Welcome to Citi's 2024 Global Property CEO Conference. I'm Nick Joseph, here with Michael Griffin with Citi Research, and we're pleased to have with us BXP and CEO Owen Thomas. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those in the room or the webcast, you can go to liveqa.com and enter code GPC 24 to submit any questions. Owen, I'll turn it over to you to introduce the company and team, provide any opening remarks, tell the audience the top reasons an investor should buy your stock today, and then we'll get into Q&A.
Okay. Well, thank you, Nick. Thank you, Michael. Pleasure, as always, to be here with you. I am joined by our president, fellow director, Doug Linde on my right, CFO Michael LaBelle on my left, and Helen Han, who's head of our IR department, to Doug's right. So, I'm not going to introduce the company. I think you all probably know who we are, but I'd love to answer your first question, which is, why should investors buy our stock today? And I think that'll, you know, cover a lot of the things that we do as a company. So let me just start by saying I think there are three reasons for this. The first is, I think that most, if not all, of the macroeconomic factors that impact BXP are either pivoted or pivoting to our favor.
So what do I mean by that? First, interest rates. You know, I don't think we're assuming that we're going to have a big reduction in interest rates anytime soon. However, the whole notion of the Fed no longer increasing rates and the prospect of decreasing rates is a big positive for all real estate, but particularly for office. And I do think if you look at trading characteristics of the company, it has been, for all office companies, it's been very correlated to interest rates. So it's helpful for our valuation, it's helpful for our cost of capital, and also it's helpful for our clients' earnings, many of whom are capital-intensive and raise debt, and it will help them grow their own businesses. So that's number one.
Number two, we think that leasing activity for us is more correlated to corporate earnings than to this work-from-home phenomena. And if you look at S&P 500 earnings, it's grown about 8% since the GFC through 2022, 8% annually. But in 2023, it grew less than 1%, and earnings are expected to recover back to a more normal growth rate in 2024 and for the foreseeable future. So when companies are growing their earnings, they're adding people, that's when they take space. If they're cost-cutting, if their earnings picture looks more uncertain, they're much less likely to lease space.
So in a typical year for BXP, we're leasing about 6 million ft. of space, and last year we leased 4.3, and we think that reduction is more related to this earnings point than work from home. That all being said, my next macro trend, I think work from home is improving. So if you look across the country, I think the mandates from our clients to have people come back to the office, I think employees' interest in coming back to the office is increasing, and that's helpful. Fourth, when we look at things going on in the life science sector, the XBI index is up 14% so far this year. And if you look at the VC funding into the life science industry, that is also increasing.
Again, we haven't seen it yet translate into tremendous increase in leasing activity, but that is the early indicator in our minds of an improvement. And lastly, we believe there is some, what we believe, some irrational hysteria about office that is leading many of our competitors to not be able to access capital, not be able to provide tenant work for their clients, have them be interested in selling their assets, and we think that's creating very interesting opportunities for us to keep our buildings more full from new clients, but also to make accretive acquisitions, which we're working on. So, point number one, macroeconomic. Second, and related to my last point, we're building share as a company.
We are seeing clients coming to us saying, "You know, you're one of the few landlords that we are talking to..." And this, by the way, this is particularly true in Washington, D.C., "where we are confident that you will fund the TI, pay our broker, and it's helping us grow share." And our company, even though the Washington, D.C., market's been challenged by the GSA not coming back to the office and so forth, that last year, we outperformed our goals in Washington more than any other market because of this competitive dynamic. We're also talking to counterparties about deals. These are banks that are taking over real estate or other institutional owners that want to exit real estate, and there are very few counterparties that they can talk to that can execute and scale.
We often hear from these counterparties, "We don't know who else to call that has the scale, the balance sheet, the commitment to office, the stability, and the skill to help us achieve our goals." And, you know, we experienced some of that in the fourth quarter. As you know, we bought in significant joint venture interests in three of our assets in the fourth quarter because we could. And, again, obviously, we thought they were great investments, and we don't think that our, we think our partners were had a strategic redirection as opposed to making necessarily what we think in the short to medium term is a financially rational decision. And then lastly, given all that dynamic, you know, we think that our stock is just undervalued.
You know, if you look at almost every historic measure, our stock from peak is down about ± 55 % , and our FFO per share is roughly the same as it was at that time. So it's been obviously a reduction in multiple. If you look at where our dividend yield is and all these other metrics, we think this is a very interesting entry point. So, those are the three reasons.
That was very interesting and helpful. I guess if we try to blend a few of those ideas together, right? So obviously the absolute valuation is maybe frustrating, but maybe the relative stability of the balance sheet in the company right now is a relative advantage. How do you think about kind of trying to create value in that environment? Right, so either from the leasing perspective or from a capital allocation perspective, you know, kind of rocky, rocky seas, but a good ship.
Yeah. So, well, a couple things I'd say. First, let's just talk about the existing portfolio. You know, our occupancy today is, you know, high 88%, 88%-89%. At the peak, and we think the company could stabilize at an occupancy of around 93%. We're not suggesting that we think we're going to get there in a quick period of time, but that's the opportunity. And if you do all the math on that, there's ± $0.80 of FFO per share in just leasing up our portfolio back to what it was before the pandemic. So I would start there. Then second, again, I talked about investment opportunities that we can make. At last quarter, we announced 3 acquisitions.
Our investment upfront for those three acquisitions was $40 million, and we took on a $41 million funding requirement. And in return for that $80 million commitment, we accreted our earnings in 2024 by $0.14 on 179 million shares. So, now some of that accretion was not cash, it was, you know, again, GAAP, FFO, but that's very material. So our look-through cap rate today is ± 7.25% , and so we are going to be attempting to make acquisitions that are accretive to that number, and that could further grow our FFO per share. And then lastly, I think this is harder to do, but we do have a handful of sites where we are talking to potential users about building significant buildings.
The yields on these would be accretive to the company at our current cap rate. I think these are hard to do because the rents required to create new construction, given the inflation and given the higher capital costs, are materially above market rents. But these discussions are underway, and we'll see if we're able to accomplish it.
When you think about that occupancy opportunity, how much of that is related to kind of the corporate earnings and maybe the need for space there that's incremental versus kind of the pie either shrinking or taking from other kind of buildings that are currently occupied? So kind of the BXP position versus the broader office leasing environment.
Yeah, well, I think we could get it from both. I think it's hard to say exactly the mix. I can tell you right now in Washington, D.C., there's no question that we are building market share relative to our competition. I think that could readily migrate into some of the other markets. And if you believe the premise I mentioned earlier, that corporate earnings are going to spur better leasing activity, there should be more growth amongst the clients that we serve and we want to serve going forward.
And then from a negotiating power with tenants, how are leasing economics changing relative to how you've seen in the both near and medium term?
Nick, this is Doug. I would say that the dynamics are different, obviously, market by market. And the, you know, the East Coast is clearly ahead of the West Coast relative to overall demand, largely because of the nature of where that demand is coming from. And so we are actually seeing net effective rent improvements in a market like Midtown Manhattan, and in our Back Bay portfolio of Boston. Pretty status quo in the other markets on the East Coast. And we're seeing a modest amount of pressure on NERs, not really in face rates, but in the transaction costs associated with the deals that we're doing on the West Coast.
Owen, you've characterized the majority of your CBD portfolio as Premier workspaces. How are these assets differentiated from what we typically see in CBD office markets in terms of tenant demand and interest?
So, we didn't just say they were Premier Workplaces; CBRE said they were Premier Workplaces. We... I think I've mentioned this probably last year, too. A couple of years ago, we saw a strange phenomenon, which was our leasing activity remained strong, but the vacancy in all of our markets went up. And so, we went to CBRE Econometrics and suggested that they start looking at office markets bifurcated by quality as opposed to submarket locations and things like that. Because they kind of look all the same, the vacancy rate, but if you look at the vacancy rate by quality, it's very different. So what's the definition of a Premier workplace?
Well, we think about it and say, if you're a leasing broker and you have as your client an industry-leading company, you know, let's say, Citibank or Google in the technology space or Kirkland & Ellis as a law firm, and again, I don't mean to leave any companies out, but if you have a client like that, that's looking for space and every building was empty, which ones would you show them? So it kind of, it's, look, new is better than old, but old buildings aren't necessarily bad if they have park views and great amenities, and they're well cared for, and they're close to public transportation. That's what we think about, right? We love to have new buildings, but what we really want are buildings that appeal to those kinds of clients.
So that was the, that was the ask. And so they went in and they took our five CBDs, and they bifurcated the market between the Premier workplaces and everything else. And it turned out that about 17% of the space and about 10% of the buildings were, quote, "Premier." 94% of our space was Premier. So we're clearly operating in that bucket in the CBDs. And if you look at the performance of those assets over the last 2 years, the net absorption for the Premier buildings has been a positive 9 million sq. ft, and the net absorption for everything else, the other 90%, has been a negative 33 million sq. ft. The vacancy rate, direct vacancy rate, is about 5 and 5.5 percentage points lower for the Premier buildings than everything else.
Asking rents are about 37%-40% higher. So, that was our definition of Premier. That was what they came up with. That's based on their discussions with their leasing professionals. And we, by the way, we publish all this data in our quarterly report. We have been for the last two years.
I'm curious then on the suburban part of your portfolio, do you have a sense of where that would fit into this higher quality Premier Workplace sort of strata that you've talked about?
So, Michael, there are sort of two suburban portfolios with BXP, and one of them is sort of probably poorly characterized. So our Northern Virginia properties in Reston are really an urban oasis of Northern Virginia, and I wouldn't consider them to be, quote, unquote, "suburban," and they are all clearly Premier properties. Then we have two other larger portfolios. One is in the Greater Boston, Waltham, Lexington submarket of 128, and it's a hodgepodge out there. We have some buildings that are very vacant right now, largely because we were considering repositioning them to a different use, mostly life science. And so we actually vacated those buildings.
And then we have our campus in Princeton at Carnegie Center, and if you were to do a survey of Northern Virginia, there is no question that Carnegie Center would be far and above everything else from a suburban perspective in terms of quality. And then finally, the last portfolio, which is really, it's really R&D, it's not suburban office, is our Mountain View portfolio in the greater Silicon Valley, and that is, that's makerspace. Those are single-story buildings that are used by automotive companies and power companies and companies that are doing pharmaceutical work, and actually a company that was doing work with X-rays. And I'd say they're a different sort of characteristic.
What I would say is that we have seen that the overall interest in and the desire of suburban assets, excluding the Reston Town Center again, is a lot lower than it's been in the urban locations. And so when I hear, you know, or read about the sort of nirvana of a suburban office building because of its, quote, unquote, "proximity" to where people live, we don't see it. We don't see it in our utilization rate. We don't see it in our activity from a demand perspective. And these are not, you know, what I would refer to as highly amenitized retail environments. So they're generally buildings that are highly convenient from a transportation perspective using an automobile, but that's their major draw relative to where they were located.
The other thing, Doug, that I would just add is the performance of these assets. So the CBD assets in Reston, on a year-over-year basis, have gained over 100 basis points of occupancy, and the 10% of the portfolio that is other suburban lost about 500 basis points of occupancy. So while our overall occupancy is generally flat, the Premier buildings are having positive absorption, and the CBD buildings are having positive absorption, and the suburban buildings, that some of which Doug described, are the ones having the negative absorption.
And just to add to that, to the scale, so of our company right now, 80% of the NOI is CBD, 20% is suburban. And I think of the suburban, half of that is Reston Town Center, which I could argue is not suburban, as Doug mentioned.
So that gives you a little feel for some of the relative scale numbers that we're talking about.
And next, maybe just a question on valuation. Obviously, we haven't seen a lot of high-quality trophy office assets trade recently, but do you have a sense for where valuations are shaking out for these Premier Workplaces and how they have held up relative to their pre-pandemic valuations?
So the question is unanswerable because it hasn't happened, and we are hoping that we, through our own actions, will be able to answer that question in the coming quarters. The one comp that I would throw out there is, last year, right before the NAREIT conference, we sold a 45% interest in two life science developments that we have in Cambridge. It was a $750 million equity raise, which I think was amongst the largest that were done in the private market in the U.S. last year. And their developments, these are great assets. They're very well located. Their labs, their credit tenants, 15-year leases, 3% bumps, etc. So it had every positive bell and whistle you could have.
But if you bump through the numbers of it, it basically is about a 5.9% cap rate. So I kind of look at that and say, that's probably the bottom. And we don't know yet where assets are going to trade, but it's clearly going to be above that.
I think the thing that the reckoning that hasn't occurred yet, particularly with large urban assets, is how do you capitalize the purchase? The debt markets are no longer what they were in the last decade, and so the idea that you're going to be able to finance 70% + of any kind of a new acquisition, I just don't think is reasonable. And that means that the equity checks that are going to have to get written are going to be significantly larger than they once were.
And if, you know, your cost of debt is for a secured financing somewhere in the high 6s-low 7s on a pretty low loan-to-value, meaning probably 40%-45%, that, that means that you're going to need a pretty high return on equity or a high cap rate to get to a high return on equity for that investment. And I don't think anybody has sort of accepted that or acknowledged that yet, and that's what's going to have to happen when somebody ultimately tries to sell one of these high-quality CBD buildings.
I guess, where would you think about underwriting, just if you were doing an acquisition or, you know, you've talked about going on offense potentially. How do you think about underwriting? What sort of IRR would you need to transact right now on the buy side?
Well, IRRs we look at, but we've mainly focused on initial yield, and our look-through Cap Rate right now is, we think, around 7.25, and that is clearly a milestone for us as we think about making an acquisition because we want it to be accretive to shareholders.
Owen, you expanded in your prepared remarks about those recent joint venture partner interests that you acquired, they announced in the fourth quarter. Were these transactions more specific to the partners wanting to decrease their exposure to office real estate, or is this the start of a broader trend of distressed deals within the office market?
I think that, we bought in three interests from two different partners, and I think that the motivations by the two partners were a little bit different. The spark for each deal for the two unwinds was the same, was we did our job, we renewed the anchor client in two different assets. When you do a big renewal, obviously, there's a capital need to do the tenant work, the leasing commission, and building refresh, and each of these partners decided they didn't want to invest that capital and wanted to come out. So the spark was the same, but I think the motivations were different. So let me explain. On 901 New York Avenue, which is in D.C., the partner there had been with us for 20 years.
They were the partner in the original development of the asset, and I think they saw it as, "Look, this building's now going into its next phase. You're renewing the anchor client, which is more than half the property, and, you know, maybe this is a good time for us to get out." I mean, 20 years is a long time for a private equity investment in any building. So, obviously, we didn't, we didn't want them to come out, but if they wanted to come out, we think we negotiated an attractive acquisition price for our shareholders. The other partner, however, had not been with us for the same period of time. It was the renewal of Snap at Santa Monica Business Park, which was a, you know, a very significant renewal, again, creating a capital need.
That partner had only been in that project probably four to five years, and I do think in that case it was a change in strategy, reduction, a lack of interest in increasing, investment in office. And then tied to that deal was the third transaction, where that same partner came out of New York. So again, I... And by the way, I think with, in the private equity world today, I think you get all kinds of different answers.
I mean, there are going to be some clients, like the ones that I just talked about, who are saying to various degrees, "We don't want to invest more in office, or we want to reduce in office." But then, you know, late last year, we did a $750 million joint venture with Norges, and they materially increased their joint venture interests with us and their investment in a certainly a highly correlated or highly related asset class. So I don't think you can conclude that all institutional investors want to come out of office. I think some clearly do, and others see the opportunity and want to do something about it.
Maybe we can just turn to leasing expectations for the year ahead. I believe you've commented in the past that, you know, an expected run rate is probably around, you know, 3 million sq. ft., call it 750,000 sq. ft. a quarter. Have you noticed any pickup maybe from larger space users in terms of making real estate decisions? And then this question probably mostly pertains to San Francisco, but do you need tech leasing to come back in order to drive occupancy?
So the answer to your question, Michael, is that for 2023, we offered, you know, a view of about 3 million sq ft of 700,000, 750,000 sq. ft. per quarter, and we actually accomplished 4.2 million sq. ft.. And so for 2024, we said we think we're going to do somewhere around 3.5 million sq. ft.. So, you know, a modest increase.
As I look at our overall portfolio today, in terms of active leases under negotiation, meaning there's an actual lease document that is being negotiated with a lawyer, someone who pretends to be a lawyer, that number is about 1 million sq. ft. right now, and that's a pretty consistent number, sort of where we started the third quarter of 2023 and the fourth quarter of 2023. So my expectation is that the leasing markets for us in 2024 will be similar to the way they were in 2023... With regards to San Francisco, our portfolio is primarily in San Francisco, what I would refer to as non-tech. Professional services, legal, financial services, asset management, etc.
Where our availability is, is at Embarcadero Center, first and foremost, and that is clearly in that profile. But we also are going to be getting back about 250,000 sq. ft. of space in a building at 680 Folsom Street, and that's a tech building. It's actually a fabulous tech building, but it is a tech building, and so we do need tech demand for that. What I would tell you is that the tech demand in San Francisco continues to be soft. It's mostly smaller tech companies, meaning 20-50,000 sq. ft., not 150-300,000 sq. ft.. I think the two deals that were done in the third quarter with Anthropic and OpenAI were unusual transactions for the current environment in San Francisco.
We don't need to have the tech market, quote unquote, "recover" in order to maintain our occupancy. We do need the tech market to improve, primarily down in the Silicon Valley, for us to exceed our expectations for occupancy during the year. We also need to see some improvement in both West LA and in the Seattle marketplaces. I would tell you that Seattle is starting to feel a little bit better. While we aren't doing many transactions right now, the volume of leasing interest that we have in 2024, in the last 2+ months, exceeds the amount of interest we had in 2021, 2022, and 2023 combined. There was literally nothing going on up there.
There were a number of large leases that were done in Bellevue in the third and fourth quarter that I think have sort of spurred people in the entire market to sort of say, "All right, let's get on with life, and we need to start moving around." I don't think it's necessarily gonna be net absorption, but it's gonna be leasing activity. Down in West L.A., again, in San Francisco, on the West Coast, it's really for our portfolio about the media business and the gaming businesses, and those streaming sector kinds of companies. And there's obviously a lot of interest, you know, in what's going on with those types of businesses right now in terms of consolidation, profitability, M&A. So I think that market is pretty quiet on a relative basis.
My expectations for 2024 are that our East Coast portfolio will continue to improve and will outperform, and our West Coast portfolio will get better and will have a consistent performance in San Francisco, and we're hoping for a little bit of pop in Seattle, and if we get, you know, even luckier, we'll have something happen in West L.A..
I think you've mentioned at previous conferences that, you know, the top 20% of office space is seeing the lion's share of demand versus the bottom 20% that's almost functionally obsolete, and it's that middle 60% that really remains to be seen what happens with that. I think according to, you know, a recent report from CBRE, they say about 15%-20% of office demand has gone away due to hybrid work. Would you agree with this? And, you know, of that middle 60 bucket that I laid out, how much of that do you think will be feasible for office versus will be, you know, more commodity and increasingly obsolete?
So, Look, there, even though I mentioned earlier that I thought for our business, that earnings were more important than work from home, I do believe that work from home is creating a permanent bite in office demand. And I think that is primarily driven by what companies are doing with their support staff. So if you look at accountants, IT professionals, HR, a typical corporation will say, "Anybody that's client-facing, product-facing, you know, revenue-facing, we want, we're gonna give them a workstation, and we want them in the office as much as possible." And I, the support areas are not in the same category. And many companies have said that those employees can work remotely, or maybe they only have to come in one day a week, and they generally don't have fixed workstations.
Companies have, you know, open pools, floating hot desks, and maybe they have, you know, 1.5-2 people per workstation. But I think that's why what we do has been more insulated from this reduction in demand, because we have the premium buildings that get a premium rent, and companies don't generally put their support staff in our properties. They're putting their front office staff because they want to recruit them and retain them. But anyway, coming now, Michael, to your question, so, I do think the demand is gonna be less. I mean, look, the demand will keep going up with the economy, but it took a step back because of this phenomena. And I do think it's gonna have a much greater impact on the B and C properties, as you suggest.
I do think the market's trifurcated. I think you got the Premier for the front office workers, or for the premium clients. There's. Look, every product has a value segment, right? Not everyone can or wants to pay premium rent or pay for the premium product. So there's clearly a segment of the office market that will accommodate the more value-conscious customers. So there and there will be a strong and I think you know active market for that. And then, as you said, I do think there's a pretty significant percentage of office stock that either needs to be demolished or made into something else. What are those exact percentages? I really don't know. But that's the way I would trifurcate the office market.
And then just maybe some thoughts about occupancy. I think you guided to be modestly down in 2024 relative to 2023, but do you think that we've hit the bottom and we'll maybe see an inflection point in office occupancy? Or do you think there's more declines to come?
We would hope that we are at the trough, and that we're going to start to, you know, get on the slope going up. I can't tell you how steep that slope is going to be. The issue is how much positive absorption will we have? Because I think that, you know, positive absorption is going to determine how the markets are reacting. As I think we said during our, you know, guidance call last quarter, we're not anticipating any positive absorption, which means we are going to be gaining market share from those customers who are simply looking to potentially relocate, you know, their premises from a building in the market to another building in the market. And so, you know, that's hand-to-hand combat effectively.
You know, one of the things that has happened is that in many of our markets, there are a lot of buildings that are not necessarily functionally obsolescent, but that are capital obsolescent. Meaning there is no ability in 2024 or 2025 for the existing ownership to provide transaction capital to do leasing. And that's happened in spades in Washington, D.C., and it is starting to happen meaningfully in San Francisco. And so as those sort of issues permeate the markets, we believe that we will capture a, a larger component of the demand. There will always be competition. There will always be a group of landlords who are prepared to invest capital, but the number of those opportunities are going to get smaller, and where the space is available is also going to change.
We hope that, you know, this year is going to be a sort of turning year, where we're, again, continuing to gain market share, even though the markets are not absorbing more space.
Maybe just to finish up on life science demand, Doug, your comments seemed a little more constructive just kind of around long-term demand than I think in recent quarters. I mean, how do you see the kind of pipeline of opportunities, I guess, both in, you know, Waltham and South San Francisco? You know, how long is the lag time from the capital formation in terms of VC funding or IPOs until firms look to lease space?
Yeah, so I guess, you know, what you have to do is you sort of have to look back to what was going on in 2014, 2015, and 2016 before the cheap free capital bubble hit the life science sector. And I think that we are starting to see, you know, an improvement in the underlying valuations of the companies that are being funded. And as those companies have successful FDA processes and they start to get closer to commercialization, they will be able to achieve additional valuations and get more capital, and then they will expand. And, you know, obviously, the changes in the way the science is being done now are making that a much more rapid process.
So I think relative to where, where it would have been in 1990 or 2000, it's dramatically accelerated. But I, I can't tell you if it's six months or nine months or 12 months, but it's, it's going to be quicker than it would have been in past cycles.
I know we're running up on time. We've got our three rapid fires to end the session. What is the best real estate decision today: buy, sell, develop, redevelop, or pause?
In our space, I think buy.
What is your expectation for same-store growth for the office sector overall for 2025?
What do you think, Mike?
I think it's probably 3%-3.5%.
Lastly, will there be more, fewer, or the same number of publicly traded office REITs a year from now?
I always say fewer, and I'm right half the time.
Great. Thank you so much.