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

Good morning, and welcome to the 10:45 session at Citi's Global Property CEO Conference. I'm Michael Bilerman. I'm here with Manny Korchman. We're extraordinarily pleased to have with us Boston Properties, CEO, Owen Thomas; President, Doug Linde; and CFO, Mike LaBelle. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast as well as up here. For those joining us here in person, you can step up to the mic if you want to ask a question, you can also just type them into live QA using the QR code and those that are on the webcast and simply type them into the question box and they'll come right to myself and Manny. Owen, I'm going to turn it over to you to introduce Boston Properties as well as Doug and Mike who are here with you. And then Manny and I will go through Q&A.

Yes. Great. Thank you, Michael. Great to be here this morning with you, and we wish you were here, Manny, but look forward to having you be part of the conversation. I'm not going to spend a lot of time on Boston Properties. I think all of you know who we are. We have about 52 million square feet. We're -- we have -- among the office REITs, we're the largest market cap. We have the broadest geographic footprint being in New York, D.C., Boston, L.A., San Francisco and most recently, Seattle. We have among the highest growth profiles in the office business based on our forecast for 2022. We also have the highest credit rating among the office REITs, and we're also a member of the S&P 500.

Owen, we've been starting off asking each company what are the top 3 reasons an investor should buy your stock over any other listed property company, not just your peers, which, obviously, I think you talked a little bit about your quality relative and your market presence and the development opportunities. But what would you say to an investor that has the choice of any property sector, in any geography, why does Boston properties rise to the top?

Yes. So Michael, 3 things I would mention. First of all, our short-term growth profile based on the midpoint of the estimates that we've given the Street, our FFO per share projected growth for 2022 is 12.5%. I'm not aware of all the companies that you cover, but my guess is that is a strong number. So why is that happening? We are firing on all cylinders. And you might find that surprising based on all of these work-from-home issues and questions that we've been receiving at this conference. But again, as we look at our business, it's firing on all cylinders. What do I mean by that? First of all, leasing. We leased in the fourth quarter basically our long-term average in terms of square footage that we normally lease over the last 10 years in the fourth quarter. The lease term was as long as it ever is. So we're going to be increasing the occupancy of the company. Second, our variable income streams like parking, retail, the hotel that we own, those are all coming back as all of the workers amongst our clients come back to the office. Development deliveries, as all of you know or many of you know, Boston Properties is a skilled development company. We are delivering major assets in '21 and '22 to our balance sheet. These are major facilities in Virginia for Fannie Mae, Marriott's headquarters, a major facility in Boston, 2 major facilities in Boston for Verizon, Google and others. So those are all coming on the balance sheet over the next -- last year and this year. We made 3 -- actually 4 new acquisitions last year and some of the income from that is coming on stream in '22. And then also last year, we did $4 billion of refinancing at very attractive rates, and so our cost of capital is lower and that's also contributing to the growth. So point #1, our short-term strong growth profile; second, the quality of our portfolio. Michael, you mentioned this, one of the things -- look, quality has always been important in the office business. It's been a key tenet of our company's strategy since its founding in 51 years ago. But today, quality has never been more important in the office business.

Right. And think about in '08, '09, when everyone said it was going to be a trade down, and it turned out to be a trade up. And so do you feel like that -- I'll let you finish that point, but just on that single thing, do you feel like it's even more so today than it was coming out of the GFC?

More so today than I've ever seen in my 30-plus year career in real estate, investing in office properties. What's happening today is all business leaders understand the importance of being in the office to build the culture, train their employees, build connectivity with employees. They all understand that. But the office has to be a destination, not an obligation. So companies are doing everything they can to make their offices great to encourage their workers to return. Great meaning, close to public transportation, easy to commute, great amenities, view corridors, et cetera. So the difference that you see, and we'll get into this, I'm sure, in the conversation, a lot of the data that's out there about broad office markets is not particularly helpful anymore. What the data that you need to be looking at, and again, we've got a lot of questions about this at the conference is, you need to segment the market by quality because the vacancy characteristics of the market when segmented by quality are very different than when you look at the overall market statistics. So my second point in your question about why should you buy our stock, our strategy is better suited to what's going on in the office business today than it was before the pandemic. And then the third point that I would make that I don't think investors give us any credit for is our built-in embedded value. And I'm intentionally not making an NAV comment here, I'm making a comment about the embedded value of the raw material we have for our developments. And that includes 16 million square feet of development land that we control, either we own it or it's through options. And included in that is 5 million square feet of incredibly high-quality life science development opportunities. And again, public market, I think, puts no value on that aspect of our company. So those are the 3 reasons, Michael.

Maybe we can dig in to the whole return to office because I think your confidence that you've expressed on a number of calls. And I think throughout the pandemic, even I can remember, there was a lot of questions early on and you were like, let's step back, we're in an economic recession. And so we can't start making proclamations about things because it's in a more difficult environment. We're now 2 years into this experiment. And I would say if I told my team before the pandemic, come in 3 days a week, they would have been jumping for joy. Now if I tell them 3 days a week, it's sort of like, why do I have to come in 3 days a week? And so the mentality of the employee has dramatically changed, given how successful they've been. I guess, how do you what -- I don't know, I mean, our industry, I don't know if you've been asking every single investor you've been meeting with, are you going back to the office and doing your own survey, granted this is only one industry out of many that house in your buildings. But what gives you the confidence that it's returning to the level that will not diminish rents and increase vacancy?

Yes. Yes. Well, I would mention 3 things. First of all, I don't think all employees think the way you just described it. I think there are a lot of particularly entry-level employees and younger employees who are saying they're picking employers that are in the office because they know they're not going to get the mentorship and the apprenticeship they need to learn anything. And I think that is very much in the water with junior employees. And I think they actually are a little bit resentful, if you will, of leaders that are not coming in and providing them those…

I would say I use that as an example, I'm in the office every day and my team is too, but I used it as a way of describing what I'm hearing from others. I just want to make that clear.

That's one. Second, as I mentioned a minute ago, I've not -- I've said this a lot of times, someone is going to say it again. I've not spoken with a business leader that thinks work from home is a good idea because they know that their culture is freeing. They know that their competitiveness is potentially diluted. They know they're not creating relationships and therefore, retention with the employees the way they used to, and they want to get their employees back into the office and we're starting to see it. I mean, not only have almost all of the financial industry clients that we have announced some form of return to office, but also now the big tech companies are. So Google announced April 4, Apple's April 11. They're all starting to come back to the office in a measured fashion. And then the last thing that I do think is going to happen is one thing that's contributed to work from home -- it started with as a health security issue, then I think it's migrated, albeit there have been some exceptions like Delta and Omicron, it migrated to more of a labor market issue because the market is so tight, employers are more reticent to force return to the office. But the other issue that's out there is we've had a huge tailwind in the economy driven by the liquidity through all the stimulus that's been put, and that is now being taken away and I think we're going to be entering into a period of time, not necessarily a recession, but a more competitive time for business. And I think that will also drive a return to the office behavior because I think leadership will again say, it's getting tougher for us to compete. We need to get our people back together more, make us more effective because we're entering into a more competitive environment.

Owen, just on those couple of points. Why does the quality of the office space matter? If the hook here is the culture builds and being together and there's truly a benefit of being together in an office space together, what is it with the concentration to the Class A and trophy properties and spaces that's driving that? It seems to be 2 sort of almost different messages. It's like we're going to make this a destination so we can advertise it as a destination and hope people to come in so that they're comfortable coming and feel nice and offer them lunch and all these other things. But really, the reason we're doing this is to build culture and be competitive. So it's like which one is it? To me, if it's truly a competitive advantage and you've got a team build and you're going to be more productive because you're together, you can be in the c******** oldest, s******** space, but achieve your goal by doing that versus having to be in the $250 per square foot, top of tower, a nice view corridor?

Well, look, I think, again, as I mentioned, I think the -- if I had to summarize it in 2 words, I would say the office needs to be more of a destination than an obligation. And I think you can make it -- we see it in what we're -- in the client behaviors that we're experiencing right now, it's easier to make it a destination, if the space is great. And if the -- I mean, the space itself is usually the obligation of our client to figure out how they want to do that, but we can provide the location, the view, the glass line, the amenities, and those are important. And look, you're seeing it in the market, okay? I'm going to turn it over to Doug because he did some primary research on San Francisco, and he can describe for you what is actually going on with client behavior based on this quality issue.

And Manny, I'd just say, I mean, if you -- what you said, I think, is an interesting idea. But when the roof leaks in your house or the wallpaper gets shabby or the rug gets dirty, are you saying, well, this is fine. I'm living here. It's great. I'm still with my wife and my family, I don't mind being in here or do you upgrade it? I just think there's a perspective that design, quality, the way people put their space together says something about who they are and what they represent. And it doesn't have to be ostentatious, to be great and there's a big difference between being in a great new space and being in a s*** box, as you described it, which is I don't think the appropriate measure of what Owen was talking about.

I'm getting very worried about the Bloomberg headlines at this point.

So I would just sort of -- to Owen's point, the city of San Francisco publishes a -- from a Cushman & Wakefield or CBRE or JLL perspective or Newmark, the 4 leading brokers, availability of 28% to 30%. And I think saying and thinking that, that means that San Francisco is a horrific market is a gross overstatement. And we have been trying to describe over the last 2 years, how well we have been doing at leasing our portfolio. And so, we asked our brokerage team at CBRE led by a gentleman named John Cecconi, to do their own independent view of what they viewed as the high-quality buildings in the city, call them trophy, if you want. And they came up with a list of between 20 and 25 buildings. It represented about 20% of the square footage in the city and the availability rate in that portfolio was 6%. And so, something that's clearly going on with regards to behavior, and this is pre-pandemic through the pandemic. And so we didn't see any real movement of availability in those high-quality buildings. In fact, what we saw was an enhanced amount of leasing activity there. So I think that the facts on the ground are illustrating what Owen was describing. And I'll sort of give you another Boston example. We have a law firm that we've been working with for decades, and they have been in a, what I refer to as a quirky, interesting building but not a modern building. They just made the decision to move to a new glass box renovated tower for the first time in their history, and I had a conversation with the managing partner last week, and I said, "So what happened here? I mean, it finally moved." He said, "It just wasn't working for us. The owner wasn't prepared to invest capital in the building. The mechanical systems just weren't doing it for us, and we were having a hard time recruiting talent. And so, we had to make the decision to move to that glass tower." So we're seeing it happen time and time again with the clients who we deem to be the customers for our portfolio.

And I would just make a stronger point on this when we're working on this with the research providers as a project, I mean, we have a senior BXP professional working on this. You need to look at the office market data on a segmented basis. This is an innovation that shouldn't be hard to do, but needs to be done to really understand what's going on. So I'll give you an example. New York is 18% available, yet there are -- there's new development going on. So how can that be? It can be because it's not all 18% vacant. The high end of the market is much less vacant and rents are strong for high-quality properties and for new construction. And unless you look at office market data segmented, you can't understand that dynamic.

Doug, there was a question that came in here about Big Tech. Big Tech has been growing employee count, but using remote work as well. How has their space per employee changed, effectively, are they taking less space per employee?

So I think it's a really fascinating question because what we have seen is throughout the entire pandemic, we're talking from the beginning of April of 2020 all the way through the last few months, we have seen what we refer to as big tech, which are -- just to describe the sort of the names behind that, Apple, Facebook, Amazon, Google, Microsoft, continue to do what they were doing pre-pandemic, which was take large blocks of space in major cities and expand into other cities across the country. And I think the critical component that you have to think about is -- and Owen said this, and I think there's a little bit of a difference between the words that we use is work from home and the fact that companies don't want to rely on work from home is different than working flexibly. And flexibly means you're acting like you have an employee base who has the maturity to decide when they should and when they shouldn't be together as groups in offices. And the tech companies are acting in that way. They are looking forward and saying, "We anticipate that our employees are going to want to be together in physical environments, a lot of the time. I can't tell you if it's the majority of the time or not, but a lot of the time. And we want to make sure that when they come into our spaces, they are getting exactly what they were getting pre-COVID, which was a great amenitized environment where they can work collaboratively together." And we are now building out a 400,000 square foot facility for Google in Cambridge, and Mike was there last week so he can give you a little bit more clarity on it, but they are creating all kinds of spaces within that infrastructure for collaboration, for canteen, so the food is close to you when you need it, for large and small meeting areas as well as lots of internal offices and lots of cubicles or work tables for people to work on an individual basis. And so, I think that what we're going to see is we're going to see some experimentation. We're going to see some changes, and we're going to try and figure out as a country and as industries, what the right cadence is for bringing human capital and physical capital together.

One thing I would add to Doug's answer. Obviously, we're engaged heavily with our client base, including the large tech companies. And one of the things they would say is we were dealing with a mobile home-enabled workforce before the pandemic. The pandemic put it on steroids, if you will, but we were dealing with that before the pandemic. So why do you think that we love high-quality buildings in great locations? Why do you think we have all this collaboration space? Why do you think we provide all these amenities like food and other services in our space? Because, again, we're trying to make the workplace a destination, not an obligation. So I think one of the things you're seeing with the pandemic is that principle is now moving into all the other sectors because now you're seeing asset managers, banks, law firms, they're adopting a lot of these principles because now their workforce is more mobile-enabled.

Do you feel like the cost of that transition is going to fall effectively to the landlord rather than the tenant either in the form of TIs that you have to give or just the rent levels or payback period? Like how will the funding for that transition happen?

So I think there are 2 components. So one is -- and we have been doing this for the last 26 years as a public company, you have to continually invest in your assets. And that means making sure you have the right amenities at the right time. And that means upgrading those amenities where necessary, which means if you had a conference facility, you've got to make it technologically adapted to what companies want to do, right? If you have meeting rooms, you got to have those meeting rooms readily available for different kinds of meetings, large meetings and small meetings. So that's part of the landlords' sort of covenant. On the tenant side, we will give TIs based upon the market conditions in any particular market. I don't think that's going to change. I do think that one of the things that we have to be careful of when we're looking at transaction costs in the office business is that the inflation that we are all experiencing relative to all kinds of new products is also happening in TIs and the landlord is potentially contributing a little bit more because the tenant is having to pay a lot more for what they need, and we are not giving them more "stuff", we're just paying for a similar proportion of what they're getting on a relative basis than what they would have been getting 2 or 3 years ago at the cost a lot higher.

And the tech leasing that you're doing where you're building out space, what's your sense of the utilization that those tech companies are budgeting for? And is it different from what they were doing in the past? Is it down to like because of what they think is going to happen from a return to office, are they just willing to accept 100 square feet or something even lower per employee head in that region?

So what we have seen is, unfortunately, not a clear path of uniformity. There are companies that are thinking about utilizing their space in ways where each and every one of the employees has a dedicated desk and those dedicated desks are going to mean that they're going to not necessarily be utilized on a day-to-day basis if people aren't in their physical office 5 days a week or 6 days a week depending on their culture. And we've seen other tenants who've said, "Anybody within a 150-mile radius of this office is "assigned" here and they can choose to come in when they want to come in," and those are creating very different dynamics relative to the amount of square feet per "assigned" person in the office. And it's really very dependent on the particular company. I would say that the larger, what we refer to again as tech Titans, for the most part, are looking at dedicated space for their employees. And that's why I think you're seeing them moving towards a sort of a consistent perspective relative to their growth as their businesses grow.

And how do you think about their growth outside of your core coastal markets, right? You think about New York, Boston, D.C., L.A., San Fran and now Seattle, where I would say, yes, there's continued growth, right? It's evident through the leasing activity that these companies are taking down, but they're also migrating much further down into the Sunbelt. And so how do you feel about the trajectory of demand in your core markets relative to other places from these large companies?

If these companies could hire all the people that they could in the markets where they currently exist, they would, but they can't. And so, we are, as everyone appreciates, in a very challenged labor market. And so these companies have acknowledged and they -- it wasn't -- this was not a COVID issue. This was a growth issue. We have to go other places in order to find employees who can help us in our business objectives. And so, it's natural to see them going to other parts of the country other than the core markets. I will tell you that I think that they are equally dedicated to remaining in those markets and growing in those markets wherever possible. I mean, let's just use the Google example of what they're planning to do near Diridon Station in San Jose. I mean, they're going to be building 10 million square feet of space, some of it are residential for their community and some of it are commercial office for their employees. They're also growing in other parts of the country. And I don't think they're -- it's not binary, it's not one or the other. It's everything, and they have such large aspirations in terms of what they would like to do with their businesses that they need to look elsewhere, including internationally for employees.

So I'm going to switch topics here because I think everyone has work from home to out.

Should we take a poll in the audience? How many people are going -- how many people are back in the office greater than 3 days a week right now? I should have started at 5, 5 days a week. 4? Well, it is greater than. I know it's -- I know it's still the morning. 5, 4, 3, 2, 1, 0, all right.

Do you want to do the correlation to -- do you want to do it by…

No, no, no, no. Go ahead, Manny. Let's turn to life science that you presented it as one of your growth avenues or an underappreciated, I guess, point of your business. It's certainly gotten a lot of press over the last couple of years. Where is your confidence on that sit today? And where does that grow to be a part of BXP?

Our confidence is high. The demand that we have for our properties exceeds the supply that we have. We're still experiencing very strong above inflation rental growth. Just as a reminder to everyone, our footprint in life science is in the 2 strongest life science markets in the country, namely East Cambridge and South San Francisco, which represents about 45% of the lab space in the U.S. So we have -- I won't go through all the projects, but everything that we've launched over the last couple of years is virtually fully leased, and we have a very strong pipeline of new life science projects that we -- that are either redevelopments or ground-up development that we intend to launch over the next couple of years. Right now, life science represents about 6% of BXP's revenue, and we've said that we think we can double that contribution in 5 years.

And just the most important thing perspective you should have on our life science is that we're developing buildings, but we're developing buildings in 2 ways: We're developing buildings on land that we have owned for a long time, which has 0 basis, meaning we didn't pay anything for that land. So for example, we developed and did a renovation for a building at 200 West Street in Waltham for a company called Translate Bio. As part of that, we were able to get permitted another 130,000 square feet of space. We didn't pay anything for that plan. People are paying $150, $200, $250, $300 a square foot for raw land to develop life science in suburban Boston. So we have a very unique opportunity and a lot of space in great areas of our marketplace where we can make hay with our embedded opportunity from a raw material perspective. Secondarily, we have a number of office buildings that were designed with a lot of flexibility relative to the structure of those buildings, which means they are readily adaptable to life science users. Now we have to invest capital in those buildings. But if we have a building that we spent $50 a square foot on in 1998 or 1999 or we purchased for $150 a square foot or $200 a square foot in 2007 or 2017, and now we're investing in that building and creating a life science building, and we're achieving net rents of $60 or $70 or $80 a square foot, it's a really terrific return on incremental investment and a great return. So our life science business is geared towards value creation, not simply growing our revenue base.

Just to clarify on that, is that to say that you have a lot less interest in going and buying land and developing a sort of a today yield and you're really just more excited about it because you get to flex that or really use that existing land to its best potential? Am I understanding that correctly?

Yes. I would say our primary growth driver that Doug described is basically using product that we already have that we have either up-zoned or converting existing office buildings. Again, that's 5 million square feet of development just in that piece of it. That being said, there are exceptions to this. We recently bought an older office park in Shady Grove, Maryland that we intend to convert to life science, and we may do additional acquisitions. We also bought 2 small lab buildings in Waltham last year. So that we will make some acquisitions, but the 5 million square feet that I described is all assets that we currently control or historically have controlled.

What about multifamily? Is that something you're going to continue to develop as well?

Yes. The multifamily that we have has been all developed from scratch. And with the exception of one project was all associated with one of our mixed-use developments and we would like to continue to develop multifamily. The issue is finding projects that generate sufficient yield. But to the extent we can find them, we will continue to grow that piece of the business. But today, it's pretty small. It's like 1% to 2% of our revenue.

Owen, what's your #1 ESG priority in 2022? I know that's been a big focus for BXP.

Yes. We have a lot of things that we're doing in ESG, and I know you don't want the laundry list, so I won't give it to you. But the priority for us right now is we're on the 1.5-degree Centigrade science-based target, which means we need to be net 0 by 2025, which is in 3 years. And by the way, we're already 75% to 80% of the way there. We got half -- this is off a 2018 base year, but we got roughly of that 75% to 80%, about 40% to 50% of that was through additional efficiency in our buildings and the rest of it was through green power purchase agreements. This last 20% to 25% is going to be harder to get, but we're committed to achieving that goal.

One here in the queue, I guess somebody is just wondering what the -- going back to our conversation on culture, what's the benefit of bringing people back to the office versus other collaboration? I'm going to switch that question up a little bit and say, how much more common space do you need to build? And I think your company is in a unique position that you have large offices throughout the country. So as you think about your own office renovation and occupation, how much do you think about sort of that like how often do we need to bring together BXP as an organization? And do we need to build our offices in a way that support that?

Well, look, I think that every company is different. And honestly, within companies, including Boston Properties, the needs for daily, weekly, monthly or quarterly collaboration is a little bit different. So I think it's hard to answer that question. But I just think it's hard to have a high-performance organization when no one has ever met each other when all of your interactions are on Zoom. I mean I've had a peer CEO tell me that 50% of the employees that they have -- his company hired since the pandemic started, have already left because they never met anybody and they didn't create any connectivity with the company. So -- but again, I don't want to leave the impression that we view that every company is going to go back to 5 days a week supervised work. I don't think that's the future of work. I think it's going to be highly tailored to the business that you're in and what those -- what the individual groups do and how important it is for them to be together. I mean we have businesses at Boston Properties that people really need to be interacting all the time in-person. And we have others that are doing more support work that frankly don't, and so they don't need to be in the office as much.

Owen, just quickly, how does acquisitions fit into the growth pipeline relative to development and redevelopment of variable income streams and increasing occupancy as growth drivers? You have obviously institutional capital partners. How eager are they and how eager are you to go out and buy today?

Yes. Our partners are enthusiastically supporting our activities. We have 2 of the most largest and most sophisticated global investors in real estate as our partners. We did 2 deals in that program last year. I think development will be a bigger source of growth, but acquisitions will be part of the growth story. Look, I think given all of the concern out there about office, we have conviction we're going to invest our -- we're not just saying this. We're putting our money behind it. And so we did get, I think, several deals last year discounted because of this overall concern about return to the office. So we're going to try to continue to find deals and take advantage of that.

Same-store NOI growth for the office sector overall…

Michael, I would just add that the 12.5% growth we have next year doesn't include any acquisitions.

Any acquisitions. Same-store NOI growth for office overall 2023.

Yes. So a long-term average for us is like 2.5% to 3%. So I think the sector is going to be recovering. So I would say 4% for office.

10-year treasury a year from now? It's back -- it's 1.9 now.

2 in a quarter.

Will the office sector have more or fewer public companies or...

I always say fewer, and I'm right every other year.

Yes. Thank you.