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

Okay. Why don't we go ahead and get started? We're here for the 11:00 session with BXP. Let me just quickly introduce management, and then I'm going to turn it over to them for some quick opening remarks. I'll go through a couple of questions. [Operator Instructions]. So next to me is Owen Thomas, CEO; and Doug Linde, President; Mike LaBelle, CFO; and Hilary Spann, EVP and Head of the New York region. So with that, let me turn it over to Owen to make some opening comments, and then we'll jump into Q&A.

Steve. Thank you for hosting us today. Good to see you all of you. Thank you for being here. Thank you for your interest in BXP. Let me just say, our message for this NAREIT meeting is our leasing is getting better materially. We've been talking about as a management team, the 2 important drivers we think of our stock price are: 1, corporate earnings, which is driving leasing and second, interest rates, which obviously drives cost of capital. And in the first quarter of this year, S&P 500 earnings grew somewhere between 5% and 6% we're seeing and I'm sure Doug is going to talk about it, some immediate impacts, very positive impacts to our overall leasing activity. So that feels very much off the bottom. And then on interest rates, none of us really know where that's going to go, but I think it will ultimately go down, which will also be a positive, although certainly, the timing is hard to discern. So Steve, that's our opening remarks.

Wow, short and sweet. I like it.

Well, maybe jumping into leasing, and we obviously spoke this morning and it was interesting to hear just how much leasing activity had picked up in Q2 versus what you did in Q1. So maybe either Doug or Hilary maybe just speak to kind of what you're seeing? Are there any particular regions where you're seeing some of that strength? And then maybe just what types of tenants are you seeing in the market today?

So I'll start macro and then go micro. When we had our earnings call, which was on May 1, I described our leasing profile and I said we did about 880,000 square feet of leasing in the first quarter. And we had a pipeline at that time of leases in negotiations, some of which had already been done, but not much of that. This was on May 1 of about 875,000 square feet. And today, on June 3, that number is 1.7 million square feet of space. So we have, I think, had a rather dramatic acceleration in the clients that we were talking to and we're considering leasing space from BXP actually moving towards a lease. And to give you to sort of perspective, so in the third quarter of 2023, that number, again, the $875 or 1.7 million was about 1.2 million square feet. And in the fourth quarter, it was about 1 million square feet. So at the beginning of the quarter when we had our earnings calls and said, this is what our pipeline looks like, those were the numbers. So we are substantially higher today than we have been over the past 4 quarters. The overall feel of that is it's Boston first Washington, D.C. second, Manhattan and Princeton, which is our 2 New York markets third, San Francisco fourth, Seattle Fifth and West L.A. 6. So still a predominance of East Coast versus West Coast leasing. More expansions in this portfolio now than contractions and more larger expansions. So as 3 examples, we have a hedge fund in Manhattan that's taking 80,000 square feet. We have a private equity firm in Boston that's looking at taking 60,000 square feet. We have a government contractor in Reston, Virginia that's looking at taking 45,000 square feet. Those are sort of where the impetus for the activity is, but it's a clear acceleration. And then we have a pipeline, so deals that are not actively in a lease negotiation, but where we have a reasonably strong view that we will be able to move those into a transaction still of about 1.2 million square feet of space. And so in May, that number was 1.6 million square feet. So we've pushed over 800,000 square feet into the active and then we backfilled another 400,000 square feet of space. So again, consistent with Owen's comment, as the macro environment gets a little bit better, and there still, by the way, is not a lot of job growth for office using jobs. We are seeing confidence in businesses and therefore, decisions to do leases, and we are effectively eating a bigger piece of the pie. The pie isn't necessarily getting larger, but we are getting a far larger share of it. And that's sort of how we expect we will gain occupancy over the next couple of years.

Maybe Doug and Owen, just maybe talk about the flight to quality and sponsorship and how important kind of balance sheets are today in those leasing discussions? And maybe to Doug's point, if the pie is not growing, but you're taking a bigger share of that pie, how much do you kind of view as strong capital versus some of your private peers?

I'll take a first cut at that, the flight to quality is certainly the same as it has been, and we've been talking about for a couple of years now. If anything, it's been accelerating. All of the numbers continue to hold out, and those are rough justice in our 6 core markets for CBD assets. The premier assets are defined as roughly 10% of the buildings. And their vacancy tends to be 5 to 6 percentage points lower than the broader market. The absorption is positive versus very negative for the bottom 90% and the asking rents are 55% higher. I mean, those -- the asking rents continue to -- the gap continues to grow. So this is incredibly important, and it's what's contributed to our stability. If you look over the last couple of years, our occupancy has been flat. Our dividend, we have held our dividend. We haven't cut our dividend. So we've exhibited a lot of stability. And the reason is because our buildings when you read about San Francisco being 40% available, it's true, but it's not as relevant to us because the buildings that we compete with are not in that same situation from an occupancy standpoint. That's 1 factor that's helping us. The other one is that Doug touched on is there's a lot of distress in office real estate. We lenders to office real estate that our mortgage lenders on the private side are generally not making new loans and they want their loans to be repaid. And so, if you're borrowing in the private market and you have a mortgage coming due, it's very difficult to extend that mortgage. Fortunately, we don't have to deal with that issue significantly because the vast majority of our borrowings are in the investment-grade unsecured market, which we have ready access to whenever we need it. So we don't face that issue. So when we're -- and it's particularly true in several of the markets that we're competing in, when a tenant is out in the market looking at different buildings, some of the buildings that they're looking at, that owner is not going to be able to give them the tenant work that's required because their building is over leveraged, and they don't know if they can extend the loan. And also importantly, the broker that they've retained may not get paid their commission if they go into that property. And those factors mean that not only are we competing with a smaller group of buildings because of quality but we're also competing with a smaller group of buildings because of sponsorship. Usually, in second-generation leasing, when you think about the factors that a client looks at Sponsorship has always been important, but I think things like location, amenities, price, all those other things were higher. But today, when we have a new client coming to us, some of the first questions are what's going on with this building. Who's the sponsor what's their capital structure look like? Are you going to hold it for a long time. Our clients are much more attentive to the sponsorship, which really plays to our advantage.

And I would just say that sponsorship is not what you think of. Sponsorship doesn't mean that it is not a high-quality owner. So in fact, many of the more distressed situations that have been in the popular press, and I'm not going to mention names have been with what you would, I think, view as very high-quality sponsors. However, they all have a perspective, and it's probably a fair perspective that they have a fiduciary obligation to their equity, not to put "good money in after bad" and to the extent that the debt capital structure of these assets has not been worked out into a position where they feel comfortable that they are going to be able to recoup any incremental capital. They're just not going to do anything. And so there are lots and lots of what we refer to as zombie buildings. Many of them are high-quality "premier assets in our marketplaces" that just are not in a position to compete for the same clients that we are talking to on a day-to-day basis.

Maybe just looking at technology because the tech companies were obviously big space users and took up a lot of the vacancy and the new development those companies have largely gone on hold for the last couple of years. So I'm curious, as you look at the next 2, 3, 4 years and you look at the recovery and your occupancy rate, how important is it for big tech to come off the sidelines. And then I'm curious kind of what you're seeing in New York, maybe Hilary can comment on some of the leasing that she's seeing down in 360 Park Avenue South and maybe speak to the Park Avenue submarket.

Hilary, you want to start and I'll finish up with the tech?

So the tightest submarket in Manhattan is Park Avenue North of 42nd Street. And the availability in that submarket is very, very constrained. If you are a 100,000 square foot tenant looking for space on Park Avenue, good luck, very hard to find at any price, much less at the price that most who are there would hope to renew at. So we are seeing pricing power in that submarket, and demand is starting to bleed outward from that submarket to the adjacent submarkets in Midtown proper. In Midtown South, that's a market has historically been more tilted to tech and media tenants. And those tenants have been softer in terms of leasing demand in recent quarters, largely because the tech industry over hired during the pandemic and started giving back jobs coming out of the pandemic. So that remains a pocket of softness for the time being, but we do believe that long term the tech industry will be sort of a marginal generator of demand for office space in New York. In the meantime, the tightness in the Midtown market has caused some tenants that want premier space and can't secure it at Midtown proper to look at Midtown South as an alternative. And so we're seeing a better diversity of industries looking for space in Midtown South. If you look at the tour activity at 360 Park Avenue South, 40% plus of the tenants that are interested in that building are in finance and law. Just this week, we toured 2 tenants through 200 Fifth Avenue. Both of them were about 350,000 square feet. One of them was a law firm, 1 of them was a corporate, neither of them sort of tech oriented. So that submarket does seemed to be diversifying in terms of the demand, but the underlying trend of tech retreating from taking space in the recent past does still present a little bit of an overhang down there.

So just broadening it out on the tech market generally, and Steve touched on this. So there's good news and bad news. The good news is if we all had to think about what companies over the next decade are going to drive the growth of the U.S. economy, I think many of us would put technology at the top of the list. So we have a lot of confidence that this group of users is going to come back to the market. The bad news is in '21 and '22, many of them took a lot of space and hired a lot of people and we're competing with each other to do this and it got overdone. And many of these companies over the last couple of years, they've been growing their earnings and part of the way they've been growing it is cutting costs. In some cases, it's head count and in many cases, it's with space. But again, given AI and given the things that are going on these lines are going to recross again because these companies are growing. They're doing well. They've given back space. And at some point, they're going to be back. I can't tell you exactly when that is. I don't think any of us know, but we're confident it's going to happen. And then we've got the next generation of tech companies that are taking space. So in San Francisco, Doug, we've had a couple of million square feet that have been leased already to open AI Anthropic and another AI company, and there are probably others that are smaller that are probably not as much on our radar screen. So again, we think about the clients like Salesforce.com. 15 years ago, I'm not sure many people knew who that company is, and they became the largest user in the city of San Francisco and the anchor tenant for Salesforce Tower. So -- is this happening again? Probably. We know which companies it's going to be, we don't. But we're confident in the ecosystem there and what's going to happen.

And I would just say that, so Steve, to explicitly answer your question, unless there is a major change in the attitude for the tech titans, we are not going to see a broad recovery in the next 12 to 24 months in the "tech cities" -- that's just not going to happen, those organizations were taking down millions of square feet of space each -- every year for the last decade. However, as Owen said, the AI opportunity is real, it is concentrated right now in San Francisco. It is meaningful absorption and it's picking up. And by the way, those organizations have made it very clear to their employees being in the office with each other 5 or 6 or 7 days a week is the most critical component for those companies delivering each susceptible generation of their tech as quickly as possible. And it may very well be that there is a significant expansion of that. In addition, there are other kinds of tech companies that we are not talking about on a day-to-day basis. So as an example, Mike and I sat in front of the CEO of a tech company that is leasing 180,000 square feet of space in Boston and is knocking on the door of 1 of our buildings asking if we can accommodate a 330,000 square feet requirement over the next 2 years, okay? That is a meaningful expansion. We have Meta as a building of ours in Northern Virginia. Meta is going the wrong direction. They had 75,000 square feet they're giving back 2 floors and they're taking 28,000 square feet on a long-term basis. We have a small private technology company in the building that is likely to take 1 or both of their existing floors. So again, these are the kinds of sort of more granular technology experiences that our client base is sort of geared towards and that our buildings are generating on a day-to-day basis, which is allowing us to maintain and slightly grow our occupancy. But macro level, if we don't see Google and Apple and Meta and Amazon, and Microsoft taking meaningfully large pieces of space, we're not going to see this broad macro recovery anytime soon.

Just one more broad leasing question. I know it's not a big part of your business, but Life Science is something that BXP has kind of weighted into with some other office companies. It was very fast growing. A lot of money was thrown at that space. That's obviously cooled off. Just what are you seeing today in Boston and San Francisco on the Life Sciences front? And are you more optimistic about kind of tech leasing come first or life science leasing?

So we are highly, highly optimistic about the nature of the changes in the life science industry's ability to improve and enhance the longevity of human life. And that the ecosystems that are -- where that is centered are the greater Boston market, predominantly Kendall Square near Cambridge, but also in South San Francisco into some degree, I guess, in San Diego although that sort of market that we participate in. We believe wholeheartedly in those marketplaces. What we expect we will see is a growth trajectory similar to what was 2014 to 2017 as opposed to the exponential growth we saw between 2018 and 2021, where money was free, every VC firm in America was looking at life science. The companies were grabbing dollars at ever-increasing valuations, and they were sucking up space like there was no tomorrow. And landlord after landlord was saying, this is the key to my success. I'm going to build the life science building or I'm going to convert a life science building. We are now dealing with the digesting of all that space and the change in the capital raising of those companies. There is money being put into the VC firms. There is a significant recovery in the [ BXP ] so that market is recovering, but they are doing it in a very different way. And so today, if we look at the markets that we operate in, we are seeing very small modest companies looking for a small incremental space. We are not seeing companies saying, we must have huge new installations. We are looking for companies to put the burden of those improvements on the landlord. So "prebuilding or building out space" for those customers seems to be a prerequisite for doing a small transaction and we have a lot of space to absorb. And so I would say that neither the technology nor the life science market is anywhere close to where it was in 2020 to '22. But we are as confident in life science as we are in technology. We are in a relatively good position relative to our availability. We have new life science buildings under construction 1 of them that will come into service in South San Francisco, which we have a partner on and the other is in Greater Boston. We have some leasing interest. I would say -- I would characterize it as more shopping as opposed to buying. So it's still, relatively speaking, more of a lease expiration-driven renewal market and not an expansionary market as we sort of sit here in the second quarter of '24.

I'm going to open it up to the audience in a second here. But Mike, you've been quiet, so I want to bring you into the conversation here. What are you hearing on the lending side for office, which I know has been a dirty word. Obviously, you guys have a very good portfolio. But just what are you hearing from the banks, CMBS unsecured bond investors. How are they looking at you, the sector, where our borrowing cost today for BXP?

Thanks, Steven. I think it's okay to be quiet because we've got a great, strong balance sheet. So that's why we don't get many questions on that. Look, the -- I think the financing markets they're getting modestly better. The unsecured market it's been open. It's been open throughout. Our spreads widened after the SVB crisis, but they have come back in. They're currently very stable over the last 4 or 5 months at about 185 basis points over for a 10-year deal. So given today's treasury, we could do a 10-year deal just north of 6%. I mean, we have active and open use of that market. We don't have a lot of expiries coming up. So we actually don't have to do a transaction in this market in the near term. Our next expiry is not until the beginning of 2025, where we would think about that potential execution. I would say that the bank market and the life insurance company market and the mortgage market, in general, is much weaker than the unsecured bond market. So if you're a company that doesn't have access to the broader unsecured market, I think it's more difficult for you to secure financing. Banks continue to look to reduce their exposure that many of them are under regulatory pressure to reduce commercial real estate exposures. They're being choosy about who they're doing business with. So you're seeing them exit some relationships that aren't as profitable for them and keeping relationships that they feel confident in both from a credit perspective and from a relationship profitability perspective. The CMBS market has come back, Credit spreads have improved significantly in that marketplace. The single asset securitization market where you can do large loans, had been shut down for a couple of years. We have seen 2 recent SASB loans done in the office sector. So I think that's showing some green shoots in that marketplace, pricing is still high. Pricing for 40% or 50% leverage loan is probably 300 over, and it's a floating rate market today. And I would say that the life insurance companies are still pretty much out of the market. So the mortgage business is a little bit more difficult, and as Doug was describing for some of these buildings that are reliant upon mortgage financing, it's hard for them to have confidence that they can refinance those mortgages. -- and that could create opportunities for others that have access to capital in the marketplace.

Let me just -- we have a few minutes. Anybody with a question from the audience? [ Seth ]?

Can you talk a little bit about the D.C. market historically, more stable through cycles, but obviously, return to office has been a challenge. And maybe where would you rank D.C. over the next 5 years as a market, not just your portfolio excluding Reston Town Center between sort of Boston, D.C., New York and San Francisco?

So a couple of quick comments on D.C. So for BXP D.C. is actually a tertiary market. Our portfolio is predominantly in Northern Virginia and Reston. And so we're -- D.C. is sort of secondary from a cash flow perspective. It's an important market in terms of our business, but it's really not an important market relative to market share. I would tell you that the D.C. market has not seen a growing customer for quite some time. And in general, the GSA has reduced space. The GSA is not coming to work, and Owen can comment on all the conversations he's had with politicians about that problem. And the legal practices, which are really the dominant user all have all shrunk or are shrinking. And so I would say that the D.C. market is a challenged market relative to demand. Interesting for us, the D.C. market is probably the most distressed market relative to capital structure. There are more zombie buildings in D.C. than anywhere, and as you know, the nature of the D.C. building, is that it's a "short squat building." And every law firm has a desire to be in the top of the "short swap building" also referred to as the muffin-top for those of you eat a lot of pastry. And so interestingly, there are virtually no good blocks of space available. So we have been actually in conversations with a law firm that is looking for a over 160,000 square feet and can't find anyone to build them a new building, where they would take the top of that building at any price, regardless of -- and they'll pay what they have to pay because no one wants to take the peculiar risk on the other portions of the building. So what I would say is that D.C. has traditionally been a merchant building market in the sense that most tenants after their initial lease look for the next shiny car, and now with capitals strains from an availability perspective are limiting the ability to get new construction going, I think over time, D.C. is going to see a lot less of that. And so I would predict that 5 or 6 years from now, there will actually be a tighter market in D.C. But for -- at the moment, without demand growth, it's just a very sort of static market. And interestingly, the best assets are getting far more market share because there are so few of us, who actually have capital that are prepared to put in those assets. We announced a 15-year extension on a lease, so that's now going to mature in the 2040s on a building called 901 New York Avenue. We actually bought our partner out and Owen can talk about that. As soon as we announced that we did that, and then we were doing a major positioning, the activity level picked up dramatically because it was clear we were going to invest in that building. So ranking. I would tell you that my view is that our New York Park Avenue and our Back Bay of Boston are sort of 1 in 1. Those are by far the most dominant markets that we have and then our Cambridge market, where we don't have much in the way of availability, so we can't make a lot of hay there other than through development would be a close second. And then sort of things sort of fall off from there. And then I would jump to Reston, Virginia. Our EC Salesforce tower sort of mission-related assets in San Francisco and then everything else is sort of tertiary to that. D.C. is just -- yes, it's sort of in that other bucket in terms of growth.

Apologies, if you've already touched upon this, but could you talk about whether this TI packages are typically stabilizing? Are you able to get annual bumps on any of your new leases? And also we're looking at tenants looking at what about duration? Are people looking for shorter leases as opposed to being happy to sign for longer?

All right. I'm going to include my colleagues here. So big picture, rents have bumps. More TIs are stabilizing. It depends on where they are. 2%, 3%, sometimes it's $5 or $7 after 5 years. And I'll let Hilary talk about TIs in New York, and I'll let Mike talk about our average lease [indiscernible].

So tenant improvements in New York saw a run up, call it, 5 to 7 years ago because construction costs were increasing quite a lot. They went up about 50% over a 5-year period. They've since stabilized, and they've been stable for the last 3 years. So we've not seen increases in tenant improvement concession packages, and we have not seen increases in free rent and concession packages. So in the submarkets where rents are going up, like Park Avenue, net effective rents are also going up. I think that once sort of the occupancy metrics in the adjacent submarkets improve, and free rent starts to go down, you'll see a real acceleration in net effective rents going up. But for now, I'd say there are modest increases in net effective rents in the best submarkets in New York.

I mean, our lease term. Our lease terms have been very consistent. So we announced it every quarter, the average lease term in our leases, and they're always somewhere between 8.5 and 10 years. new leases where you're doing new installation where a new tenant is coming into a building, still mostly 10- to 15-year terms. Renewals, we get a lot more 3- to 7-year terms on renewals, and you have less of a TI investment in those, right? So we're not in a situation in our buildings, where we're seeing a lot of -- we're not what we want to do, let's just do a 1-year extension or a 2-year extension and kind of kick the can and we'll decide later. Most of the clients in our buildings have decided what they want to do and they're willing to sign long-term leases, and they're investing in the space.

All right. Well, as we can hear from next door, we're kind of out of time. So I want to thank the BXP management team and to all of you for joining us today and enjoy the rest of the conference.