Boston Properties: Superior Property Portfolio But Office Outlook Remains Weak

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Boston Properties is a REIT that owns office real estate across major developed cities like Boston, Los Angeles, New York, San Francisco, Seattle, and Washington, DC.The company has a portfolio of ...

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Kawisara Kaewprasert/iStock via Getty ImagesIntroduction Boston Properties, Inc. (NYSE:BXP) is a real estate investment trust (\"REIT\") that owns office real estate across major developed cities across the United States. While the company has a portfolio of good assets with lower vacancy rates than the comparables for similar property types in similar cities, the office market outlook remains particularly weak and there are a number of trends like interest rate headwinds, work-from-home, and migration factors that are likely to persist. These factors give me some confidence that while the market prices in a more rosy outlook that office real estate may take a lot longer time to recover than what people anticipate. In this article, I'll discuss my rationale for avoiding shares of Boston Properties despite its portfolio of quality real estate and safe dividend and my reasons for rating the shares as a 'hold'. Company Overview Boston Properties, Inc is a REIT that owns several office properties in major markets across the united States. It primarily operates in developed cities like Boston, Los Angeles, New York, San Francisco, Seattle, and Washington, DC, most principally in premium central business district areas (78.5% of total NOI comes from CBD areas). With a total of 188 properties (some of which are owned by the company and others that are owned through joint ventures), the company has a total of 53.3 million square feet of land to its name. Out of the 188 properties, 167 are offices, 14 are retail properties, 6 are residential, and one is a hotel. Investor PresentationBackground Overall, I like the geographic diversification that Boston Properties has. But when we look at the U.S. Office Market Outlook report by Colliers, these markets have fared pretty poorly. For example, despite the national average U.S. office vacancy rate at 16.9%, cities like Boston, Los Angeles, Seattle, Washington DC, and San Francisco have fared far worse with vacancy rates of 23.1%, 21.8%, 25.4%, 18.4%, and 27.9%, respectively for Downtown Class A. Only New York has a better vacancy rate than the national average at 13.1%. U.S. Office Market Vacancy Rates (Colliers)Keep in mind that these rates are for Downtown Class A, which most of Boston Properties' offices are. Interestingly, in most of these markets (Boston, Los Angeles, San Francisco), the Downtown Class A properties have higher vacancy rates than the suburban office properties. So despite the notion that Downtown Class A is higher quality, it's actually been hit the hardest and has proven to be less resilient than suburban over the last few years. One positive for Boston Properties is that these markets tend to be more liquid, with Manhattan, Los Angeles, and Boston having the highest active sales market by volume in 2023 at $4.6 billion, $3.6 billion, and $2.7 billion. But when you compare Downtown Class A (premier) to the rest of Downtown (non-premier), we can see from the graph below that there's been a widening divergence between vacancy rates as well as rents between premier and non-premier assets, both data points favoring premier office properties. This data, collected by CBRE and presented in the company's investor presentation, is consistent with the Colliers report, but the findings are interesting when you compare Downtown Class A to the rest of Downtown and Downtown Class A to suburban. Investor PresentationWhen we compare Boston Properties' vacancy rates to the rest of office, it doesn't look so bad. Boston Properties' portfolio is 88% occupied so the vacancy rate is around 12%, implying that its been generally more resilient and likely has a better quality portfolio. We see this clearly with the tenant mix of the portfolio. No one client makes up more than 4% of the company's rental revenues and most of these companies are Fortune 500 companies like Salesforce (CRM), Google (GOOG), and Microsoft (MSFT), to name a few.   Top Tenants (Investor Presentation)Even amongst the end markets that these companies serve, it's not just technology companies or just companies in one industry. While technology and media does make the largest portion at 21% of rental revenues, financial services, legal services, and life sciences are all well represented so there isn't much concentration risk here.   Industry Diversification (Investor Presentation)Outlook When looking at the latest Q4 and full year results for Boston Properties reported earlier this March, the company reported NOI of just under $2 billion which represented an increase of 3.59% year over year. Most of this was as a result of new properties added to the portfolio, as net operating income on a same property portfolio basis was essentially unchanged (down 0.31%). The new properties were primarily attributable to three main ones, notably Madison Centre (Seattle), 125 Broadway (a $603 million life sciences property in Boston), and Santa Monica Business Park. Collectively, these added 2.2 million square feet to the property portfolio, partially offset by some office/flex and residential properties which were sold. Recent Results (Company Filings)From a funds from operations (FFO) perspective, Boston properties actually saw a decline of 3.4% from $1.18 billion in 2022 to $1.14 billion for 2023. Dividing the $1.18 billion by the weighted average shares outstanding at the quarter end date gives us an FFO per share value of $7.29, which was also 3.4% on a per share basis against last year's $7.55. So overall, Boston Properties seems to have performed in line with what we might have expected based on the findings from industry reports about office. FFO Breakdown (Company Filings)Looking out into the future, it's hard to find a concrete catalyst that will propel Boston Properties shares higher. For one thing, management wasn't so upbeat on the earnings call, forecasting just $7.28 per share in FFO, implying zero growth for 2024. This guidance includes assumptions about various properties reaching completion during the year so I would expect that on a same property portfolio basis, we're likely to see declines again for the year. Development Pipeline (Investor Presentation)One of the largest contributing factors in terms of how office real estate will perform over the next few years will be the impact of interest rates and what happens to the yield curve. In CBRE's U.S. Real Estate Outlook report, the real estate services firm sees office performing negatively, but vacancies should peak at 19.8% sometime later this year. Based on this, real estate values are likely to decline 5% to 15% as cap rates rise. One thing I found interesting was that the markets that are expected to perform well are Las Vegas, Miami, and Nashville (markets that Boston Properties doesn't have exposure to) and the markets that are expected to do poorly include many of the markets that the REIT is located in. In Las Vegas for example, the vacancy rates have already started to narrow with positive net absorption. To me, there are likely better markets to be exposed to, especially considering the exodus of high income earners leaving due to high taxes and high cost of living. This also shows up in census data which shows definitively that the population in markets like New York is in fact declining. In my view, I think the pandemic has likely changed migration trends and factors like work from home are here to stay. A large number of jobs (including my own) allow individuals to work in hybrid working environments or entirely remote. According to Forbes, at the end of 2023, about 12.7% of full-time employees work from home, while 28.2% work a hybrid model. By 2025, its projected that 22% of the workforce will work remotely. That doesn't bode well for office real estate and certainly not for Boston Properties. As for the company's balance sheet, Boston Properties is highly levered. The main items as far as debt goes is $4.2 billion in mortgage notes, $10.5 billion in senior unsecured notes, and an unsecured term loan for $1.2 billion for total long-term debt of $15.9 billion ex-leases. With $1.6 billion of cash, this brings the net leverage to about 7.4x and the fixed charge coverage ratio to about 2.5x. This seems quite high risk, however management noted that they are comfortable with the current leverage in the capital structure and don't anticipate increasing its net leverage ratio from here. As for the maturity cycle and credit ratings, most of the debt is laddered and has been secured at fixed rates. The credit outlook according to S&P and Moody's is stable with an A- and Baa2 rating, respectively (source: TD Securities). Mortgage Notes Payable (Company Filings)Unsecured Senior Notes (Company Filings)Valuation Based on the 13 analysts who cover the stock, there are 5 'buy' ratings and 8 'hold' ratings on Boston Properties with an average price target of $74.00, a high estimate of $80.00, and a low estimate of $67.00 (source: TD Securities). From the current price to the average price target one year out, this implies potential upside of 17.0%, not including the 6.2% yield. With 23.2% total return potential, it seems that despite the predominantly hold ratings that analysts are bullish on the near-term upside of the stock. Overall, I disagree with the analysts' consensus here, noting that most of the target revisions upwards were due to multiple expansion over the last few quarters, rather than rating upgrades and adjustments upwards in FFO. Thus, I don't see a reason to assign the company a higher multiple from here on out. Despite the FFO outlook being flat for 2024 as per management's guidance, the stock is up 25% in the last twelve months. This gives it a forward multiple of 8.6x, which seems reasonable, especially against peers like $Vornado Realty Trust(VNO-N)$ (VNO), Kilroy Realty (KRC), and SL Green (SLG) who have P/FFO multiples of 9.2x, 7.8x, and 8.2x, respectively, so it does trade at a small premium to the group. Investors should keep in mind however that FFO is unlikely to grow much from here. Data by YChartsBoston Properties 6.2% dividend yield appears to be supported sufficiently with FFO having not been cut at all during the pandemic. However, with an over leveraged balance sheet and limited FFO growth, it's also unlikely we will see dividend increases going forward. Until we see a meaningful rebound in office real estate, I'm not confident in the REITs ability to raise its dividend. Seeking Alpha Conclusion  In summary, Boston Properties seems to own quality assets given its vacancy rates are lower than Downtown Class A properties in comparable markets. However, with several factors including work-from-home, interest rates, and migration trends, office real estate, particularly in the markets that BXP is in, are being hit a lot harder which makes me think that a recovery is unlikely to come any time soon. With the company's shares having rallied over the past year, it seems that the market is pricing in a more rosy outlook. In addition, while the company doesn't seem expensive at 8.6x P/FFO, there isn't much room for FFO growth and management's guidance imply a decline in NOI on a comparable property basis in 2024. As such, despite its superior property portfolio with diversified and long-term tenants and my confidence in the REIT's ability to maintain its dividend, I rate shares of BXP as a 'hold' until we start to see signs of improvement.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2422927727"}