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

Welcome to the 9:15 AM session at Citi's 2023 Global Property CEO Conference. I'm Nick Joseph here with Michael Griffin with Citi Research. We're very pleased to have with us BXP and CEO, Owen Thomas. The session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those in the room or the webcast, you can sign on to liveqa.com and enter code Citi2023 to submit any questions if you do not want to raise your hand. Owen will turn it over to you to introduce the company and any members of management that are with you today, provide in the opening remarks, and then we'll get into Q&A.

Thank you, Nick. I think this table is long enough. So we're back to -- pleasure to be back at Citi. You all know Doug Linde, who's the President of the company on my left, James Magaldi is on my right, who is our SVP of Finance, is filling in for Mike LaBelle today; and then Helen Han is our Head of IR. I'm just going to give a couple of quick comments about BXP for those that don't know the company. We're the largest public company in the country that focuses on premier workplaces. We're in the S&P 500. We're Baa1 rated. We currently lease and manage 54 million square feet of space. We're in 6 -- even though we're a large company. We're concentrated in 6 cities, those being Boston, New York, Washington, D.C., San Francisco, Seattle and Los Angeles. We own some of the most recognizable premier workplaces in those cities like the Prudential Center, Kendall Center in Cambridge, the General Motors Building, Reston Town Center outside of D.C., Salesforce Tower in San Francisco, Embarcadero Center and Madison Center in Seattle. I think also, and very importantly, we are not just an owner and manager of real estate, but we're a developer. That's how the company started. That's in our DNA. We're always building somewhere between 4 million and 6 million square feet of space, and that contributes significant external growth.

Terrific. We're opening every session off with the same question. What are the top 3 reasons investors should buy BXP stock today?

Okay. So -- number one is, notwithstanding the recessionary environment that many of our clients find themselves in. We think the company has a solid growth profile and why do I say that? First of all, we have a $3.3 billion development pipeline underway that generates 4% external growth to the company's NOI over the next 3 to 5 years. By the way, of that $3.3 billion, $2.1 billion is in the life science segment. And those properties are currently 65% leased and a year or 2 ago, our life science contribution to total revenue was up 5%. And when those projects are completed and assuming everything else is static, which is an assumption, we go to over 13% life science as a contribution to the company's revenues. So that's 1 growth driver. The second growth driver is occupancy improvements. We're currently at about 89% plus or minus percent. We're below what we think has stabilized for the company. We are seeing solid leasing performance, and we think we can have occupancy improvements in the years ahead. And also, we're entering into a much more interesting opportunistic investment cycle, and we have capital available to make investments as should they rise. So that's the growth profile. The second thing that I would mention is I think that there are some fundamental misunderstandings about what our business is and how it operates that many shareholders have, and I'd like to use this opportunity to clear it up. So the first thing I would say is the slowdown that we're seeing in our business is related to higher interest rates and recession much more than it is from work from home. And so what are the implications to shareholders of that? Well, a slowdown due to higher interest rates and recession is a cyclical phenomenon, cyclical meaning that it will recover, whereas work from home sounds like more of a secular trend. And again, as I mentioned, if you look back at history, at the end of the first quarter last year, when more people were working at home than they are now, our stock price was $140 a share and it started dropping the minute interest rates went up. So I think that's a demonstration or proof of that concept. The second thing is when we talk about our business, we talk about not office but premier workplaces. And we think the distinction is critically important. CBRE kind of metric advisers has done a lot of work for its constituents about quality in the office business. And in the 5 CBDs where we operate, they identified the premier workplaces. And by the way, that represents less than 10% of the buildings at about 17% of the space. And if you look at these premier workplaces, the vacancy rate is sub 10%, where it's about -- where it is about 16% for everything else. And if you look at net absorption over the last 2 years, it's a positive 7 million square feet for only 10% of the buildings and everything else is negative 25 million square feet. And by the way, CBRE rates 95% or 94% of BXP's assets in that premier workplace, if you include 2 assets that we're converting. So that's the second thing. This understandings about how our business operates. And then third, that leads to my third point, which is there is an unprecedented entry point for shareholders and BXP shares at the current time. If you look back at our history, our dividend yield is now either at or pushing 6%. That is a fairly unprecedented territory. Our look through cap rate right now is -- depends on the provider, but we think it's around 8% to 8.25% on a look-through basis. I talked earlier about some of the assets that we own. And our look-through price per pound is around $570 a foot, and I can tell you, we can't build any buildings where we do business for $570 a foot. So that's way below replacement cost. So those are the 3 reasons we think BXP stock is interesting at the current time.

That's very helpful. I appreciate that. Just maybe touching back on those premier workplaces you talked about on if this is commanding the lion's share of demand, but we're seeing news such as Salesforce, subleasing space at Salesforce Tower, 181 Fremont Facebook vacating that entire building of San Francisco is probably one of the softer markets out there, but how should we then marry this idea of the CBD premier workplaces gets the lion's share of demand mix with the fact that maybe particularly in the tech sector, maybe related to San Francisco, you're just seeing kind of elevated sublease and vacancy rates there.

Yes, Michael, I think you're making my point, which is let's take Salesforce Tower. We get calls every month from potential clients wanting to be in the Salesforce Tower and up until about a month ago, that was not available because it was 100.0% leased. Salesforce has put some space on the market. And guess what, they're having a lot of success because people want to be in the tower. We had a -- Doug talked about this on our last earnings call. There was a law firm that was in the market in the second half of last year, Doug it was 50,000 feet -- 50,000 square feet. They looked all over the market, which, by the way, the research would tell you is 30% available -- 30% of the space available. They looked all over the market. They found 2 locations that were acceptable to them and one of which was at Embarcadero Center, and we were able to do a transaction with them. So again, it's just -- if you think about BXP and you think about the markets 30% vacant, you don't understand the business that we're in.

That's a fair point. We had a great question come in from our live QA feed here, so thank you for submitted that. If the implied cap rate is call it currently in the low to mid-8s where do you see private market transaction cap rates? I know there's been kind of less activity out there, but kind of any sense on where cap rates might have moved?

Yes. It's a great question. There has been de minimis transaction activity in certainly for premier workplaces, but for office in general, since interest rates have started to go up. There were a few deals that were done in the middle of last year that I would say were a little bit left over from prior marketing processes. But since then, there's been very little activity. We have a situation today where interest rates are rising rapidly. Buyers don't know exactly what their debt financing cost of capital is and therefore, they are reluctant to purchase. And you have owners that have valuations or appraisals that were created at the beginning of last year, and they're not prepared to take at least yet any significant discounts. So Michael, I wish I could tell you the answer. I don't think it's 8.2%. I think it's lower than that. But I can't answer your question with any more precision because we don't have any trade to look at.

Appreciate that. Maybe we can just talk about leasing for a sec. Are there anything tenants might be out there in the market for it now that they're asking for, they might not have been 6 to 12 months ago? Are you starting to see real estate decision makers come up a sideline? Or is it still for lot of those bigger corporations, maybe a wait-and-see mode?

So Michael, this is Doug. I would say that what we have been describing for the last couple of quarters is pretty consistent today, which is that the vast majority of the demand is coming from what we consider to be "traditional" utilization of office space by professional service firm and financial services firms. Those organizations, while they are going through a downturn in their businesses on a relative basis, continue to have a constructive view of how they're going to use their space, how much space they're going to use and where they want to be. That's the vast majority of the transactional activity which, by the way, is why we're seeing much more activity in Boston, New York City and Washington, D.C. than we are in San Francisco, Seattle and West L.A., which is predominantly a market that is occupied by technology or media companies. Those companies are obviously going through a change in their business models and they are the companies that have announced significant reductions in their personnel. They've also talked about reducing or stopping construction of buildings that were planned. Those companies are not in a position at this moment where they're going to ultimately be adding to their portfolio of office space. So we're seeing a pretty consistent picture relative to what we've been seeing in the last couple of quarters.

We got a question right here.

When tenants are planning out their space today, what are you seeing in terms of density of employees in that space now relative to sort of 3 to 5 years ago?

So I would say, Scott, that the density is modestly improved on a relative basis, meaning there is more "space" around the edges, the cubicles or the workstations are becoming larger. There are more areas for "huddle" rooms or meeting rooms. The private offices, interestingly have gotten smaller and they've become more, I would say, modulated, meaning everyone is sort of getting the same kind of a unit, which is reducing the amount of space devoted to those types of spaces. But net-net organizations are picking up more space per employee. The real question that we won't now have an answer to is, what, if any, hot desking will impact the utilization of space. I think there are many kinds of organizations that have different types of user groups. People who are bankers or who are in trading or in sales may have a different kind of a space utilization than people who are in accounting or an IT or an HR in an organization, and that will impact how much "sharing of workspaces" goes on relative to having a dedicated space that's "yours". And obviously, if the organizations are asking their people on a more frequent basis to be in person, meaning it's not 1 or 2 days a week, it's 3 or 4 days a week, that's going to change the calculus as well.

Yes. One thing I would add to Doug's answer, his breakdown of between what I'd call front office versus support areas is 1 of the reasons for this increasing dynamic and difference between premier workplaces and everything else because our clients want to have premier workplaces for their client-facing and product-facing employees that work together and they're prepared to pay a premium for that because they want to encourage everyone to be in the office. And then likewise, for lesser quality space that's usually cheaper, that historically is where more support staff has been housed and those workers are less in the office because of the remote capability. And I think that's also creating more of a demand issue for the non-premier workplace assets. So that's adding to this disparity that I talked about in my opening remarks.

Owen, to touch on this idea of quality product, community demand versus the obsolete share that could be repurposed for other use. I think you recently highlighted at a competitor conference that call it about 25% of the office stock out there remains competitive, bottom 20% probably should be converted to some other use. And the remaining 60% remains to be seen. If we're sitting here maybe a year or 2 from now, I'm just curious on your thoughts how that kind of middle 60% is going to trend or anything you have there?

Yes. So the answer is you don't really know. I think that, look, there are lots of offices that probably need to be or should be something else. They are located in dense areas. The land is clearly valuable and the improvements have some value. To convert to residential is not easy, right? I think this is a big trend that's going to unfold slowly, because you need the building to be empty, the bay depths can only be of a certain size, and there's also financial implications because the entry point to convert an office to residential actually has to be pretty low relative to where I think a lot of asset values are today. But to come back to your question, I think of that middle 60%, I think it could go in several directions. It could be the conversions that I just talked about to something else. I think they're going to be -- and we've done this in a couple of cases, Safeco Plaza in Seattle, 360 Park Avenue South in New York. I'm not sure I would have said either one of those buildings was a premier workplace until we got a hold of it, and [ obviously ] was prepared to put significant capital and redevelop the asset into a premier workplace. So I think you'll see some of that activity, particularly as leasing demand increases. And then the third area is, look, we try to serve leading companies with the most talented workforces in our buildings. And those clients are always price sensitive, but they're a little less price sensitive given what they're trying to accomplish. But there's another market which are office users that are more value conscious that actually don't want to pay the premier rents in our cities. And I think that middle cohort of office, that's 60% will serve that market as well.

Maybe just touching back on markets for a second. I know we talked about San Francisco for a little bit. I think, Doug, with your commentary, it seems like the East Coast markets have held up relatively better to the West Coast. I guess, why does the bicoastal platform that BXP provide makes sense? And should opportunities arise could you look to lighten up in markets like San Francisco, I know the exposure in L.A. and Seattle is pretty minimal, and those are recent expansion markets, but maybe San Francisco specifically and reallocate that capital elsewhere?

So I'll make a couple of comments. I'm sure Doug will have some input on this. We have focused our company's footprint on the largest office markets that are talent-rich and where high talent workforce wants to move and live. So that's number one. Number two, the market is large, and there are usually several submarkets where we can also do business. So think about Boston next to Cambridge, next to Waltham, D.C. next to Reston and things like that. So that's been very important. And then the cities where we operate where there are more barriers to entry, because of entitlement, because of cost, because of complexity. And so the development pipelines tend to be less. And that's why we focused on the perimeter that we have. So we're committed to our perimeter. And then the answer to your question about asset allocation is all deal driven. So if -- because we set a strategy about perimeter, but we make individual investment decisions opportunistically particularly on the new investment side based on the opportunities that we see and that our regional executives generate. Perhaps we're a little bit more prescriptive on the disposition side. For example, over the last several years, we have been pretty active disposing of assets in the Washington D.C. CBD, which we found to be a somewhat challenging market even before the COVID pandemic. So again, we don't start the year and say, "Oh, this year, we're going to take our San Francisco exposure from 18% to 15% ready break. Let's go figure out how to do that." It's more, okay, what's out there in the market, where do we think the best opportunities are, what assets do we have that we feel are nonstrategic that we can sell. And then we obviously we're always monitoring how those allocations look.

I'm going to cut your question a little differently, Michael. So we have been trying to hone in and increase the value that we have put into the best buildings in our markets on a consistent basis year after year after year. And even though we'll just use San Francisco because you used it as sort of the, I'd say, the one of the weaker markets in the country relative to demand, even in a market like San Francisco and even in a building like Salesforce Tower, that you also brought up as potentially having some sublet space. We have -- and I mean, last week, got an offer on a renewal on a piece of a over $100 triple net at the 200 Clarendon Street building, which is the former John Hancock Tower, we are doing transactions in 2023 at over $85 triple net. At 880 Boylston Street, we have a tenant that needs space and then we can't accommodate their growth in that building, and they're looking at our other buildings at the Prudential or other spaces in the Prudential Center. At the General Motors Building, we have space in the 46th and the 43rd floor. We're looking for rents well in excess of $150 a square foot in those buildings. Even in these soft markets, the premier workplaces continue to be an attractive place for companies to do business, and that's why we are where we are. And so even though you can sort of say, well, maybe you should be in Nashville, Hey, maybe you should be in Austin, Hey, maybe you should be in Atlanta. I would tell you that the demand picture in those markets is no different on a relative basis than they are in the other markets on the East and West Coast. The technology companies that are located there are doing the exact same thing to putting projects on hold, they're reducing their workforces and there is as much "available supply" in those markets as they are in many markets in this country. So I think the graph is not necessarily greener in other locations.

Maybe just 2 other market-specific questions. Obviously, you saw the news about Amazon pausing their developments in Northern Virginia. Would you maybe necessarily see this as an incremental negative to your portfolio? I know you've highlighted Reston as a potential opportunity there and then just on Dock 72 in Brooklyn, it seems like there's been some weakness there relative to your Manhattan portfolio. But any comments around those would be helpful.

I think that Amazon's decisions at Washington Harbour, our landing are not impacting our views on what's "happening in the DC market." The tenants that are looking in the district themselves wouldn't be looking there. The tenants that are looking in Northern Virginia wouldn't be looking there. So on a relative basis, I think it's a [ nonplus ]. Dock 72 has been a challenging investment for us for a long time. We did a mark-to-market write-down of that building last quarter as we looked at the likelihood of us doing additional significant leasing in the short term, hadn't we to do it all over again, we probably wouldn't have made that investment today.

Okay. We've seen using a handful of high-profile announcements of owners pay back keys to lenders. So maybe if you can touch on the broader office financing market and how you see that playing out over the next few years?

So you said something that I think is not necessarily correct. They haven't hand the keys back to the lenders yet. What you have started to see is a realization that buildings that were financed at SOFR or LIBOR 25 basis points with a 500-basis-point increase with a $200 to $300 -- 300 basis points spread can't support the debt service at the current loan levels at those types of interest rates. In addition, the softness in the markets on the demand side have created a situation where it's unclear how long it's going to take for these buildings to increase their occupancy. And therefore, the landlords are saying, we're not sure it's the right thing for us to be putting additional capital into these assets that it's subordinated to the existing capital structure. We need to have a conversation. I think that is the stage that we are in right now with many of these, what I would consider to be very high-quality asset managers on landlords "who are putting their buildings into a position where they're in a workout kind of a discussion." How that ultimately resolves itself is something that we don't know the answer to, as Owen suggested, there are no private market sales that say, well, if we put this building on the market, we will achieve blank dollars for it. It's not obvious how long it's going to be until we start to see a reduction in the interest rate of floating rate debt. And therefore, we're going to see a more normalized position in terms of what the interest expenses are. We're not sure what the right LTV on these capital structures are. So there are a lot of questions you're going to have to get answered before this stuff resolved itself, but I wouldn't suggest that "landlords are giving the keys back to the -- to their lenders at this point."

We had a question come in from live QA. I must appreciate who ever submitted it. Just on, Owen, when you talked about the share price for office, it seems that if you look back to historical examples of malls in the mid-2010s, maybe the public markets are saying that office is what malls were back then? Do you think the market has it right? Or do you think that they could potentially be wrong and why that may or may not be the case?

Yes. No, I think that the current stock price movement for our company and perhaps the sector is related to the business cycle. If you go back to the GFC, if you go back to recessions before that, post the IPO in 1997, BXP and office companies, a lot of real estate companies trade down in those environments. And I think that's what's driving stock price behavior, which kind of goes back to that fundamental misunderstanding that I'm talking about, which is I think this is a cyclical phenomenon, not a secular one.

We got a question right here.

Anyway, Doug and Owen, other countries in the world seem to be having a more dramatic return to the office than the U.S. You have access to all sorts of corporate clients that are S&P 500 related with international operations. Do you have a sense as to why that is? I mean is it cultural? Is it -- what do you think?

It's -- I think it's completely related to a 3.5% unemployment rate. Workers in the United States have more power generally than in Europe, where the unemployment rate is a lot higher and one of the demands that they're making on their employers is we want to work remotely. And so there are certain sectors, particularly in the technology area, where there's a lot of concern by the employer that if they're too prescriptive about in-person work, they may have a retention issue. But I will say that is a little bit from our standpoint of silver lining of this increasingly recessionary environment that we're in because if you -- as things slow down, right? What are companies doing? They're laying off employees and they're being a lot more prescriptive about in-person work. And so it started in the financial sector, but you're now seeing it in the technology sector. I think all the major tech companies now have announced 2 days, 3 days back in the office, some now, some May 1. But I think that's fundamentally the difference is the unemployment rate.

Maybe we can just touch on life science a bit, in your prepared remarks, you talked about that being a growing portion of your platform, but it seems like demand might be sort of softer there, Doug. I think you highlighted on the recent call, the softness that you might be experiencing. Just curious to get your expanded thoughts there? And do you still anticipate is that longer-term exposure kind of doubling or more what it is in the current portfolio and why it makes sense?

Yes. Well, I think you're correct. We're seeing venture capital investment in life science declined somewhat, and we're still seeing demand in life science, but the -- particularly the smaller users are wanting us to provide more of their financing. So in other words, when you do a life science lease, there's a much bigger tenant improvement package given all the lab equipment and installation. And prior to this downturn, more of that load was borne by the client. And in this market, they're asking the landlords to bear more of it. That all being said, over the long term, I think this is going to be a growth opportunity for the overall market and certainly 1 for us. That growth from 5% to 13% that I mentioned, that's already baked in. That just assumes that we deliver 290 Binney Street and 300 Binney Street on time and on budget. Those buildings are already fully leased -- so that's already going to happen. Now on top of that, we have another 3 million square feet of sites and buildings that we think are good conversion candidates. And I think as we come out of this recessionary environment, that's going to be a good, that's going to be an excellent growth driver for BXP.

Yes. Just on the conversion opportunities, I know you've got the ones out in Waltham on Winter Street, you've targeted the Carnegie Center ones in Princeton. Do you have a sense of how many opportunities there are within your portfolio for these kind of office to lab conversions?

Yes. Well, we've quantified in our IR materials around 3 million square feet of opportunities for life science. There's a big chunk of that are sites. So maybe half of that, plus or minus, are probably ground-up development sites that we have at Kendall Center and at Gateway in South San Francisco and the balance are office-to-lab conversions. And by the way, we do those 1 at a time. So -- we've always taken 1 project in South San Francisco, 1 project in Waltham. We build it, we lease it and then we move on to the next one. As we just described, we're having a little bit of a slowdown now. So for example, we finished our first Gateway project. Now we're on 651 Gateway. We won't start another project speculatively until 651 gets more substantially leased.

We're asking an ESG-related question in every one of these sessions. I'm going to marry this with a question that came in from live QA. Can you highlight important ESG initiatives that BXP is undertaking? And then how do you affect -- how do you marry into the stuff like Local Law 97 in New York and the environmental impacts that, that might have on CapEx and kind of getting your portfolio making sure you're compliant with issues like that?

So let me just start, and I want to change the question from ESG to sustainability. This is a little bit of a point I'd just like to make. I think when you -- ESG is sustainability, social impact issues in governance, right? We're -- I think you're asking about the sustainability, the environmental part, so that's what I'm going to focus on. The most important thing we're doing in sustainability as we've signed up for a science-based target of 1.5-degree C climate change, which means we are going to be net 0 as a company by 2025. We're already 70% of the way there off a 2008 base year and half of those gains we generated by simply making our buildings more efficient and the other half we got by purchasing green power, and we will be doing more of that between now and 2025. I think -- and why are we doing this? You mentioned one of the reasons which is our communities care and they care so much that they're starting to regulate us and levy fines for excessive carbon generation by commercial buildings. These laws currently exist in New York and Boston. And I wouldn't be at all surprised if they don't proliferate to other cities. The other thing that's super important to us is our clients are a lot more focused on this, and we are increasingly seeing clients coming to us with their fulfillment requirements, wanting them to be on a net 0 basis.

I appreciate the preview for your lunch panel discussion. Maybe just lastly on the residential portion of the portfolio. I mean I know you recently sold The Avant in Northern Virginia, just given maybe the more favorable tailwinds that residential real estate is facing relative to office. Where do you see this portion of the portfolio growing? And any additional comments around that?

Yes. So we have successfully developed around 2,200 or 2,300 units since BXP got into the residential development business 10 years ago. We then sold a couple of those projects, including The Avant and we have in our IR materials, the value that we created and the IRRs for those. So we're confident that we can be successful as a developer. We currently have 1,700 units in our portfolio. And then we also have sites that we control for new development. That's probably another 2,000 to 2,500 square feet. I think you'll see us do this more actively. Some of it will be associated with BXP premier workplace assets, some of it won't. We'll probably increasingly do this with financial partners. So for example, we're doing -- we're building a very significant 500-plus unit residential tower in Reston right now where we have an 80% private equity partner in that deal. And I also think this part of the portfolio, I talked a little bit about how life science is growing as a percentage. In residential, that may not happen because we are probably going to be more opportunistic with this portfolio and probably more of a merchant builder. So you may see us sell these assets when they are mature. The space is we're successful as a developer and a builder, but it's less strategic for us because we don't lease and manage the assets. We have a very capable third party doing that. So it's a little bit less of a strategic activity. So we -- I think increasingly, you'll find us successfully build the building, earn the profits, earn the carried interest, sell the assets redeploy the capital into something new.

Real quick, 3 rapid fire to end, best real estate decision today, buy, sell, develop, redevelop or pause?

I'm sorry, could you repeat that?

Sorry, buy, sell, develop, redevelop, pause?

Pause.

same-store growth for 2024?

It's basically, I think we've said it's a couple of basis points below 0.

More, fewer of the same number of office REITs year from now?

Fewer. I say that every year.

Great. That's...

[ I'm -- it's half the time. ]