, a wonderful landmark in Boston.

Great. Okay. Sara, Mike, Owen, thank you very much for doing this, and thanks for making the effort, and hopefully, we'll see you in November in Atlanta at NAREIT.

Great.

Thank you, John.

John, thank you very much.

Thank you, John.

Have a good day. Bye-bye.