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

Hi. Good morning. We're going to transition to the next panel, which is the office panel. The title when we created this was A Look at Technology Demand and the Impact from New Supply, but obviously, there are a lot of things that have more -- since this panel was originally put together. But we've got 3 really great folks joining us today. We have Owen Thomas, who is the CEO of Boston Properties; Michael Franco, who is President of Vornado; and David Ritchey who is EVP and Head of Commercial Asset Management and Leasing for JBG SMITH. So we're going to lead a 50 minute discussion here. [Operator Instructions] So before we get in -- we got a lot of questions here. I know we're not going to get through all of them in the 50 minutes we have allotted. But maybe, Owen, I'll start with you and then Michael and then David. Just take sort of 2 minutes to give us a real quick kind of update on kind of your portfolio to the extent that you have any new building utilization type data and just sort of people coming back to work, where your properties stand, any just broad thoughts around collections and any issues there and then just basically conversations around returning to the office and now that we're sort of through Labor Day hopefully things are looking up a little bit for office landlords and people coming back to the office. So OT, I'll turn it to you.

Great. Thank you, Steve. Good morning, everyone. Steve, thank you for including me and Boston Properties this morning. Just a couple anecdotes from me. I think things are picking up post Labor Day. And I have some data and some anecdotes. Our buildings in New York went from roughly 7% occupied in August on average, and they were about 10% yesterday. Boston was about 5% occupied in August on average, and it was about 7% yesterday. So still low numbers. By the way, those numbers exclude workers in the building and visitors, so they're pretty conservative, but it's a material percentage increase from what it was in August. I can tell you as a commuter in New York, traffic is much worse and the trains are a lot more full. So there's definitely something going on. There's been a lot of press and discussion about the banks in New York and the various programs they're putting in place to get their people back to work. So I do think things are picking up modestly post Labor Day. On collections, from Boston Properties' standpoint, our collections in August were -- for office, were 98% just as they have been because they've been consistent from what they were in prior months. September is basically on track. And in total, collections were about -- were at 96% for August. Again, that's up a little bit from where they were in prior months. And I would just say from discussions that we've had with our customers, I think generally, our customers want to return to work. The leadership wants to return. I think many/most of the workers want to return. But there's obstacles and barriers. In several of our cities, California and New Jersey, there are legal barriers. Offices can't be open. So that obviously is significant. And then when looking at DC, New York and Boston, there are lots of different things in every household and every worker is different. Some people face childcare issues because schools haven't fully reopened yet. There's definitely still some virus out there, although it's certainly gotten a lot better, but there are still health concerns. I think more with public transportation than actually the office space. And I think every individual is different. But I do think, in general, our customers want to return to work.

Michael, sort of similar question, just sort of how the buildings in New York have kind of morphed and maybe any different trends. Owen mentioned in California having basically not working. But anything in Chicago that would maybe be different than what you're seeing in New York?

Good morning, Steve. Nice to be with you. Like I would echo a lot of Owen's sentiments with respect to New York. For us, building utilization was probably a little bit [indiscernible] over the last couple of months and that's ticked up this week. I think it's going to tick up more over the next few weeks. I was actually, as I was coming in this morning, I was pleasantly surprised to see school kids on the street, and I do think that is a gating item in terms of people returning to work. It's obviously not going to be full time, right, and maybe 2, 3 days a week. But just the fact that with kids in school, more people are back in the city, I think they're going to have a higher percentage coming back to work. And so I think that percentage will tick up. That being said, based on discussions with tenants as much as they want to get back, as much of leadership is coming back, realistically, I think that number ends up plus/minus 25% through year-end. And then I think it ramps back up beginning January. So I think companies would like their employees back, we've been back since late June, our employees on a 50-50 basis. Our employees like being back in the office, they're clearly more productive, more creative being together, hearing that from tenants as well. So that being said, as Owen mentioned, whether it's childcare, I would just call it, frankly, fear the unknown. The incidents rate in New York is, frankly, very low. But it's fairly unknown, whether it's getting on mass transit or other things. And so it's a little bit of muscle memory of getting back, and you just got to come back in the office as safe. So I mean I think for us, and I know the BXP team and JBG Smith teams, I think all of us have instituted robust protocols in our buildings, right? So I think all of our tenants that are back are very comfortable, might have given us very high marks on what we've done. So that's not an impediment to coming back. I really think it's -- whether it's the schools, whether it's the fear of the unknown, I think that's what's driving this. And it's just going to be a slow ramp. In terms of collection rates, I would say August was consistent with July, which was up a little bit from the prior months. September, a little too early to tell yet, but consistent as well. So it feels like that's -- the initial shock has passed and tenants are paying and the ones that can't, either because their businesses have been damaged or in the case of restaurants where it's just existential right now, that's just going to continue to be the lag. So with that, I'll turn it over to Dave.

Yes, Dave, I guess just question wise, Washington does have heavy subway ridership, metro ridership. But some of your buildings are also maybe a bit more accessible via car than folks coming into Manhattan. So are you seeing any real differences in kind of the building utilizations today or maybe even in August, maybe just given a little bit of car flexibility?

Yes, Steve, absolutely. And also thank you for including me in JBG Smith this morning. To answer your question, yes, Steve, it's interesting hearing, Owen and Michael reference utilization. Ours is a touch higher. So kind of mid-week, summer average occupancy utilization was between 15% and 20%. So a little bit higher. We saw the highest utilization from our larger government contractors. So kind of interesting there. In terms of collections, as we referenced in our 2Q investor letter, we were at 98.6% on the office side. So it sounds like consistent with Owen's numbers. We haven't publicly put out numbers on August, but they are largely in line with 2Q. So feel good about that. And then we are having a lot of conversations with our tenants. We have doubled down in our outreach and communication to our tenants. We feel like it's more important than ever to be communicating with them regularly. We've received great feedback on our healthy workplace blueprint, which is our -- all of the changes, both operationally and physically, we've made to our buildings to make them safer. And echo Owen and Michael's comments, too, that at the end of the day, it's external factors that are limiting our utilization. So it's schools, it's transit and it's testing or where we see the challenges. Because we are focused on the DC market, we are taking a proactive effort as business leaders to try to leverage where we can, our involvement in the Greater Washington partnership and other business groups to try to effect change relative to improved cleaning process and procedures for metro and trying to see if there's an opportunity to get to ubiquitous testing in the D.C. area. So trying to be proactive on some of those external issues to see if we can help.

Okay. We're going to get into a bunch of stuff on leasing. But one of the questions that we've been getting a lot kind of post-Q2 was, did the company sort of take enough medicine? Did they kind of write-off enough of the bad kind of debt charges? Did they sort of sweep a lot in and sort of take all the pain in Q2? And I'm not asking everybody to give a Q3 earnings update here. But just as you guys sort of broadly thought about the problems in the portfolio and kind of what you decided to write-off, what sort of bubble tenants might have still been around just looking maybe for orders of magnitude? Maybe Michael, to start with you on this one. Just as you sort of thought about the problems that you had, how would you sort of characterize what you took or maybe what you didn't take and what would precipitate further charges or write-downs or tenant problems kind of looking forward?

Sure. So in the last quarter, we took a little over $300 million write-down on our High Street retail joint venture that if you remember was marked up quite significantly, about $2.5 billion a little over a year ago. So this was a bit of an unwind from that. I know that's surprising given what's happened with the retail environment. And really, it's driven by -- look, I mean, it's -- all this is accounting-driven, right? So every quarter, you look at all your assets and see whether there's an impairment, that impairment is anything other than temporary. And the rules are a little bit tighter for joint ventures than they are for wholly owned assets. And so with respect to the High Street JV, obviously, there have been some changed circumstances, whether it's the Forever 21 bankruptcy, some other vacancies. And so as we remodeled that and what we expected, obviously, the loss of rent, we expected reduction in replacement rent that drove an impairment. And so in terms of making predictions about the future, we can't do that. To the extent that there are other tenants that either go out or that we feel like near-term role, where the rents are going to be materially lower than what we already assumed, that would drive. But I would say one other thing is that notwithstanding, these are accounting charges, right? These are noncash charges, these aren't permanent value losses. Obviously, you hold the assets, you have the potential for recovery there. But based on today's environment, there clearly have been deterioration. There clearly have been some tenants that failed. We felt it was appropriate to take a mark. And I think the public has marked much more dramatically than all that. I think they probably marked to retail to close to 0. So the public has done their own accounting work that I think is much more severe than what reality is but that's the market we live in right now.

Right. And I guess, Owen, you guys also took some large charges in the quarter right off of straight-line rent, but also moved a fair number of your, I think, retail tenants to more of a cash accounting, just given the challenges that you guys have all talked about. I guess, broadly speaking, do you feel like all of those things that you thought were problems that you took in the quarter largely reflect the problems today? Or have things gotten worse? Or do you sort of feel like you captured most of the real challenges kind of in Q2?

Well, Steve, as you mentioned, we did take charges as well. They weren't related to asset values, it was related to customers paying rent and either revenues that we had booked in the past or were going to book for the quarter. So we did a very thorough review of all these credits, and we don't foresee significant future write-offs. Because honestly, if we foresee them, we should have taken them. And so the issue is that's today, and you can't make any statements about not having future write-offs because you don't know what the future holds. You don't know what the future holds for the economy, you don't know what the future holds for each of these customers, whose credits we're relying upon. But again, I feel like we did a very thorough job in the second quarter and came up with the numbers that we did.

Okay. Maybe just trying to switch gears a little bit and just talk about the leasing environment. Obviously, summer tends to be rather slow in general and then you put a pandemic on top of it. Doesn't help leasing in general. But maybe, David, I'll start with just you on leasing activity, how are you guys sort of feeling now that we're approaching the early part of fall? What are the discussions like with tenants? Our conversations with brokers have continued to be rather soft and slow for new deals, renewals seemed to be moving at their normal pace, maybe a little slower. But just what are you seeing on the leasing activity? And are there any green shoots that you can sort of point to on the new leasing front that would certainly make people on this call, I think, excited?

Yes. I think, Steve, to your question, we look at the long-term demand fundamentals in the Washington region, and we feel really good about things. So we look at the fact that over the last 30 years in every market downturn, every recessionary environment, the DC market has outperformed its peers. We look at the fact that our unemployment rate, while higher than we would like it to be, is better than the other major markets. Look at the fact that CBRE put out their tech talent report this summer and ranked the DC area #2 in the country behind the Bay Area relative to depth of tech talent. We looked to the fact that in the second quarter, you look at the major brokerage firms and their quarterly reports, while the DC region had negative net absorption, some modest negative net absorption, there was actually a bit of positive absorption in Northern Virginia, of course, driven primarily by government contractors and tech. So we do see some green shoots out there, Steve. Again, long-term demand fundamentals related is where we're most optimistic. And also to your question about renewals, if you look at our leasing in the second quarter, 80% of it was renewals and certainly for small to mid-sized companies, there is a practical reality that trying to execute a move in this environment is not easy. And so we do think that, that helps us a bit from a leverage standpoint as we're talking to groups and that we are having a little bit of outside success on the renewal front.

Okay. Michael, I'll come back specifically on Facebook because there's a couple of questions. But just in general.

I know you would, Steve.

I know. It only took me 19 minutes. So just in general, what are you guys seeing on the overall leasing environment discussions with tenants, and I know that there were some very large deals that have been in the hopper that ultimately got to the finish line. But I'm just curious, can you point to all you've seen any real new leasing activity that I would sort of call it post-pandemic that's maybe come out of it or the new deals really just kind of vestiges of pre-COVID activity?

We're largely through that. I think the activity that's going on now is all post-pandemic, right? Maybe there are some things that have paused, they've restarted, but sort of proactive on the tenants. So look, I think that no question, New York is slower in general. We were the eye of the storm at the outset, and tenants have been -- I think if we go back to where we started the call have been prioritizing getting their employees back and frankly didn't focus much on leasing over the first 3, 4 months of this pandemic. So I think it's slow. I think we're now seeing and clearly seeing a focus on renewables versus new leasing. There's some selective new leasing. And I would say, that's focused, I would say, driven by -- if tenants are in space that are decrepit, very old and they can move to a turnkey solution reasonably quickly, we're seeing a couple of examples of that, that we're working on. There's been a couple of renewals where -- I put the renewals in 2 buckets where we've got a number that are short term where the tenants were saying, I just want to renewal. And where it's 2 years, 5 years, let's see where the world is. And then there's a separate camp where the tenant spaces are run down, they want to reinvest in those. And those discussions have either picked back up or started up in the last 30 days. And I feel like those will get done. And in a couple of those cases, there'll be a modest expansion in the space. So look, I would characterize the market as still challenging. I think it's going to be slow in all 3 markets that we're in. But renewals are -- there's a steady pace of renewals. And I think the new leasing is going to be modest. There's some larger things that are out there, and I think those will either occur over the course of this year more likely. That search will go this year and continue next year, and we'll see what happens there.

And before I turn to Owen, just what do you think the gating factor is? Is it truly getting a vaccine or a therapeutic that kind of makes that late switch go on for new leasing? Like what do you think it takes to have a conversation or to start to see that new leasing activity really pick up?

Yes. I think it's specific to each company's business, right? And is that business growing? Are they going to evaluate taking a different approach? Right now, I know this -- over the last few months, there has been a number of different -- a fair amount of thinking about de-densification, thinking about utilization rates within their space, right? All that is still to be determined, right? I think there was initial rush to that and then I'll step back and say, you know what, what if there's a vaccine come, let's say, in the first quarter, then maybe we would have done something differently, and it would have taken us that long to space plan in any event. So I think realistically, Steve, it's about getting their employees back to the office, right? Figuring out the nature of their business and then thinking about, okay, is our business -- are we growing right now or are we not growing? And again, that's specific to each business, right? I mean, obviously, Facebook, which is the most significant example probably in the country, their business is growing, and they're thinking 5, 10 years out, they're not slowing down. Other companies, obviously, have been more impacted by this, maybe not even down, but just they see a different trajectory. And so maybe they're not going to expand, they're just going to renew, right? So I just think it's different for every company. And I think it's going to take getting back to business generally, which realistically is a 2021 matter.

Got it. Okay. I've got a few questions coming in, which I'll turn to in a minute, but maybe Owen, just to kind of finish up that thought on new leasing. We have heard some positive comments out of Boston on life science. You're converting a few buildings here. But just what are you seeing in your major markets? And outside of life science demand, is there any really new office demand that you can sort of point to in your 5 core markets?

Yes. Steve, when there's a recession, generally leasing volumes slow down. There's nothing unique about this relative to prior recessions. There's a bid ask. There are business leaders who are doing a lot of the things that Michael talked about. I don't want to make a decision right now because I don't know how the world is going to shake out. So optionality is valuable. I think some customers, even if they want, need the space, they're saying, well, maybe if I wait 6 months, it will be cheaper. So this goes on. And when you have a downshift, like we've had in the economy and rents are changing downward generally across our markets. So again, I just would point that out. I would put the customers in 2 categories. The ones that want to retain optionality and are doing shorter-term renewals, 6 months to 2 years plus, no capital, which is important. We've actually had customers that are one larger one in particular that was going to leave one of our buildings that decided to stay at least for now because they didn't want to make that major decision. So we get another opportunity to try to retain them. But I do think that large tech companies, life science companies are out in the market making commitments. Boston Properties, Vornado, JBG have all done major leases with tech companies during this pandemic. I would point to the work we did with Microsoft at Reston, for example. I'd say in our overall markets, the most activity that we're seeing right now from new tenants is in Northern Virginia in our installed base and also in Waltham and our suburban Boston portfolio, and a lot of that demand is coming from life science tenants.

Okay. I've got a few questions that have come in. So I want to try and turn to those. So the first one, really, I guess, is probably for Michael and/or Owen, but it says our tenants in New York City concerned about the rise in violent crime and are they bringing political pressure on the city government to address it. We've heard this and seen it and if you think kind of long term, hopefully, New York doesn't head back to the New York of the 70s, but City did a great job over the prior couple of decades cleaning up a lot of the problems. So I guess, Michael, I'll start with you on this and get Owen's thoughts. But how do you sort of look at this? And what are the concerns you have kind of longer term?

Yes. I mean I'd say a few things, Steve. I'd say that has not been one of the concerns expressed by tenants. And I think that, in general, like the media likes to look at -- to sell papers, right? Saying that everything is fine doesn't sell papers. When you actually look at the statistics of crime in the city, whatever it is, yes, it's up, but it's still at record low levels, right? Far below what it was under Bloomberg, which was obviously a great period for the city. So all that -- the percentages are up, but the absolute numbers are still extremely low. And the reality is there were 2 days of protest of any significance. The boarded stores are generally old and the plywood has been taken down. So I'd say the environment is fine. There's no question that what's going on has put pressure on, frankly, every major city from a fiscal standpoint, right? They've been the eye of the storm in terms of dealing with the pandemic of the asset. And so when you look at the big cities, particularly like in New York, that's dependent on tourism, the sales tax isn't there and all the different revenue streams that come in from tourists and from workers being in the city every day and the additional cost from dealing with us, right? That's putting fiscal pressures on the city. And so I think there is some concern about that. I don't know that's unique to New York, but New York clearly is feeling that. The business leaders are active together, not just the real estate leaders, but the business leaders in general, they're working with the city, working with the state in order to try to take moves constructively together, right? I'm dealing with whether it's homeless issues, dealing with cleanliness, et cetera. And I do think there's a little bit of a virtuous circle here, right, where with no one in the city, people feel like, oh, there's nothing going on. And then even as Owen and I talked about earlier, you see people back on the street traffic picks up. Now indoor dining is going to restart at the end of September, albeit, limited. But even when you drive by and you see the outdoor dining, it improves the feel of the city. So I think all that is going to naturally lay the ground for people feeling better, getting more confident. And as I talked about, a little bit of the fear of the unknown. You just have to wade back in the pool. And the pool is fine, and the city is doing fine in terms of once you're back. And I think that's just going to take some time to get back there.