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

[ Audio Gap ] A Premier workplace organization that operates premier assets in 6 geographic markets, Boston, Washington and New York City on the East Coast. San Francisco, West L.A. and Seattle on the West Coast. In total, we have about 50-plus million square feet of in-service assets, the majority, almost 80% are in CBD locations. We have an active development pipeline. So we are not only an owner and a manager, but we are a developer of premier assets. Some of those assets today are in the life science sector. The majority of that life science development is pre-leased to high-quality large pharma companies, but we also have some speculative office under development as well, including a building in Manhattan, referred to as 360 Park Avenue South, which I believe [indiscernible] is going to be touring on Thursday. So you're welcome to walk through that and see what's going on there. We are a company that has been in the public realm for 26 years. We went public in 1997. We are an investment-grade unsecured issuer -- high investment grade. We have a view that we have a perpetual ownership perspective when we own or develop a building, meaning we think about it on a long-term basis, and we constantly and continually improve and upgrade and reinvest in our assets, but we also sell. And so when we deem that an asset has not performed to the point where it can get actual performance out of it or we think that there is a better allocation of our capital to something else, we will sell and recycle. So while we have this perpetual mentality, we are also astute allocators and recyclers of capital, and Camille, I'll stop there.

Okay. Thank you for the introduction. And we'd like to make this an interactive session. So if you have questions, please feel free to raise your hand. But to kick it off, we did hear a lot on the topic about migration trends into suburbs, continuing to weigh on CBDs from the panelists this morning. And over the past year, we've seen improvements, particularly in certain markets. But any data you look at it, whether it be spending, office utilization and true traffic, it still remains well below pre-pandemic levels. So how would you characterize the state of the economy in your office markets today.

I'm going to stay away from the state of economy for a moment. I would tell you that the utilization of our space is ticking up on a very marginal small basis. Meaning, I think we've sort of gotten to a stabilization point unless there is a dramatic change in the perspective of certain kinds of clients of ours in terms of how they're utilizing their space. What do I mean by that? What I mean is that, in general, the vast majority of our clients' customers are utilizing their space quite productively at least 3 days of the week. So Tuesday, Wednesdays and Thursdays, it's a pretty vibrant occupancy utilization in our buildings, meaning we're seeing up to 70% of our seats being used in a place like San Francisco and up to 80% of our seats being used in a market like New York City on a weekly basis. But if you look at Friday, it's a pretty anemic picture, and if you look at Monday, there's a lot more variability. So we actually have some of our clients who actually have their high watermark on Mondays and others who are not utilizing their space much at all. So if there's going to be a change, it's going to be in the pattern of the utilization on a weekly basis, not in are we using or not using our space. And we are continuing to do significant amounts of leasing activity. And so we did about 650,000 square feet of leases in the first quarter. We did about 950,000 square feet of leases in the second quarter. I expect that we will be closer to the 900,000 square feet than the 600,000 square feet when we report to you at the end of the third quarter, which is sort of a continuation of that trend. And it's pretty consistent with what we expected to have occurring during the year. And I think the bifurcation of our demand is as follows. We are seeing consistent normal activity from the financial, professional services and asset management sectors of the economy. And we are seeing a pretty lethargic demand picture from what I would refer to as the technology and life science sectors of the economy where capital formation has been much more challenged, where job cuts and reductions and utilization of space stemming from the way those companies are operating is sort of part of the playbook right now. And so naturally, if you look at our portfolio, which on the East Coast, is geared more towards the professional services, legal, financial firms and on the West Coast, geared more towards technology. You're seeing a higher propensity of activity on the East Coast than the West Coast. And so I would tell you that the way people are thinking about their space has not changed significantly from 2019. Those organizations that are making leasing decisions are looking at their space as a critically important component of their business productivity and they're assigning spaces to individuals. So there's very little in our portfolio in the way of "hot desking or reservation desking or hoteling." People have an assigned place where they go when they come. It may be a cubicle, it may be an office, it may be a conference room, it may be a trading operation, but not terribly different than it was in 2019.

So would like to dive into your leasing pipeline more. But before we get there, I mean, New York City seems to be outperforming much more with regards to implementing the hybrid work policies. And your comments around utilization hitting this new stable level. So do you think we're close now to knowing what that new normal is or do we still have another 2, 3 years to work through this?

I'm not a user or one of my clients -- so I can't tell you how aggressive the organizations are being with their either commentary or actions relative to requiring the sort of rules that they've at least articulated to be enforced. And I mean we know that from the press clippings that we see and the conversations that we have, that there is not the kind of adoption of utilization that is being described on a sort of day-to-day basis, meaning a financial firm is saying, we demand everyone to be back 5 days a week. I know that people are not coming back 5 days a week. I mean we see it in the data, right? We can -- we are watching what is going on in our buildings. And so I would assume that if we are in a consistent economy with a consistent unemployment picture for the various sectors that you will continue to see a tick up, a tick up, a tick up, I don't if we're going to recover Fridays, the way we ever did. But I will tell you that if we don't, then I think we're going to be sort of where we are for quite some time. But if we actually start to utilize our space 5 days a week, the way we were doing it in 2019, then there will be another step function.

And given that the East Coast and West Coast are on polar ends of the recovery. What do you think needs to happen in, like a market like San Francisco for the competitiveness of the region to improve?

So that's -- I could answer that question for the next 25 minutes, but I'll just sort of try and simplify my response, which is there is a wide disparity with the technology organizations as to how they are thinking about requiring their workforces to be in-person working together. So you have -- I'll give you sort of the 3 spectrums. So spectrum #1 is a core organization like Amazon, who's explicitly said, everyone must be in the office a minimum of 3 days a week, no exceptions. You have an organization like Google that has said, we want people back a minimum of 3 days a week. And while we are not requiring it per se, we are -- your performance evaluation will have as one of its important characteristics, how much time you're spending with your colleagues in person. And then you have an organization like Microsoft, which has not created any specific regimented approach and said, individual managers are asking their teams to work depending upon what they deem to be the most productive, and we don't have a "policy" towards how we are dealing with our workforces. And they're all seeing different utilizations. And so I think that one of the challenges on the West Coast, predominantly with the technology companies is that there's a wide variation, and there's really no consensus. And it will -- I think, ultimately, productivity and performance of the organizations will get the companies to a point where they should or shouldn't be utilizing their in-person environments on a more consistent basis depending upon how things are actually working.

And are there any other cities that are taking the right steps?

So it's -- these are not cities. These are really employers in these cities, right? I think every major city in the country acknowledges that they have a problem relative to the street plane and the number of people who are commuting in on their transportation networks and then working with and enjoying the sort of service economy in those cities, AKA, the hair dressers, the nail salons, restaurants, the tailors that -- you name it, right? And it is absolutely true that these organizations that are working on the Street platform are unable to thrive if they have a 65% utilization relative to the number of people that were working in those cities in 2019. And so you're seeing all kinds of programs by all of the mayors in these cities to encourage retailers to come back to encourage customers to come back. I mean, I've said this on more than one occasion, in San Francisco, we are not charging rent to a significant number of our street-level retailers, largely because they're not even able to sort of make ends meet from an operating expense perspective in terms of just their payroll and their cost of goods. And so for us to sort of throw a paint on it and ask for rent is a tough message to swallow, but we want those organizations to do well because we want them there to serve our clients who are in these office buildings, and so it's a challenging situation that on the margin is getting better week-to-week and month-to-month, but it's a slow progression.

Maybe a quick question regarding [indiscernible] diversion between the Premier [indiscernible] the rest of the market? Do you see the [indiscernible] growing due to the normalization of the market or are [indiscernible]?

Yes. So the question was how do we see the sort of the shifting between what we define as Premier Workplaces and sort of everything else. And what I would tell you is when you have a 25% to 35% availability, in a market, which is, I'd say, sort of the typical rate in the Sunbelt markets and in a market like San Francisco, you are clearly seeing a dramatic shift of absorption from the okay buildings to the really good buildings. And remember that in many cities, we were in very tight supply situations in 2017, '18, '19, and what happened during those periods of time is what I would refer to as marginal locations became acceptable because they were the only places that, that organizations could find the magnitude of space that they needed. And when things get much less tight, those locations become far less attractive. And so the longer the sort of supply continues to be extended in terms of there being significant availability, I think that more challenging those locations will have as an opportunity to attract new clients. And those clients are going to gravitate to the better locations and the better buildings. The other thing that almost always happens when you are in a sort of high supply, lower demand characteristic AKA sort of a real estate recession is that organizations upgrade and they can for their dollar, get a lot more bang for their buck in a higher value, higher-quality building. And then the third thing that is going on today, which I think is slightly different is that as we are dealing with what we were just discussing a few minutes ago regarding getting and convincing your talent to come back to work, earning their desire to come back to work as opposed to requiring their desire to come back to work is important. And 1 of the ways to do that is to upgrade the premises and the quality of the installation and the environment that you were providing them. And so being in a high-quality, well-managed Premier building gives you a leg up when you sort of say, I really think it's time for everyone to return to work on a consistent basis as opposed to being in a less desirable either location or environment that is just not very exciting or interesting to the employee base.

So can we shift back to the leasing pipeline and comments around that? It sounds like third quarter, you're building some momentum here. So has anything changed in the discussions you're having with tenants? What are you seeing right now?

So what I would tell you is when we had our second quarter call, which was a little late this year was on August 3, I was looking at our pipeline of what I would refer to as not transactions that were negotiation because that's I'd say, is sort of a great silo of surety in terms of what's going on, but sort of the next set of things that might percolate into transactions. And I was, I would say, cautious to slightly pessimistic as we were entering the summer. And as I returned and sort of was working with our teams, the second to last week of August through last Monday, and we were sort of preparing for this conference, I was actually surprised by the level of transactions that were actually coming to fruition and that we're getting done. I mean -- and I'll give you an example. We have a Fortune 500 company in the greater Boston suburb that is in a location that was considering making a move, and it's a 66,000 square foot requirement, and I was very skeptical that they were going to move out of their existing location because it's a good building. And lo and behold, we've signed a letter of intent with them, and we actually have to relocate a tenant. And so instead of having an exploration on space in the second quarter of 2024 for 66,000 square feet, I'm actually gaining 80,000 square feet of occupancy in that building. And that's sort of, from my perspective, a little bit of a surprise. Or as many of you know, we have had some WeWork exposure, and we had an installation in Greater Washington, D.C. And in one of our buildings, they defaulted on their lease in last quarter. And we are in a situation where we actually have a 70,000 square foot new tenant coming in and backfilling a portion of that space. And that's a transaction that I think -- I thought was highly unlikely at the beginning of the quarter. And as we entered the summer, I didn't think it was going to happen and lo and behold we signed a letter of intent, we're negotiating a lease. So what I -- my point in all this is that I am more constructive on the overall level of demand that we are seeing. And if I jump to the West Coast, we're working on a number of renewals in our locations in L.A. And we're working on a number of early renewals in our San Francisco region. These are 2024 to 2025 lease expirations where I thought the tenants were going to sort of pause for a longer period of time, but they've actually engaged. And as I speak with our leasing teams, our sales folks, and I asked them why they thought this was happening, and they basically sort of in each case say, well, if you think about what they are -- this organization is looking for, they want to be in view space. And interestingly, in a market with a 38% availability if you're looking for 50,000 square feet of space, which has a view of the Golden Gate Bridge or the Bay or the Bay Bridge, it's few and far between. And so a firm that is looking to maintain high quality of view space actually has very few options, and they are engaging earlier, and they're paying a rent that is in excess of what they would have been paying in 2019. Now to be fair, the transaction costs are higher. So the net effective rent hasn't really gone up very much. But there is -- but there are these micro markets where we are seeing some degree of both stability and pricing power from the landlord's perspective. So again, I'll jump to Midtown Manhattan. We are -- our most active building is the General Motors Building, 767 Fifth Avenue, by far. And in terms of -- we're gaining occupancy, and we have growing tenants. And so I mean, we've already signed 60,000 square feet of leases in the last couple of weeks, and we're negotiating another 50,000 square feet of leases in that building. And all of those transactions commenced during the second quarter or third quarter of 2023. So it's like a -- there's just sort of a continuation of this demand that again, it makes me more constructive on the overall leasing velocity across our entire portfolio.

That's really helpful context. And just because you mentioned WeWork and it's been the news a bit. Can you just talk a little bit about your exposure there? Like which markets there...

Sure. So we have about 1 million square feet of WeWork leases. We have 5 installations, Dock 72 in Brooklyn, where they have a 200,000 square feet, and then we have 3 installations in San Francisco and 1 in Seattle. And my prediction is that they will default on their leases on at least 2 or 3 of those, and we will potentially work out an interim solution on a few of them. But this is sort of a pattern -- this would be the fifth time we have tried to renegotiate terms with WeWork on certain leases. And look, it's a challenging market for those types of businesses. I think that the business model that was originated and described -- expressed by certain brokerage firms as being sort of the new thing and that was going to be a result in 30-plus percent of all space being leased in these types of installations, I think, is just it's not come to pass and the capital required to rebuild these things is significant. Everybody in that business wants to be in the management business like here, they want to change like the hotels change from owning hotels to managing hotels. I just don't think the capital is there to build new facilities. And I think the landlords unless they have an installation are not going to generally be excited about investing capital into a management agreement with a third-party operator given the variability of the income stream. So look, I just -- it's too bad. They were an interesting source of demand for a period of time, but it's a rapidly changing environment.

And Camille, our exposure is about 1.3% of our revenue and it's about 650,000 square feet.

And we continue to hear about how access -- gaining access to credit remains difficult. And if we think about the supply pipeline coming up over the next few years, that the imbalance between -- for the new construction seems to be slowing. And so when you think about the occupancy of the portfolio for your competitive product, do you think it's close to bottoming here?

Yes. So I would tell you that I think when we were all sitting around these types of tables in June at NAREIT, there was, I think, a pretty strong consensus that if we weren't at the bottom, we were certainly at the deceleration at the bottom relative to additional space being pushed into the market through lack of demand. And so now we're sort of dealing with all the space that's been pushed into the market through subleases or givebacks with lease expirations. And we're sort of waiting to see positive absorption. And in certain cases, we're seeing it in certain submarkets, we're not seeing it in general in any global perspective or in any general perspective from a large-scale market. But we are of the opinion that we will gain market share at the expense of lesser buildings in some of our competitors in our marketplaces. And so that we are in an acceleration position. It's going to be slow, however, right? We're going to add 10 or 15 or 30 basis points of occupancy over the next number of quarters. And so we'll slowly move from the high 88s to the 89s, and hopefully, by 2025 will be in the 90s. But it's going to be slow progress. I mean, and that's just if you think about the business that we have been in for the last decade, the technology-oriented demand coming from large tech companies has by far been the largest source of absorption. And until those organizations are again growing in a meaningful way. I just don't think you will see significant absorption from bulky occupancy users. You'll see a much more granular situation with small gains incrementally growing a little bit here and a little bit there. If you're -- the one thing I think that's really important to acknowledge, however, is that new supply is, I think, highly, highly unlikely for an extended period of time. Why? Number one, the cost of building a building is astronomically higher than it was 5 years ago. So the inflation we saw in the supply chain and the inflation in labor that we have seen has, in fact, occurred in the construction industry, and so we have seen a greater than 50% increases in hard costs for a new building. Second, capital availability is just very different today. The pricing and the access to it are different. So you have instead of being able to borrow a construction loan at LIBOR plus 200, which is, call it, 2.5% or 3%, you're buying -- if you could, which you can't get a construction loan, it would be SOFR plus 300, which would be at 8.5%. Second, the requirements from an equity perspective are very, very different. Nobody and I mean nobody is thinking about building a building for a stabilized cash on cost of 5.5% or 6%. That's just -- that is just not economical. And so you take those inputs and you throw them into what that means from a rental rate perspective and the gap between replacement cost rents and what the current rental market is, is pretty significant, meaning 50% to 100% in some cases. And so there was a long, long runway that is out there between the rents that are achievable in the market today and what's necessary for new construction, which I think will actually be additive to landlords who have high-quality product because we will be able see those increases because I don't believe tenants will be prepared to pay the significant premiums required for those new construction. Now that doesn't mean there won't be buildings because if you're a 1 million square foot tenant and you need to relocate, you got no place to go in any city. But if you're making that decision, you are going to be paying a significant premium associated with where you are today. And I just think there are relatively few organizations that are prepared to do that.

And that's a good segue because we get a lot of questions on your development pipeline, whether it be the $3 billion that's under construction, is that still realistic in this market, has funding been secured? Maybe if you can touch on those points.

So I mean we have all the funding we need to complete our development pipeline. We've got about $1.6 billion left to fund over the next 3 years to fund that. The pipeline is 55% preleased overall. Pretty significant component of it is life science that's 65% preleased. So our expectations from a liquidity perspective, what we've been doing is raising capital, and we've been very successful at doing that, and we have a lot of flexibility, and we have a lot of different access points for capital. So we'll continue to do that and put ourselves in a position to allocate new capital. It may not be to development right? It could be 2 acquisition opportunities that occur in the marketplace because as we talked about briefly, the secured debt markets are in a difficult position. It's more costly and underwriting standards are definitely tighter. So we're going to see some assets in our marketplaces that are overleveraged come back to the market have some distress -- and we think that there's going to be opportunities for us to invest in some of these assets over the next couple of years. So our goal is to continue to be very, very liquid and be prepared for that.

And just to remind everybody, we basically shut down 1 of our projects because we determined that we didn't think that demand was going to be there for the timing of when that building was going to be completed, which was Platform 16, which obviously reduced a significant amount of future funding. I mean, it's disappointing that we are -- we have this effectively this underground parking structure, which is going to have a cap on top of it. But this is not the first time this has happened to us. So back in the early 2000s, we were building a building at 250 West 55th Street in Manhattan and similar situation, the market went into a significant downturn. And we actually terminated a lease that we had signed with a law firm, and we stopped the building at the grade and we waited and we paused and then we restarted the building 2 years later. And it's been a very successful building on a going-forward basis. So we're not afraid to make those hard decisions relative to funding. But as Mike said, our existing development pipeline is effectively either buildings that have been completed, and we're waiting to try and lease them or the life science buildings that we are committed to build with tenants that have signed 15-plus years of term. And so they are fully executed leases. So we will complete those buildings. Unlikely that you will see us starting anything else unless we have a significant precommitment. And as I said, the premium required for that is going to be extensive. And so I'm not sure there is a client of ours who would be prepared to pay what we will require in order to start a new building in the next, call it, 12 to 24 months.

Do tenants today realize that there's not going to be this new construction available in a couple of years?

They are starting to realize that because they're asking us for proposals. And so I'll give you 2 examples, live examples. We have a site at 343 Madison which we would start a building on in a couple of years and a tenant came to us and said, we are looking space in '28. Please make us a proposal. And we said, well, based upon where we are today on our drawings, this is what we think the cost is and this is what our return requirement is, and that translated into a rent for the base of the building of about $220 a square foot. Similarly, we have a client in Boston who said, we want a proposal for you for the new building that you can build at the Back Bay train station. It's a fully permitted, fully drawn building. So we have real numbers on this one. And that we quoted them a rent that was in excess of a $140 a square foot on a gross basis. And you can lease space from BXP at 1 of our existing buildings for somewhere well under $100 a square foot on a gross basis, high-quality building. So -- and the nice thing about both of those situations were we actually did it open book. We said, here is our land basis, which is effectively nothing in each of these cases because of the deals that we've cut. And here are all of our costs. And here's what we're looking for a return. And this is how the math works. And if it's higher, you're going to pay more and if it's lower, you're going to pay less. And it's like, let the truth set you free. And so we have no hesitation about having those conversations with our clients. So if other landlords have the same discipline that we have and they need capital in order to build something, I would expect the message will start to permeate the marketplace in a significant way.

And we have time for 1 or 2 more questions before going into rapid fire.

Maybe just a quick one on my end. Can you like give any color how much do you think like net effective rents might be down from pre-COVID and maybe how do you see that trending over the next few years? Have we bottomed on that front? Or is there more pain to come.

So it depends on the market, and I think it's market dependent relative whether or not we've bottomed or not. I would tell you that in Midtown Manhattan, we have absolutely bottomed and that in general, I think rents -- net effective rents, meaning for those of you who are unfamiliar, the sort of the calculation of the whole package. So the free rent that's required for a transaction, the brokerage commission that you have to pay and the tenant improvement allowance that you have to give are against the rent that you're achieving over the term of the lease, which also includes the bump. So it's not starting rent. I believe that those rents are down anywhere between 10% and 20% in general across all of our marketplaces. I mean I can tell you that in greater Boston to date, we've seen virtually no degradation, but it's coming because there's a couple of million square feet of supply in the marketplace. So again, I think it's -- things are going to get worse for the unleased space there. But in a market like Manhattan where it's occurred, I think we're going to start to see actually net effective rents increase. And in a market like San Francisco, it's really bifurcated depending upon the space and whether it's direct or it's sublet or if it's the top or the bottom of the building. So I would tell you that net effective rents at the tops of high-quality buildings north of market are probably down, I don't know, 10% and net effective rents on sublet space for buildings that were once leased at $90 a square foot on a net basis are now being leased at $45 or $50 a square foot on a gross basis, we're down over 100%. There's obviously no capital associated with that, but it's just because it's a sublet. It's just -- it's a risk mitigation exercise for that customer as opposed to a value opportunity for them. And so there's a huge degree of variability.

And maybe 1 final question before Rapidfire. Mike, could we get your thoughts on dividend, how you're thinking about that? You've seen a lot of your peers cut. So what could make you change your assessment there.

Well, I think that we have -- we cover our dividend quite well, very consistently. So we're very comfortable with the cash flows of the organization. I think the outlook for the dividend would change if the restrictions -- the ability of ourselves to raise capital through the debt or equity markets, either private equity or debt markets change significantly so that we're very uncomfortable that we could raise capital in the future. We don't feel that way right now. We actually are feeling better about that right now because we've been quite successful. Our dividend, we do have -- I mentioned on a call a couple of quarters ago, there is room in our dividend because the taxable income from our operations are lower than our dividend. But we've been able to fill that with asset sales very consistently every year such that we're paying out the full amount or even more. So I feel very confident. We've maintained our dividend. I think it differentiates us significantly from many of our peers. It's one of the many things that differentiate our company from our peers, not only our dividend, but the quality of our assets and the stability of our income stream and the diversity of our income stream. So I think that right now, our view is we will maintain our dividend as we have.

And so just 3 rapid fire questions for you. First, a question on the Fed. Do you believe the Fed is on hiking, yes or no?

No.

Do you expect the Fed to cut rates in 2024?

In 2024, I think, yes. .

Okay. Second, do you believe real estate transactions will meaningly pick up by: a, the fourth quarter of 2023; b, first half of '24; or c, second half of '24.

C.

And third, are you using AI today to help you run your business? Yes or no?

No.

And do you plan to ramp up spending on AI initiatives over the next 2 years?

I would define AI initiatives as rule-based programs. So if you use the data as AI, the answer is yes. If it's truly generative analysis, the answer is no.

Okay. Well, thank you for the time. And thank you, everyone, for joining us.