Boston Properties, Inc. (NYSE:BXP) Q1 2024 Earnings Call Transcript May 1, 2024
Boston Properties, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day, and thank you for standing by. Welcome to BXP First Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation there will be a question-and-answer session. [Operator Instructions]. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your first speaker, Helen Han, Vice President of Investor Relations. Please go ahead.
Helen Han: Good morning, and welcome to BXP’s first quarter 2024 earnings conference call. The press release and supplemental package were distributed last night and furnished on Form 8-K. In the supplemental package, BXP has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Reg G. If you did not receive a copy, these documents are available in the Investors section of our website at investors.bxp.com. A webcast of this call will be available for 12 months. At this time, we would like to inform you that certain statements made during this conference call, which are not historical, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act.
Although BXP believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be a change. Factors and risks that could cause actual results to differ materially from those expressed or implied by forward-looking statements were detailed in yesterday’s press release and from time-to-time in BXP’s filings with the SEC. BXP does not undertake a duty to update any forward-looking statements. I’d like to welcome Owen Thomas, Chairman and Chief Executive Officer; Doug Linde, President; and Mike LaBelle, Chief Financial Officer. During the Q&A portion of our call, Ray Ritchey, Senior Executive Vice President, and our regional management teams will be available to address any questions.
We ask that those of you participating in the Q&A portion of the call to please limit yourself to one question. If you have any additional query or follow-up, please feel free to rejoin the queue. I would now like to turn the call over to Owen Thomas for his formal remarks.
Owen Thomas: Thank you, Helen, and good morning, everyone. BXP’s performance in the first quarter continued to defy the negative market sentiment for the commercial office sector. Our FFO per share was in line with our forecast and market consensus for the first quarter. We completed just under 900,000 square feet of leasing, which is 35% greater than the first quarter of ’23 when we leased 660,000 square feet. And this is a more relevant comparison than to the fourth quarter of ’23, given elevated leasing activity associated with the quarter at year-end. Our weighted average lease term on leases signed this past quarter was also notable at 11.6 years in comparison the leases we signed in 2023 at a weighted average lease term of 8.2 years.
Our occupancy remains stable. We closed the previously announced joint venture with Norges at 290 Binney Street, our lab development in Cambridge that is fully leased to AstraZeneca. This transaction mitigates $534 million of development funding for BXP by raising property level equity for the company on attractive terms. Now moving to macro market conditions. The two most important external factors impacting BXP’s performance or long-term interest rates and corporate earnings growth. Lower interest rates would improve our cost of capital, spark more transaction activity and investment opportunities in our sector, reduce the cost of new development and be a tailwind for our clients’ earnings growth. Much has been written and forecasted about the trajectory of interest rates, which we believe will come down over time, but we can only speculate on the exact timing.
Companies generally do not hire new employees and increase their office space requirements unless their earnings are growing. Over time, the S&P 500 earnings grow around 10% per year. But in 2023, that growth rate was 0%. And in 2022, it was 5%. Though the U.S. economy is growing and unemployment remains low, only about 7% of the jobs created are in office-using categories versus a long-term average of over 25%. S&P 500 earnings are projected to grow 11% to 13% per annum over the next two years, which should be constructive to BXP’s leasing activity. Many technology clients, a critically important sector driving space demand post the global financial crisis overcommitted to space during the pandemic and are currently in a digestion process, which has curtailed demand.
There are exceptions such as net demand for space from the AI sector in San Francisco. Over the long term, we expect many tech companies will experience strong earnings growth and return to requiring more office space. Premier Workplace is defined as the best 6% of buildings representing 13% of total space in our five CBD markets continue to materially outperform the broader market. Direct vacancy for Premier Workplaces is 11.2% versus 17.9% for the broader market. Likewise, net absorption for premier workplaces has been a positive 7 million square feet over the last 13 quarters versus a negative 30 million square feet for the broader market. Asking rents for premier workplaces are 50% higher than the broader market, a widening gap from prior quarters.
This outperformance is evident in BXP’s portfolio, where 89% of our NOI comes from assets located in CBDs that are predominantly premier workplaces. These CBD assets are 91% occupied and 93% leased as of the end of the first quarter. Regarding the real estate private equity capital markets, office sales volume in the first quarter was down was $8.7 billion, down 3% from the prior quarter and up 32% from a low base one year ago. Office sales as a percentage of total commercial real estate transaction volume are continue to rise to over 20%. Transaction activity for premier workplaces was very limited. BXP’s overriding goal is to leverage our competitive advantages to preserve and build FFO per share over time. The key advantages for BXP are our commitment to the office asset class and our clients as many competitors disinvest in the sector, a strong balance sheet with access to capital in the secured and unsecured debt and private equity markets, and one of the highest quality portfolios of premier workplaces in the U.S. assembled over several decades of intentional development acquisitions and dispositions.
Today, clients and their advisers are more focused than ever on building quality as well as the financial stability and long-term commitment of their building owners, all strong competitive advantages for BXP. Last quarter, I spoke about three priorities for BXP in 2024, leasing space, new investments and development. Now Doug will provide more details on leasing. We’re off to a good start in the first quarter and see a growing pipeline of opportunities for later this year in 2025. On new investment activity, as you know, we pivoted to offense late last year and early this year through buying joint venture interest in three significant in-service assets at attractive prices. We remain in active pursuit of opportunities in our core markets and asset types with primarily two types of counterparties.
Lenders to highly leveraged assets that require recapitalization and institutional owners seeking to diversify from the office asset plan. To date, there has been limited market transaction activity for high-quality office assets. With lenders, there are fewer premier workplaces that are struggling with leverage. And in the few cases involving premier workplaces, lenders are generally electing borrowers who agreed to invest modestly in their assets. Institutional owners are less interested in selling their highest quality assets, and there remains a material bid-ask spread given assets have, in most cases, not been marked down to market clearing levels. Notwithstanding these current challenges, our expectations are the transactions and our investment activity will increase in coming quarters given the volume of maturing financings, continued markdowns in institutional portfolios and higher for longer interest rates.
We also have interest from institutional investors in contesting with us for select opportunities. On development, we commenced our 121 Broadway residential tower in Kendall Center as part of the 1 million square feet of commercial entitlements we received from the city of Cambridge to build 290 Binney Street and a future to-be-determined commercial building. Comprising 37 stories and 439 units, 121 Broadway will be the tallest building in Cambridge with a state-of-the-art design and amenity setting a new quality standard for residential offerings in the Kendall Square neighborhood. Earlier this month, on Boston Marathon weekend, we celebrated the grand opening for and delivered into service the 118,000 square foot [indiscernible] House of Sports store on Boylston Street at Prudential Center.
We continue to push forward with several residential projects under control that are being entitled and designed for which we intend to raise joint venture equity capital in the second half of the year. For office development, we have been approached by multiple clients in all our core markets who are interested in occupying new space and anchoring development projects. Given escalated material labor and capital costs, anchor clients must pay a premium to market rent today to justify the launch of a new development project, which is a challenging dynamic exacerbated by the earnings growth issue previously described. Though BXP’s new office development activity has slowed, there will also be a very limited new office that will also be very limited new office development for the foreseeable future in our core markets, which is favorable for our existing portfolio.
As vacancies continue to decline for premier workplaces, rents should rise, which will ultimately bridge the economic gap to justify new development. Though we believe buying is a better opportunity than selling in the current market environment, we are interested in raising capital through asset sales if attractive opportunities present themselves. We have a handful of small dispositions defined as under $30 million we are currently exploring. BXP continues to execute a significant development pipeline with 11 office lab retail and residential projects underway as of the end of the first quarter. These projects aggregate approximately 3.2 million square feet and $2.4 billion of BXP investment with $1.3 billion remaining to be funded and are projected to generate attractive yields in the aggregate upon delivery.
So to summarize, in the face of strong negative market sentiment, BXP continues to display resilience and stability and occupancy FFO and dividend level. BXP is well positioned to continue to gain market share in both assets and clients during this time of market dislocation. The prospect of lower interest rates and stronger corporate earnings also provides a backdrop for renewed growth. Let me turn the call over to Doug.
Douglas Linde: Thanks, Owen. Good morning, everybody. I hope what you’re going to hear today from me is you’re going to be with a pretty constructive perspective on what’s going on in our markets and what’s going on with our revenue picture and our leasing picture. As we sit here at the end of the first quarter, in spite of the absence of a broad pickup in office-using jobs, BXP continues to lease space. We are leasing space. There’s momentum in the economy despite persistent high interest rates. Overall earnings growth for our clients and potential clients appears to be improving, and we’re pretty optimistic it’s going to lead to employment and space additions. And while we are not going to see broad reports of shrinking availability across any market, until there is a pickup in white collar job formation, there are pockets of supply constrained in select submarkets where we are seeing competition for space and improving economics.
As reported in our supplemental, the mark-to-market of the leases that commenced this quarter was up 7% and the transaction costs averaged $8.60 per year, which is lower than it’s been in the last few quarters. The overall mark-to-market of the starting cash rents on leases executed this quarter relative to the previous in-place cash rent was up about 2%. The starting cash rents on leases we signed this quarter on second-generation space, we’re up about 22% in Boston, down 6.5% in Manhattan, down 3% in D.C. and up 8% on the West Coast with San Francisco CBD up 12%. Boston’s increased is in large part due to a replacement of a tenant that was in default and had stopped paying. Adjusting for the transaction, the Boston numbers would have been up about 6%.
As Owen stated, the seasonal trend line of BXP’s leasing activity in the first quarter of ’24 picked up relative to what we experienced in the first quarter of ’23. This quarter, we completed 61 transactions, 32 new leases for 494,000 square feet and 29 renewals encompassing 399,000 square feet. We had three expansions totaling 18,000 square feet and four contractions totaling 44,000 square feet. As a point of comparison, in the first quarter of ’23, there were 57 leases, 29 leases were with new clients for 410,000 and 28 renewals for 250,000. There were 10 expansions and three contractions. Last quarter, Fourth quarter of ’23, we signed 37 lease renewals and 37 leases with new clients, and there were eight contractions and nine expansions among our existing clients.
This quarter, new leases encompass 55% of the volume. Activity was across the entire portfolio with 178,000 square feet in Boston, 225,000 square feet in the New York region, 154,000 square feet from the West Coast and D.C. lead attack with 336,000 square feet. And to give you some additional color on this activity, there was only one transaction greater than 60,000 square feet due to the 215,000 square feet long-term law firm extension that included a 25,000 square foot contraction in D.C. although that same law firm took an additional 7,600 square feet in our Reston portfolio. Princeton made up 38% of the New York activity this quarter, almost all new clients. New clients made up 90% of the leasing volume in Boston and in New York, while renewals captured 73% of the West Coast and D.C. market.
Equally important is our pipeline. Post March 31, we have over 875,000 square feet of active leases under negotiation, which we define as a transaction that is being documented by our legal teams and some of these transactions have been completed. This is consistent with the level of in-process leases we’ve made for the last few quarters. These transactions include a multi-floor expansion of an asset manager in our Midtown portfolio in New York, a full floor expansion by a law firm in Midtown, an asset manager taking a full floor 360 Park Avenue South, consumer brand company relocating to a building in Waltham, a multi-floor renewal of a law firm in San Francisco with no change in the premises and a downsizing along with an extension of a technology company in Reston, Virginia and a similar transaction in Waltham.
We have seen an uptick in the number of active deals. At the end of the quarter, we had signed leases that had yet to commence on the in-service vacancy, totaling approximately 817,000 square feet, which includes 624,000 square feet that is anticipated to commence in 2024. We also have signed leases with new clients for another 534,000 square feet of currently occupied states. These leases have yet to commence but they are reflected in the reduction of our rollover exposure shown in our supplemental. The strongest user demand continues to come from the asset managers, including private equity venture hedge funds, specialized fund managers and their financial and legal advisers. These organizations are the heart and soul of our New York and our Back Bay activity and are an important driver of our San Francisco CBD demand.
In some instances, these clients are growing their teams and capital under management. But in all cases, they want to occupy premier workplaces. We continue to see significantly more client demand in our East Coast portfolio versus the West Coast due to the disproportionate concentration of technology and media content related demand on the West Coast. However, there have been some subtle and encouraging trends across much of the portfolio. Our Back Bay Boston and Park Avenue Centric New York City portfolio continue to have outsized demand relative to our availability. While concessions are still at elevated levels, we’ve been able to increase our taking rents and we actually have clients that we cannot accommodate due to a lack of available space in certain buildings.
In the last 90 days, there is the strong pickup of client activity in our Urban Edge Waltham portfolio. We have an 80,000 square foot tech client expiring in 2024 with a planted downsize to 16,000 square feet. This quarter, we completed a lease for 45,000 square feet and are in negotiations with two other clients, new ones for another 37,000 square feet of that expiration, and the existing client will stay with us but relocate within the building. Additionally, in a different Urban Edge building, we’re negotiating a 45,000 square foot lease with an existing subtenant to extend when their prime lease expires in ’25. We’re negotiating a 25,000 square foot lease with a lab user proportion of our availability on Second Avenue and we’re negotiating a 55,000 square foot lease with a non-tech company in a different building.
None of these transactions more than 220,000 square feet were in our pipeline on 12/31/2023. All of this occurred in the last 90 to 120 days. In the District of Columbia and Northern Virginia, we continue to see more buildings with over leveraged capital structures unwilling to provide capital for new transactions, and therefore, they have very little client interest. At the other end of the spectrum, when the market got wind of our lease extension at 901 New York Avenue and the anticipated enhancements that we are planning, the interest in the available space at New York — 901 New York accelerated dramatically. Reston continues to house the largest concentration of our Washington regional portfolio. It’s the headquarters for VW, Batel, Leidos, SAIC, Peraton, Kaki, Metron, Comscore, Mandiant, and the College Board and it’s also the home to a number of large technology companies like Microsoft.
Because of the environment of the Town Center with seven days a week food, beverage and shopping and is also a natural location for small businesses in the financial services and legal industries. This quarter, we completed a 58,000 square foot lease with a new technology client at Reston Next that’s moving from a toll road building, an expansion for law firm, and we are seeing a pickup in small tenant activity relate to ’23 and as well as large users looking to upgrade their premises. The AI organizations in the city of San Francisco continue to look for additional space, which will continue the positive absorption story. They continue to focus, however, on build and expensive space. And while there is an abundance of available space in the city, there continues to be outsized demand for view-spaced north of market relative to the available supply.
We completed a 35,000 square foot lease with a boutique financial adviser at Embarcadero Center this quarter that was only interested in use-spaced north of market. We’re negotiating six transactions with new clients totaling 40,000 square feet as well as an 80,000 square foot renewal with a law firm that’s retaining their existing point. Today, the Seattle CBD is almost exclusively a lease expiration-driven market, and there has been a material pickup in the level of activity. The number of tenant tours that we have conducted has picked up in the last quarters. We completed a lease with a new client on a 10,000 square-foot prebuilt suite and are in negotiations with a law firm for a parcel floor and discussions with a technology company for a full floor.
West L.A, however, continues to be the market where activity remains light. While Century City is seeing great demand and strong rents as financial and professional services firms head west from the downtown market, those clients are not yet prepared to take space in low-rise buildings in Santa Monica. There continues to be pressure from streaming profitability, industry consolidation and job reduction in the gaming and media space that is impacting overall demand growth in the West L.A. area. As we forecast during our last call, our occupancies declined also slightly from 88.4% to 88.2% during the quarter, with a known expiration of 230,000 square feet in Princeton, where, as I mentioned, we have signed 80,000 square feet of new client deals this quarter that will commence this year.
We have two additional large lease expirations across the portfolio in ’24 that will occur during the second quarter, 200,000 square feet at 680 Folsom in San Francisco and 230,000 square feet at 7 Times Square, where we own 55%. Occupancy will drop in the second quarter and recover as we move into the fourth quarter. Mike is going to spend some time discussing changes to our interest expense outlook in his remarks. The issue of the day is the level of inflation, and I thought I’d make a few brief comments on how inflation is impacting our business. We are not seeing any deflation in our base building costs as we build — as we bid potential stick-frame residential the projects Owen was describing earlier, but escalation assumptions are now normalized.
No more 8% to 9%. The changes to the building in energy codes, along with the elevated level of interest expense associated with any construction financing, continue to pressure project costs and make new starts very challenging. However, we are seeing costs come down on tenant improvement jobs, which is a reflection of reduced demand on the group of contractors and subcontractors that focus on interiors work who are looking to maintain a consistent book of business. New high-rise tower construction costs are unlikely to deflate in the longer-term interest rate environment and the long-term interest rates remain at the elevated levels, the longer it’s going to be before we see market rents approach the levels necessary to rationalize new office building, leasing economics and corresponding new development.
We are experiencing an operating environment where leasing available space is primarily driven by gaining market share. That’s with the world that we are living in, and we’re winning. As clients choose premier properties in sound financial condition, operated by the best property management teams, BXP will continue to be successful in doing just that. I’ll stop there and turn it over to Mike.
Michael LaBelle: Great. Thank you, Doug. I appreciate it. Good morning, everybody. This morning, I plan to cover the details of our first quarter performance and also the updates to our 2024 full year guidance. We’ve also been active in the debt markets this quarter. So I’m going to start with a summary of some of the changes in our debt structure. In early February, we paid off $700 million of unsecured notes with available cash, that was in line with our plan. We also entered into a $500 million unsecured commercial paper program. This program offers an additional market for us to tap beyond the bank market mortgage and unsecured bond markets that we currently actively utilize. We started issuing under the program last week, and we’ve raised the full $500 million for terms ranging from overnight to one month at a weighted average rate of SOFR plus 25 basis points.
The all-in rate, including fees is approximately 5.75%. We’ve used the proceeds to pay down our term loan from $1.2 billion to $700 million, which will reduce our borrowing cost on $500 million by 75 basis points or about $0.01 per share in 2024. In addition, we increased our corporate line of credit by $185 million to $2 billion. Our banks continue to be strong supporters of BXP even as they evaluate their global commercial real estate exposure and exit certain relationships. Now I’d like to turn to our first quarter earnings results. Despite the difficult real estate operating conditions and the stagnant office using job growth statistics, our portfolio is demonstrating strength and stability. As Owen and Doug described, portfolio occupancy has been relatively steady for the past six quarters.
Our revenues continue to grow with top line total revenue up again this quarter by $10 million or 1.3%, and our share of portfolio NOI is also higher, up $6 million or 1.2% from last quarter. High interest rates are our biggest earnings challenge. This quarter, our interest expense increased $7 million. It’s important to point out that more than half of this increase was due to higher noncash fair value interest expense, related to below-market debt on our recent acquisitions. We reported funds from operation of $1.73 per share for the quarter that was in line with our guidance for the first quarter and it was equal to our first quarter FFO from one year ago, again, demonstrating the stability of our income statement. Portfolio NOI exceeded our expectations by about $0.02 per share.
The majority of this is from lower-than-anticipated net operating expenses that we expect will be deferred to later in 2024. This was offset by higher-than-projected net interest expense of $0.02 per share primarily from higher noncash fair value interest expense related to the acquisitions, and we also booked lower-than-projected interest income due to changes in the timing of closing our 290 Binney Street joint venture. So moving to the full year. Since providing our initial 2024 guidance, we finalized the assumptions utilized in valuing the in-place debt and interest rate swaps for our 901 New York Avenue and Santa Monica Business Park acquisitions. For 901 New York Avenue, we increased our assumption for the interest rate on the debt by 70 basis points to 7.7%.
And for the interest rate hedge at Santa Monica Business Park, we determined that the change in market value will be amortized through our interest expense for the remaining term of the loan that expires in 2025. These adjustments result in an additional $0.05 per share of noncash fair value interest expense in 2024 relative to the estimate we used when we provided our guidance last quarter. This noncash adjustment impacts our full year guidance and is the primary reason we have reduced our FFO guidance for 2024. Other interest expense assumptions have also been impacted by the changing expectations for rate cuts in 2024. Last quarter, we forecasted four rate cuts commencing in the second quarter which was actually conservative to market expectations at the time.
We’ve now pushed out any rate cuts to late in 2024. The impact on our floating rate debt is partially offset by the lower cost of our commercial paper program, but overall, we expect $0.02 of dilution from higher short-term interest rates compared to our prior guidance. The operating assumptions for the portfolio occupancy and same-store NOI remain relatively unchanged from our prior forecast. As Doug described, we do expect occupancy to decline slightly this quarter, we did expect occupancy to decline slightly this quarter and in the second quarter before improving in the back half of the year. Our assumption for same-property NOI growth of negative 1% to 3% is unchanged. Other modifications to our guidance include reducing our assumption for 2024 G&A expense by $0.01 per share and a modest reduction in our fee income projection.
So in summary, we are reducing and narrowing our 2024 full year guidance for FFO to $6.98 to $7.10 per share. This represents a reduction of $0.06 per share at the midpoint from our prior guidance. The primary reason for the reductions are $0.05 of higher noncash fair value interest expense and $0.02 of higher interest expense from higher short-term interest rates, offset by $0.01 of lower G&A expense. The last item I would like to mention is that we published our 2023 sustainability and impact report, and it can be found on our website. The report contains a wealth of information on our sustainability efforts and the progress towards achieving our critical goals of reducing our energy use intensity, carbon emissions and achieving net zero carbon operations for Scope 1 and 2 greenhouse gas emissions by 2025.
We invite you to join us for our sustainability and impact webcast on May 15th. If you have not received an invitation, please reach out to Helen and our Investor Relations team. That completes our formal remarks. Operator, can you open up the line for questions?
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