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

All right. Good morning. My name is Jamie Feldman. I'm the Office REIT Analyst at Bank of America. Appreciate you joining us today for this session with Boston Properties. We are pleased to have with us Owen Thomas, CEO; Doug Linde, President; and Mike LaBelle, Chief Financial Officer. And if you have any questions, please feel free to step up to the microphone. Otherwise, we're going to turn it over to the team to give you a quick overview of the company and then get into some Q&A.

Good. Jamie, thank you. Good morning, everybody. Good to see everyone here. Good to be in person. Jamie, thank you for hosting us this morning. A couple of comments at the outset. We get asked often what's our theme for this particular NAREIT meeting. And our theme is that we believe there's a real disconnect between the headlines that you see in the marketplace today about office, about recession and so forth and what we're actually experiencing and operating our company. And what I specifically mean by that, obviously, you've all seen the -- you read every day about all the media about how people aren't returning to the office and what the impacts of that will be. But what we're experiencing is the following. We're having our fourth consecutive quarter of increasing leasing volumes and tour activity. Our buildings, though they are not as full as they were before the pandemic, they're getting more full each week for the buildings that we can monitor that have turned styles. And we've been beating our own forecasts for FFO, as you know, and have been growing the company's earnings quite consistently and at an elevated levels. So that's our theme. A couple of other things I would just mention about our company for those of you that don't know. Our consistent focus from the actual inception of the company has been focusing on quality, owning the absolute best assets that we can own in all of our markets. And today, that's an increasingly important part of the office business. Our clients increasingly want to be in great buildings in great locations with great amenities because they need to do more to encourage their workforces to return to the office. And what we're seeing is a real bifurcation in the performance in all of our cities between prime assets and the rest of the market. And I'm sure Jamie or others will have questions about this that we can answer. Also in terms of our balance sheet, we do have the highest rating among the public office REITs. And also, we're very pleased with our current execution. The company currently offers a very strong growth profile. Our own estimates of FFO growth in 2022 are around 14%. We have a nearly $3 billion development pipeline that's generating 4% growth to our earnings over the next 3 to 4 years. Those developments represent over 4 million square feet and we believe we're going to deliver them at over a 7% cash yield. Increasingly, it's a life -- there is life science in this development portfolio. And as you know, we're very active in Boston and San Francisco, which are the 2 largest life science markets in the country. And then lastly, I would just point to the valuation of where our stock currently trades. Our look through cap rate is right now over 6%, which we think is a disconnect from the private market value of the assets that we own. Our dividend yield is also at elevated levels from historical norms. It's at 3.7%, and we've actually demonstrated strong dividend growth over the last 6 years. So with that as an introduction, Jamie, let me turn it back over to you for questions.

Great. Thank you. Maybe just talk a little bit your market exposure. You recently entered Seattle, several years ago, you entered Los Angeles. How does Boston Properties think about the markets it wants to be in, especially in light of -- we hear about the Sunbelt picking up and you've seen REITs go to other markets around the country?

Well, as Jamie said, we did enter the Seattle market last year with the purchase of Safeco Plaza, and we just added to our portfolio in Seattle with the acquisition of Madison Center. And we did enter the L.A. market about 4 or 5 years ago and own 2 very significant assets in Santa Monica. The focus of our company is on the gateway markets of the United States. We think to create value for shareholders over time, we want to be in one large markets. We want to have markets where there is economic growth. And we want to have markets where there's barriers to entry. And we do think that the 6 markets that we've selected have all those characteristics. I mean, some are higher than others at different points in time. There are different demand generators, whether it be financials today in New York or technology in Boston and the West Coast and in Northern Virginia or life science in Boston and San Francisco. There are different drivers of growth. But we do see that at different levels in all the cities that we're in and there are barriers to entry. In some of our cities, development is precluded. In some of our cities, development is regulated by law. And in all of our cities, development is complicated and expensive and difficult to do. And we think that creates some barriers to supply. Look, there are -- you can pick at any point in time and look at a market and say, well, that's growing faster than where you are, and that's probably true. But we're very long-term in our approach. We have -- when we go to a city, we setup a fully integrated real estate presence. So we need to pick cities where we're going to make those kinds of investments and setup for the long-term. And that's why we've selected the markets where we're in.

And we've seen heavy demand this cycle from tech. You had mentioned life science as a growth area as well. What are your thoughts on the near-term and long-term demand profiles of both those sectors? And then maybe even more broadly, where do you see demand coming from for your portfolio?

Doug, do you want to hit that one?

Sure. So I do wanted to sort of clarify your sort of comment, which is between 2010 and early 2020, we did see a lot of demand from tech. Really interestingly, during the last 2 and a quarter years in the pandemic area, we actually haven't seen a lot of tech demand. We've seen some large technology companies and we like to sort of refer them as the Tech Titans; the Microsoft, Google, Facebook, Amazon, Apple. They have continued to make large decisions to enter into either existing or new real estate markets, but in a really fascinating sort of turn of events. During the last 2 plus years, there's been very little actual tech leasing in any of our major markets. And honestly, I think one of the reasons that we are slightly challenged right now in every market in the country, not just the markets that we operate in relative to sort of the amount of available space is that there were a lot of tech companies that were hiring significant numbers of employees without having the desire at the moment to hire or to lease additional space to put those bodies into seats. So most of the leasing that we have seen and that we are seeing today, sort of as a continuation of what Owen was describing, has actually been very, what I'd refer to as traditional leasing. It's been financial services, asset management, consulting, insurance, banking, the sort of the typical traditional urban office user. And there's been some companies that have gotten smaller and lots of companies that have grown as they've sort of re-thought how they're going to utilize space and what they're going to be doing. I do think that one of the challenges that we look at on a going-forward basis is what impact will the change in mentality relative to work from home and not necessarily having all of your people coming to a headquarters-oriented location on a daily basis mean for the long-term amount of additional growth that we're going to see in the office business. And we've had lots of people come in and give us studies on what they think. Nobody has said we think it's going to be more than it was in 2019 or 2018. But nobody really has a good way of sort of demonstratively saying what the reduction in growth might be from that sector. In the life science world, there has been an acceleration over the past couple of years, including during the pandemic, in significant markets like Boston/ Cambridge or in South San Francisco. And that's been driven by drug discovery and the confluence of changes in the genome project and the rapid nature of computing from supercomputers and just the pace at which you can move from a test tube into an FDA regulatory Phase 1 study and then potentially have a commercialized product, and we don't see that changing or slowing down. Capital is an issue and we've all been living the volatility of the past 6 months and seeing what's going on in the public markets. Clearly, it's also happening in the private markets. And there will be I think some slowdown relative to the amount of cash that is put it into new ventures, be they life science ventures or be they technology or other business ventures from the private community. And so we're expecting to see that. And that we'll have some sort of pressure or headwind, if you will, on again the growth in leasing. But there is still lots of activity. And most importantly, there are still lots of open positions across the country, across every sector. And those positions are going to get filled. And the question will be how much more pressure management teams will be able to put on their employees to be more appreciative of working in-person over the next couple of years as we sort of move into a tire labor market.

So you mentioned remote work and hybrid working, but at the same time, you have an outlook for occupancy in the portfolio to grow this year. So can you maybe talk about whether it's specific projects that you've had great success with or just in general, how your platform seems to stack up to the competition where we're looking at Castle data that's showing buildings are half full, but your occupancy is growing? What's unique about your platform coming out of the pandemic that you think will help you stand out?

Well, a couple of things I would say. Look, I think this occupancy data -- I think occupancy is the wrong word. Let's call it, census data, because when I think about occupancy, I'm thinking about more of the financial term of what's the occupancy of our portfolio from a leasing standpoint. So let's use the word census. So we have been quoting some census numbers that's the number of people that are currently walking through the turn styles in our buildings versus the number of people that were walking through them in February of 2020 right before the pandemic. And as time goes on, that number becomes more less interesting and important and valuable because there's lots of changes going on in the portfolio. For example, there were space that we might have leased, but it wasn't occupied in February '20, but now it's occupied, so maybe that number is too high. So I think the right way to look at it is to look at what is the occupancy versus the workstations that are in your building. And I think that's the way Castle systems does it. And whether -- on any of these measures, we know that the occupancy or the census in our buildings is going up in all of our markets. Markets are very different. New York is a lot higher than the other markets and San Francisco is the least. I also think that the census in the buildings that we own is going to be higher than the market. They're premium buildings and the types of clients that we have occupying those spaces are more professional service companies that are finding increasing value in in-person work. We don't have a lot of support functions, back office functions that are in our buildings. And I think those workforces are working remote a lot more. And I think buildings that have those kinds of workers in them, which tend to be I think a little bit lower on the quality scale, I think their census numbers are going to be lower.

But I guess even -- and I was thinking more about your portfolio occupancy statistics. So here we are in a market where people are concerned about remote work and fewer people in the office, yet your actual portfolio -- the number of leases in your portfolio is rising. So what do you attribute that to? And as people think about the office business going forward, what is it about your platform that you think will be a strong competitive edge?

Well, I think -- I mean, Mike and Doug should jump in here. Look, I think it's the quality is the most important thing I would focus on. We talked about this on our last earnings call, but we worked with CBRE to look at market statistics and we just made this simple; prime assets and everything else. In 5 of the 6 cities where we operate, L.A. was excluded because we're not operating downtown, we're operating in primarily in West L.A. But on the 5 markets where we operate, we asked CBRE to; one, select which buildings they thought were prime based on their expertise and market access, which by the way is considerable, because as you know, CBRE is very active in the leasing market, so they know which buildings are most desirable to tenants. By the way, I've seen studies done just on age and that's an interesting cut, but that's not the most important cut, because you can have older buildings that are kept current, that are in great locations, that are just as competitive as a brand-new building. So anyway, they did this work and the conclusion from it was is the market statistics are very, very different for the prime assets versus everything else. First of all, the prime assets represented about 17%, 17% of total stock. And if you look at rent growth, significantly higher in the prime assets. If you look at the availability rate, it's considerably lower in the prime assets, particularly in San Francisco. If you look at the net absorption, it was materially positive, like over 1 million square feet in 2021 for the prime assets. So Jamie, the quick answer is the market is getting -- the availability rate is coming down for the prime assets because there's net absorption. But for the non-prime assets, it was actually minus over 6 million square feet. So that's where the availability is happening. So I think that's a primary driver. And then we're also benefiting from recovery from the pandemic, particularly in the retail area. We had a number of our clients that did not perform through the pandemic and gave us back space and we've been reletting that and that's also helping our occupancy statistics.

And Jamie, we're an operating company that has this regional operating team where we have people on the ground managing our buildings and dealing with our tenants on a day-to-day basis. And that team talks to and works with our tenants to solve their problems all the time, and we look for opportunities within the portfolio. We have tenants who may be shrinking and we have the tenants that may be growing. And instead of doing nothing and letting leases simply expire, we work the leases and we work those relationships to try and be additive from a value creation perspective organically in the buildings, and we see a lot of that going on right now. But fundamentally, Boston Properties as a public company, we're on, I think in another week, we'll be at our 25th anniversary. We have been investing in our assets every year, every month across the portfolio, every single day that we are in this business. And that means that when you go to our assets, you get the sense of what we are doing in the building. So we'll just use New York City as sort of an example of a portfolio that we have. So at the corner of 53rd and Lexington Avenue, we just made a major investment in a culinary collective called The Hugh, which is a pretty interesting place to go and meet and gather, and by the way, also eat and drink, for the population of our buildings around 53rd and Lexington Avenue. It was a meaningful investment. In addition, we've re-done the lobbies at the General Motors building. We've re-done the lobby at Times Square Tower. We're re-doing the lobby at 599. We did a facade replacement at 399 Park Avenue. We've changed the mechanical systems in these buildings so that we can make sure we're meeting energy code and providing better air quality and fan return volumes to our tenants from an outside air perspective. We're building amenity centers in these buildings. We're just -- we're doing all of those things on a habitual basis and it costs money. There's no question about it. Our organization is spending somewhere in the neighborhood of $2 to $2.5 a year on that kind of capital across the portfolio on a consistent basis. And we're a 50 million square foot portfolio. So we're talking about $125 million plus or minus on those kinds of things every single year, but it matters and it puts our buildings in a position where as tenants are looking to upgrade their space so they can recruit and retain talent and they want their space to be the kind of place people are encouraged to come back to by what it is as opposed to being required to come back to. It's those kind of spaces that we think are going to be most attractive to the tenants as we are dealing with this supply challenge from a labor perspective. And so as companies are trying to use their space as a tool for building affinity and building culture and suggesting that people should be coming back and wanting to be together, those are the kind of things that we're doing in our portfolios across the country and New York City is just simply an example of that.

I would just -- just to put some numbers on it, Jamie, I would just add that our leasing volumes, and Owen touched on this, are up. So for 4 consecutive quarters, we're leasing over 1 million square feet a quarter of space in our in-service portfolio. The annual rollover that we have over the next couple of years is about 2.5 million square feet. So we're leasing more space than is expiring, and that's why our occupancy is going up, and that's why we expect our occupancy to continue to go up because the pace of the leasing is creating positive absorption. And it's the result of all the marketing and the work and the quality of the assets that we have that we're getting more than our share -- higher market share and the higher quality buildings that we own.

I guess, Mike, while we have your attention, can you just talk more about the Boston Properties balance sheet philosophy? Some of your peers are starting to feel the pain of more floating rate debt. How do you think about fixed versus floating? What does your maturity schedule look like in the next couple of years? And just how do you think about sources of capital when you look at the opportunities ahead for the company?

So I mean, our philosophy has always been long and strong, right? I mean, we use long-term debt that matches what our assets are. So we're generally using 10 to 15-year debt terms when we do new debt. So our maturities are very well laddered over time. And then we get in front of these maturities and deal with them in advance. So in 2021, in a much more favorable rate environment, we did $4.2 billion of financing. And with that money, we refinanced everything that we had coming due in '22 except for one mortgage and most of our 2023 maturities. So we don't have a bond financing coming due until the end of '23. And it's only a $500 million unsecured bond. So we are not very exposed to having to refinance assets over the next couple of years. We've also always used fixed rate debt. Our consolidated debt is 97% fixed. So we have very, very little exposure to floating rate debt. So the debt that we do have to refinance is going to be at a higher rate than it was last year and the very small amount of floating rate debt is going to be higher, but the impact on our earnings is really not material at all because of the way that we've structured our balance sheet. We have the strongest corporate credit rating of any company in our sector. And our leverage is very moderate and it's been very consistent in how we've managed our balance sheet and our leverage over the last 25 years.

So do you have a target leverage range?

So from a net debt to EBITDA perspective, our range is kind of somewhere in the mid-to-high-6s to the mid-to-high-7s. We have a development pipeline that Owen mentioned that's coming into service over the next couple of years. That's going to add over $200 million of cash NOI. That will serve to further deleverage us. So right now, our net debt to EBITDA is in the mid-7s, but we anticipate that it will be coming down as this income comes into place. And that provides additional balance sheet capacity for us to do additional things.

And then just how do you think about other sources of capital, whether it's JV partners or any other?

So as Mike mentioned, our rating is very important to us to preserve that rating. And so as we continue to make new investments in development and acquisitions, we need to -- the question is, what's the pace of the delivery of the new developments because that gives us debt capacity versus the dollars that we're investing in new things. And for many years, those have matched up. We've been able to grow the company and make new investments using the debt capacity that was created by the developments. But we've pushed the envelope on this. And what -- so therefore, what we've done is grown a pretty significant private equity capability within BXP. So we're not interested in issuing our public equity at the valuation that I described in my opening remarks. So if we're going to bring new equity in the company, we want to -- we decided the best thing to do is to bring it in privately. Only about 5% to 10% of office real estate is owned in the public market. The private market is actually much larger and much more active. So there are many sources, sophisticated sources of private equity capital that we can access to do our business. And many of these players very much want to do business and joint venture with Boston Properties. So last year, we bought 2 buildings, Safeco Plaza in Seattle and 360 Park Avenue South in New York, and did both of those deals with 2 sophisticated joint venture partners. We own 1/3, each of them own 1/3. So we're all equal. Again, we're not trying to build a fund management business. We're trying to fund the business that we always do in a different manner. And so being equal with those other investors was important to us. The other benefit of it is, again, we don't invest as much capital. So obviously, for successful investments which we think these will be, the shareholder return is diluted. However, the return on the third that we put in is higher because we do earn fees from the joint venture partners that we have. So the yield on the 1/3 of the capital that we put in is actually higher than if we own the whole building. So -- and I think as we look at new acquisitions now and going forward, this will be our approach from a funding perspective.

Will you be happy to have the stock higher and issue equity if that was an option?

Well, that's always been the strategy of the company is to keep everything for shareholders and use our currency to fund the business. But at our current share price, we don't think that's the right thing to do. By the way, we generally haven't been -- we haven't brought in joint venture partners generally into our developments. Some of our developments are JVs, but they're generally with landowners that did not want to sell the site, but wanted to stay in the deal. But we haven't brought in the financial JV partners generally into the development.

And maybe can you talk -- and we have -- I guess, we have a little bit less than 5 minutes left. You've been really a leader in ESG. There's -- most of the municipalities are starting to push environmental legislation. Can you just talk through whether you think there will be incremental investment required or the steps you've taken to comply with either ESG or just kind of prepare the platform for what's to come?

So we have been, I'd say, a leader in thinking about sustainability, which is the part that you're describing, for the better part of a decade. And we have been aggressively moving towards doing things to reduce our carbon footprint in a significant way year after year after year, and it's part of that capital program that I was describing before. And effectively from the sustainability perspective, what that means is revamping your mechanical plans so you're no longer burning fossil fuels. So instead of having a steam chiller, you have an electric chiller that kind of a thing. So we are way ahead of the game. And we actually believe we already comply with the 2025 regulations of Local Law 97 as an example in New York City. And we are moving as rapidly as we can to use building management tools and some degree of artificial intelligence to help us reduce the amount of power that we are using on a minute-by-minute, hour-by-hour basis in our building so that we can dramatically reduce the need for the consumption of kilowatt hours, and therefore, we can reduce our carbon footprint in a meaningful way. As a company, we've made a commitment to be carbon neutral over the next few years. And I mean, as an example of the kinds of things we're doing, one of our tenants in Boston came to us and said, we have a requirement, we would like to be in a building that in theory could be net zero. And we thought long and hard about whether or not we could achieve a net zero installation and found a building in one of our suburban portfolios where there was enough surface area for us to create a solar array and have a battery storage plant so that we could actually generate all of the energy necessary to manage this building on a day-to-day basis during a calendar year with a surplus. And so this tenant is going to have a net zero building. And that means we're doing some modifications to the [ mechanical ] plant. We're actually adding insulation to the building, in the interiors, but because we're demoing the existing space, it's not a difficult thing to do. And then we're building this major solar array on the property. So we are thinking about these things every single day. We're driving to reduce our Scope 1 and 2 emissions. Interestingly, one of the things that we're thinking long and hard about is how do we get to Scope 3? How do we get to the built environment itself? And are there ways for us to procure materials like steel or concrete or glass or aluminum for our facades in ways that are much more efficient from a carbon perspective. So it's a very important focus of the companies. And we also have the social part of it the S. The social part from our perspective is thinking about our workforce, thinking about how we can diversify our workforce, both from a gender and from a rate perspective. We have goals. We have objectives. We have a diversity inclusion and equity team of people across the company who are thinking about this stuff every single day. And so, again, it's a primary focus of the company's management team.

So we have about a minute left. Any final thoughts or anything we did -- sorry, a question in the back.

Can I just ask a question on the New York office. Can you talk about kind of like-for-like rental? I think on your -- on the last call [indiscernible] for you, but it's been positive for some years. Can you talk about the market in general how you think about [indiscernible]

So real quickly, like-to-like is about what's actually expiring at that time. So it's very much dependent upon when the lease was originally constructed and when it's expiring. So if we did a lease in 2010, which was sort of at the beginning of the last sort of boom cycle, and that rate -- those rents are escalating both from operating expense increases as well as bumps. We suddenly get to 2021 or '22, and there's probably a roll down. If we did a deal in 2014 or 2015, which was sort of in a slower time, we're probably going -- getting to the point in 2024, 2025 when that rolls over, and it's going to be a roll up. So it's really very much hit or miss. In general, in our opinion, the New York City office market sort of did a reset in late 2020, '21, where effectively net effective rents, concession packages, free rent, the overall face rent resets down somewhere between 15% and 20%. That's been very sort of static since that time. There's a lot of space in the marketplace. So things haven't improved, but they have not gotten worse. And in fact, as Own was describing, in the better quality buildings, there's a lot more pent-up demand for space. And so we've been able to increase our availability -- our vacancy rates or decrease our vacancy rates and put us all in a position where we have a little bit more pricing power.

I think we're out of time here. I'm getting away from the back of the room. So Doug, Owen, Mike, thank you very much for your time, and thanks everyone for listening.

Thank you, Jamie.