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

Okay. It's 3:00 right at the top of the hour, so we're going to go ahead and get started. I'm Steve Sakwa. I head up the real estate research effort at Evercore ISI, and I'm very happy to host the panel this afternoon with Boston Properties. Let me just quickly introduce the management team here, and then I'm going to turn it over to Owen Thomas, who is sitting to my left is the CEO. Next is Mike LaBelle, Chief Financial Officer; Doug Linde, President; and then Hilary Spann, who's EVP and Head of New York. So with that, I'll turn it over to Owen to make some opening comments. I'll ask a few questions, and then I'll certainly leave time for the audience to ask some questions.

Great. Steve, thank you very much for hosting us, and thank all of you for being here. As a premier workplace company, we're delighted to have a full house of interested investors. So I appreciate you being here. So BXP, for those who don't know, we're the largest public company in the country that focuses on premier workplaces. We have -- we own and manage and have in service around 54 million square feet of office, life science and residential properties. We -- even though we're large, we're very focused on the largest and most talent-rich cities in our country, those being Boston, New York, Washington, D.C., San Francisco, Seattle and Los Angeles. Historically, and I believe in the future, most of our external growth comes through development. So if you look at our portfolio, we haven't done large M&A deals. Every building -- virtually every building has been bought individually or built by us. And likewise, our disposition decisions are made the same way. Lastly, I would just close with, I think the sentiment in our industry is a lot worse than our experience as an operator. We are leasing what we've been telling the market we're going to lease. We've been leasing about 0.5 million to 1 million square feet a quarter. We expect to experience that result this quarter as well. Our occupancy is flat, maybe even up a little bit this year. We're not really sure yet, but it's certainly not going down. Our dividend has been stable. Our ratings have been stable. We haven't defaulted on debts and things like we're -- and we also have a tremendous amount of liquidity at $3.2 billion. So with that, Steve, I'll turn it back to you.

Great. Let me start on the leasing front, and I'll throw a question maybe to Doug and to Hilary. They can maybe tag team this. But maybe can you just talk about the leasing dynamics and what you're seeing maybe on the East Coast markets, and in particular, New York and Washington and Boston and maybe juxtapose that against kind of what you're seeing in L.A., San Francisco and Seattle?

Sure. So Doug Linde, President of BXP, We call ourselves BXP, by the way, Steve, not Boston Properties. So the dynamic is that we are witnessing what Owen has referred to as the tech rec, meaning there are very few, if any, technology companies that are adding employees and therefore, adding to their platform of real estate. But what we are seeing is a pretty consistent traditional user in the markets on the East Coast and, to some degree, in San Francisco, which we define as professional services, legal, financial services, asset management, be it long, short, hedge fund, VC, private equity. Those companies are continuing to do what they would normally do in a relatively modest economic growth time, which is think about how they're utilizing their space, look for opportunities to get into the better space when they think the markets are slightly weaker, make commitments for long term, meaning leases of 10 to 15 to 20 years and to upgrade their premises to what we deem to be premier workplaces, which are in our sweet spot, which are the kind of assets that we have in all of our markets, but particularly in the east side of Manhattan, in the sort of Fifth Avenue, Park Avenue, Madison Avenue district, in the Back Bay of Boston and in the CBD of the sort of north financial market in San Francisco and then in the Greater West End of Washington, D.C. And we are continuing to see pretty active volume from that segment of the market. What we're not seeing is any technology expansion or much in the way of technology interest in talking to or discussing ideas for how they might utilize their space differently. They are really in a -- what I would refer to as an internal cost-cutting, rethinking of their workplace strategy mode. And we don't expect that to change anytime in the short term. But I'll let Hilary talk a little bit more about the specifics of Manhattan.

Sure. Thanks. So I would say in New York, our primary focus is the Plaza District of Manhattan, which is Park Avenue and the area surrounding it. There's actually a relative scarcity of available space in the Plaza District and the premier workplace environment. And so we're starting to see that market tighten up. And landlords are beginning to see some pricing power. If you are a prospective client that needs 100,000 square feet on Park Avenue, it is very challenging to find it at any price point. And so we think that being north of 42nd Street for the majority of our portfolio, again, focused on wealth management, financial services, professional services, et cetera, has stood us in really good stead because the bulk of our portfolio is actually in that submarket.

And maybe just as a follow-up because you're right, your -- most of your stuff is up 53rd and North, but you do have 360 Park Avenue South, which I believe was geared more towards tech firms at the time of the purchase. So can you just maybe speak to what demand you might be seeing down in that part of New York City?

Sure. Happy to. You're absolutely right. Midtown South has historically been very attractive to tech and media tenants because the nature of the buildings is sort of more creative. And I would say that as interest rates started to rise, the demand from prospective tech tenants slowed dramatically. We are seeing, interestingly, in the last, call it, 6 to 8 weeks, an uptick in demand from clients that are more diversified. So financial services, professional services, law, et cetera. And I think part of that is that the tightness in the Plaza District is leading some of these tenants to consider coming to Midtown South to go to a premier workplace because their other option is staying in Midtown in an asset that is not premier. And so versus seeing a majority of tech tenants looking at the space, we're now seeing a slightly more diversified group of tenants looking at the space. And the range of sizes is anything from sort of 25,000 feet up to 250,000 feet.

And maybe just last point on New York. We've seen a real flight to quality. And I think rents really haven't been an issue in the kind of brand new builds, tenants have been willing to pay $150, $200, even $250 a foot. Maybe just talk about what you're seeing on the pricing front in New York and how the sort of true A buildings premier space may be comparing to some of the more commodity space in the marketplace.

So I think there are fundamentally 2 different markets. The premier workplace segment of the market is about 10% of the market, and there is, as I said before, pricing power in that segment of the market. The vacancy rate in the premier workplace segment of the market in Manhattan declined about 7 percentage points since 2019. The reverse is true in the rest of the market. And so you're absolutely right. Folks are willing to pay $150 to $250 a square foot to access new construction because the cost of new construction is $2,000 a square foot. And in order to justify launching a new development, you have to achieve rents that get you a return on cost commensurate with the risk associated with development. So if a client wants to be in a brand-new building, that is the cost of doing business today. And I would contrast that to premier workplaces that are not brand new, being more in the $100 to $125, $150 square foot range.

Okay. Maybe transition a little bit. One area that you pivoted into several years ago was to grow your life science portfolio, which, for many years, was a great thing to be in. That market has certainly seen a lot of supply in certainly Boston and South San Francisco, in particular, maybe a little less so in San Diego and Seattle. But maybe speak to just kind of what you're seeing on the life science front and how maybe you're altering or changing or adapting your strategy given that new supply?

So Steve, I think it's important to acknowledge that we didn't become a life science company. What we saw was an opportunity to serve clients in existing owned assets that we had in 2 specific parts of the country, the Greater Boston market, which is really for us, Cambridge and Waltham, Lexington; and then secondarily in South San Francisco, which were as -- the premier established life science markets. And so what we have gone about doing is trying to position incremental properties that we have in those particular locations either for build-to-suits or for, in some cases, some speculative development. It is absolutely true that there is now -- we're in a period of time where the demand has certainly changed relative to where it was in '19, [indiscernible] 2021, where there was unlimited availability of capital to fund new scientific discovery and ideas, and companies who were probably going public earlier than they might have realized they should have, and VCs were creating valuations that were probably ahead of where they should have been. In the face of all that, many owners of real estate said, aha, we can now find a new source of demand which is life science, and we'll convert or will build a new life science building. Surprise, surprise. The real estate community did what it always does, it overbuilds. And so we're now sitting in a situation where there is actively under construction in-service buildings with significant amount of availability in these best markets in the country. These will always be the best markets, and it will take reasonable amount of time for that supply to be absorbed because the demand has really started to look very different than it did during those periods of time. We have had the luck or opportunity, depending upon your perspective, to do 2 new transactions in 2022 and 2023, which were a build-to-suit for AstraZeneca in Cambridge, Massachusetts on a 15-year lease on a brand-new purpose-built building that we'll deliver in '26; and a lease with an organization called the Broad Institute, which was actually a purpose-built lab building that we had leased to Biogen. We took the building back and are now converting it by putting in the mechanical equipment, not shafts, not floor loads, not the spatial distance between the floors, not the loading dock, but simply the mechanical systems to lease it to them for 15 years, fully leased. So these are sort of what I refer to as build-to-suits. And that's the sort of the focus will likely be in the short term for BXP. We have 2 other developments underway in suburban Waltham. One of them is about 40% leased. It's a 300,000 square foot building, and the other is a 120,000 square foot smaller building actually with a GMP, a gross -- a general manufacturing facility associated with it that we hope will be very attractive to a life science company that is doing some kind of an early-stage R&D development for production. But it's going to be a challenging market for a period of time, and the majority of the leasing activity is very small tenants that are looking for what we refer to as turnkey, fully built space, which has a cost associated with it in the form of a much higher tenant improvement allowance.

Maybe just switching gears a little bit to just capital deployment overall and how you're thinking about it. Given where your stock price trades today, it's not something that I assume the company wants to issue equity to fund. But you do have a large development pipeline that's underway. So maybe you and/or Mike and Owen can sort of talk about how you think about the spend and the funding for the stuff that's underway, and then maybe thinking about if there are opportunities that surface, how would you likely go about funding it? And then talk about the dispositions maybe that you have underway?

Sure. Thanks, Steve. So I mean, as Doug said, we increased our development pipeline at the beginning of this year because we have the opportunity to do these 2 large life science developments that were fully leased, which have a total investment of about $1.5 billion over the next 3 years or so. So the first thing we did before we even executed on that is we did a bond deal in November of last year and raised $750 million so that we would have more than sufficient liquidity to be able to deal with that. And since then, we've continued to kind of increase the liquidity that the company has both in the bond market where we issued again another $750 million more recently in the bank market. We funded a term loan, which we extended and expanded with a group of 15 banks, all of which re-upped with us, and we brought new banks into that facility. And we've had some mortgage loans where we've done some new mortgage refinancings, and we've done some extensions. So we've done a lot of capital raising. And right now, we have about $3 billion of liquidity, which includes cash from this financing that we've done as well as our $1.5 billion line of credit that's fully available to us. So we have all the capital that we need to fund our development pipeline that we have as well as fund our near-term debt maturity. So we're really in great shape from that perspective. I think that we will continue to look at ways to increase capacity. So we're considering things like bringing in private equity into a portion of our development pipeline to help us fund that and bringing that in a profitable manner to us. And that will increase our flexibility going forward and give us the more financial flexibility if opportunities arise for us to make new investments. And we're looking at some moderate asset sales as well in our portfolio. Nothing on the market right now, but we're considering whether we would execute on some asset sales to raise $300 million, $400 million or $500 million, something like that, which is kind of in line with the type of financing that we do every year. I mean we've sold assets kind of in that amount every year for probably the last 5 or 6 years, which is a way to fund our development pipeline. So all of those things are things that we're looking at, and all of those markets are available to us today.

Maybe just speak to the depth of the transaction market because the folks here, and we all get CNBC news stories, Bloomberg stories, Wall Street Journal Article stories just about the challenging transaction market and certainly the problems in office. But maybe just talk about what you're seeing from a buyer perspective. You guys sold an office building in Washington several months ago and then got good pricing. But what are you seeing in the transaction market today? And how deep is the buyer pool?

We did sell an office building in Washington. We got a great price for it, but that was in July of 2022. So it was a little while ago. So let's break it into pieces. So on office, I think it's difficult. There are non-premier workplace office assets, smaller, maybe suburban or less big city locations, maybe those are in the 7-plus percent cap rate range, but there haven't been any asset sales of note that are of assets, I would say, that are comparable to what BXP owns, those being premier workplaces in urban centers. So I think kind of maybe 7% sets a little bit of a floor, but I don't think that's where the pricing is. I think it's better than that, but we don't have any evidence of it. There has been some life science development recap activity that was done in the kind of mid-5s cap rate. So that's a little bit of pricing discovery. Multifamily, I do think is -- and we do have some multifamily assets that we could potentially sell. Again, we're going to figure out what that is. It's definitely a higher cap rate than what it was before interest rates went up, but it's definitely better than what it would be for a premier workplace. So again, as Mike described, we have a tremendous amount of liquidity now. We don't have to raise capital, but we are exploring these different avenues, the multifamily sales, the potential JVs on lease developments to explore what the capital markets, how it would price that capital and whether it would be interesting to us.

So Steve, just -- I want to make one comment about the articles and the thought process behind the thinking as we look at and read these things in the -- and sort of the challenge that we have as operators. So the -- I think the latest and greatest was this morning was an article about someone being picked by the Wells Fargo building in San Francisco. But I'm going to sort of go back to 1 deal, which was supposedly the closing of the Union Bank of California building for $225 or $250 a square foot. And the commentary was building sales for 25% or 1/3 of what it might have sold at in a previous cycle. And I would just sort of pause there and say, well, it's a vacant office building. Tenant improvement costs in San Francisco for a 15 -- 10- to 15-year lease are $200 a square foot. The brokerage commission for the inside and the outside broker probably totals $50 a square foot. Something has to get done to the building to sort of make it a building that people would want to lease. Let's use $100 a square foot of capital to go into the building. And then there's going to be the time necessary for the work to be done, the tenant to be procured, the tenant to start a lease, the lease to start, the stabilization to occur. I'm guessing it's 2 years, 3 years, 5 years in that marketplace today for that particular kind of a building. And there's no debt capital to finance a vacant office building in San Francisco today. So you ever -- you need an equity return on that. And so you turn the clock on that equity, which probably is at least double digits to give somebody the kind of return they need to take that kind of risk. And lo and behold, when you get to the end of the day, you're -- you've got a basis that's probably $800 a square foot or more. And I don't know what the net rents of the building were in 2017, '18, '19, but my guess is they were in the $40 to $50 a square foot range. So the number at $250 a square foot is actually not that surprising. And it's really not a fair comparison to say the building just traded at 25% of value because you need to do things to get the value. And if the building were 100% leased to a bank for 15 years with a 2.5% or 3% escalator, our expectation is it would sell at a going in return of somewhere in the 6s or 7s depending upon what kind of financing you could get, and that would generate a reasonably healthy return that would sort of describe to you where you would ultimately get to when you do all this work. So this is not a sort of, in our opinion, a negative story. It's just the reality of what you have to do in order to create value in today's commercial real estate market.

We've got maybe about 8 or 9 minutes. So I just -- I'm going to open it up to the audience and see if there's any questions.

Yes. I have a question. What would be the key attributes between a premier building versus a non-premier [indiscernible]?

Yes, it's a great question. So the question was, how do you define a premier building? Is it age? Other aspects? So at the beginning of 2022, we were seeing the availability rates in all of our cities go up, and we were experiencing prepandemic levels of leasing, and it didn't make any sense. So we went to CBRE Econometric. And we said, you all need to -- we would suggest that you rethink the way you do office research. And instead of breaking down the markets by sub-location within a city, you actually ought to do it by quality. And quality -- age is clearly an important factor, but it's not the only factor. And our suggestion to you is, you have a leading real estate leasing brokerage affiliate, and you should go to all the brokers and say, look, if you have an industry-leading tenant, a bank, a tech firm, hedge fund, asset manager, which buildings would you show them, and that defines premier. And so yes, newer buildings are usually premier, not all. The building that we get the highest rents in, in New York is the General Motors building that was built in the 1960s because of the views that it has and all the amenitization that we've put into it. So broadly defined, it's a building that premier tenants want to be in because of its age, its ability, it's access to transit, the amenities that it has and frankly, the sponsorship, including the great work that our property managers do in managing these buildings. So when they did that work on the 5 CBDs where we operate, the amount of space that was premier was about 17% out of about 750 million square feet. And in terms of number of buildings, it was about 10% of the buildings. And I think the total buildings in those cities was like 230 something like that. And then they are actually now chart the availability rate and the net absorption, face rents, all that data, premier, not premier. And we probably publicize it more than they do. So if you go into all our IR materials every quarter, we're providing all of that because as we think about market stats and how we manage our business, we're not looking at the broad office research. We're looking at this premier workplace research to understand what's the health of the market that we're actually competing in.

I'm a private investor, and I own [indiscernible] in New York and others. My question is on the non-prime buildings, one is the [indiscernible] come due and how does the new normal working hours affect [indiscernible] new offices. I'm concerned are they ever going to [indiscernible] the other factor, of course, which is not under your control is stock price and [indiscernible] operations are bad. What is you talk about the stock price, which you don't control [indiscernible]

Why don't I -- I'll address the stock price and maybe Hilary could talk about the buildings in New York. So look, our -- we -- I mentioned earlier that there are B buildings, suburban, small that are trading at 7 caps. The look-through cap rate for BXP right now is 8.5% to 9%. We own the GM Building, Salesforce Tower, Prudential Center, Reston Town Center, on and on and on. Those are not 8.5% to 9% cap rate assets. So it's -- in our view, it's clearly too low. Our dividend yield is 7.5%, and it's been stable. So again, there's lots of factors in it. As I said at the outset of my remarks, the sentiment in our space is much worse than the operating reality of what we're experiencing. So that is an issue for us because sentiment drives the capital markets. It impacts the stock price, and it impacts our cost of borrowing. And again, we think we will operate well through this. We have decreasing amounts of competition because people are getting out of the business. We have a lot of liquidity to take advantage of the opportunities that will present ourselves. We just have to be patient and execute through it, which we're well equipped to do. So let me turn it over to Hilary to talk a little bit about building quality in New York.

Sure. So the nonpremier workplaces in New York have seen an increase in vacancies since 2019 of about 7%, taking them to almost 20% vacant. I think the distinction is the individuals who are working in premier workplaces are generally revenue-producing members of their companies. They've been back in the office, and they've been driving their businesses execution. And so those buildings have benefited from the fact that those people want to be in the office and need to be in the office to drive their building success. I would say that the lesser quality buildings have tended to focus on employees that are perhaps back-office, services-type employees. Some of those employees have found that remote working works for them. And so that has affected the physical occupancy of those buildings in a disproportionate way coming out of the pandemic. The city is very alive to this issue because it has a meaningful effect on the tax base of the city. And so there are a couple of interesting initiatives underway. The governor tried very hard to pass legislation that would permit conversion to residential that did not make it through the legislature this session, but I know that she and the mayor of New York continue to work on the ability to convert less functional office buildings to residential. The New York City Economic Development Corporation just launched a program called M-CORE that will allow owners of older buildings to reinvest in those buildings using EDC capital to make those buildings more functional and attract clients explicitly for the purpose of supporting the tax base in New York. So while I would say there's definitely risk in that space, the city is also very aware of those risks and is working actively to help the owners and prospective buyers of those assets mitigate those risks as best they can right now. It's just going to take time.

The stock price, which you don't control, will -- do you think someday interest rates go down a bit, the stock price make it well. Who knows?

That's the plan.

I think there was a question up front.

Who are your financial role models? And why do you guys go to work on a daily basis? What you guys enjoy about your jobs? And why did you chose to [indiscernible]?

Well, I'll start. Okay. So the question was who are our financial role models and why do we go to work every day and what do we enjoy about our jobs. So I would just say for me, it's just the diversity of the things I get to be involved in. Real estate is got a financial piece. So I get to do all that. It's got an engineering piece because we build buildings. It's got a community piece because we're impacting how our environments. Look, we're impacting people. We go into our assets and see all the excitement that we create. So it's -- and then it's a people job because I lead people and work with clients and counterparties on deals. So for me, it's having all those experiences.

What is the status of your development on Madison Avenue where the MTA [indiscernible]

The question is, what is the status of our development on Madison Avenue where the MTA was. The development is called 343 Madison Avenue. The project is about a 900,000 square foot office building. It is designed to have the access to the east side entrance for the new Long Island Railroad terminal at Grand Central Station. The project is currently under design. We have demolished the existing building and are in the process of clearing some adjacent encroachments. And I think we believe that the design process will take us another several months to solidify. Along the way, we're looking at pre-leasing. And we've had some interest from clients who are looking for premier workplaces. And to the point that we've all made, can't find any space in the Plaza District. And so we're encouraged by the activities surrounding the building. I will say it is an expensive building to build. It's expensive to build in New York, period. And so we'll launch the building if we achieve a rent that gives us a return that we like.

All right. Well, listen, I'm sorry, we're out of time. We hit our 30-minute mark. I want to thank you all for coming for the questions. And I want to thank BXP.