BXP - Q1 2024

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to BXP's Q1 2024 Earnings Conference Call. At this time, all participants are on a listen-only mode. After the speakers' presentations, there will be a question-and-answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. 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 (VP of Investor Relations)

Good morning, and welcome to BXP's Q1 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 attained.

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 (CEO)

Thank you, Helen, and good morning, everyone. BXP's performance in the Q1 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 Q1. We completed just under 900,000 sq ft of leasing, which is 35% greater than the Q1 of 2023, when we leased 660,000 sq ft. And this is a more relevant comparison than to the Q4 of 2023, given elevated leasing activity associated with a 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 had 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 are 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%-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 Workplaces, defined as the best 6% of buildings, representing 13% of total space in our 5 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 sq ft over the last 13 quarters versus a negative 30 million sq ft 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 Q1. Regarding the real estate private equity capital markets, office sales volume in the Q1 was down $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 continued 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 advisors 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. Though Doug will provide more details on leasing, we're off to a good start in the Q1 and see a growing pipeline of opportunities for later this year and 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 class. 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 agree 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 that 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 co-investing with us for select opportunities. On development, we commenced our 121 Broadway residential tower in Kendall Center as part of the 1 million sq ft 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 amenities, 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 sq ft DICK'S House of Sport 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 H2 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 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 $30,000,000, 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 Q1.

These projects aggregate approximately 3.2 million sq ft and $2.4 billion of BXP investment, with $1.3 billion dollars 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 in 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 (President)

Thanks, Owen. Good morning, everybody. I hope what you're gonna hear today from me is you're gonna view as a pretty constructive perspective on what's going on in our markets and what's going on with our, our revenue picture and our leasing picture. As we sit here at the end of the Q1, 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.

While we are not gonna see broad reports of shrinking availability across any market until there is a pickup in white-collar job formation, there are pockets of supply constraint 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 were up about 23% 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 increase 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've been up about 6%. As Owen stated, the seasonal trend line of BXP's leasing activity in the Q1 of 2024 picked up relative to what we experienced in the Q1 of 2023. This quarter, we completed 61 transactions, 32 new leases for 494,000 sq ft, and 29 renewals encompassing 399,000 sq ft.

We had three expansions totaling 18,000 sq ft and four contractions totaling 44,000 sq ft. As a point of comparison, in the Q1 of 2023, 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, Q4 of 2023, we signed 37 lease renewals and 37 leases with new, new clients, and there were eight contractions and nine expansions among our existing clients. This quarter, new leases encompassed 55% of the volume.

Activity was across the entire portfolio, with 178,000 sq ft in Boston, 225,000 sq ft in the New York region, 154,000 sq ft from the West Coast, and DC led the pack with 336,000 sq ft. To give you some additional color on this activity, there was only one transaction greater than 60,000 sq ft, which was a 215,000 sq ft long-term law firm extension that included a 25,000 sq ft contraction in DC, although that same law firm took an additional 7,600 sq ft 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 DC markets. Equally important is our pipeline. Post March thirty-first, we have over 875,000 sq ft 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 managed 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 at 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 sq ft, which includes 624,000 sq ft that is anticipated to commence in 2024.

We also have signed leases with new clients for another 534,000 sq ft of currently occupied space. 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 advisors. 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, 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 portfolios 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's been a strong pickup of client activity in our Urban Edge Waltham portfolio. We have an 80,000 sq ft tech client expiring in 2024, with a plan to downsize to 16,000 sq ft.

This quarter, we completed a lease for 45,000 sq ft and are in negotiations with two other clients, new ones, for another 37,000 sq ft of that expiration. 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 sq ft lease with an existing subtenant to extend when their prime lease expires in 2025. We're negotiating a 25,000 sq ft lease with a lab user for a portion of our availability on Second Avenue, and we're negotiating a 55,000 sq ft lease with a non-tech company in a different building. None of these transactions, more than 220,000 sq ft, 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're 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, Bechtel, Leidos, SAIC, Peraton, CACI, 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, it is also a natural location for small businesses and the financial services and legal industries. This quarter, we completed a 58,000 sq ft lease with a new technology client at Reston Next, that's moving from a Dulles Toll Road building, an expansion for a law firm, and we are seeing a pickup in small tenant activity relative to 2023, 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 built, inexpensive space. While there is an abundance of available space in the city, there continues to be outsized demand for view space north of Market relative to the available supply.

We completed a 35,000 sq ft lease with a boutique financial advisor at Embarcadero Center this quarter, that was only interested in view space north of Market. We're negotiating six transactions with new clients, totaling 40,000 sq ft, as well as an 80,000 sq ft renewal with a law firm that's retaining their existing footprint. 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 two quarters. We completed a lease with a new client on a 10,000 sq ft pre-built suite, and are in negotiations with a law firm for a partial floor and discussions with a technology company for a full floor.

West LA, 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 LA area. As we forecast during our last call, our occupancy declined, oh, so slightly from 88.4% to 88.2% during the quarter, with the known expiration of 230,000 sq ft in Princeton, where, as I mentioned, we have signed 80,000 sq ft of new client deals this quarter that will commence this year.

We have two additional large lease expirations across the portfolio in 2024 that will occur during the Q2, 200,000 sq ft at 680 Folsom in San Francisco, and 230,000 sq ft at seven Times Square, where we own 55%. Occupancy will drop in the Q2 and recover as we move into the Q4. Mike's going to spend some time discussing changes to our interest expense outlooks 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 bid potential stick frame residential, the project's owner was describing earlier. But escalation assumptions are now normalized. No more 8% to 9%.

The changes to the building and 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, and the longer 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 where 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 (CFO)

Great. Thank you, Doug. Appreciate it. Good morning, everybody. This morning, I plan to cover the details of our Q1 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 gonna start with a summary of some of the changes in our debt structure. In early February, we paid off $700,000,000 of unsecured notes with available cash. That was in line with our plan. We also entered into a $500,000,000 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 $500,000,000 for terms ranging from overnight to one month at a weighted average rate of SOFR +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 $700,000,000, which will reduce our borrowing costs on $500,000,000 by 75 basis points, or about $0.01 per share in 2024. In addition, we increased our corporate line of credit by $185,000,000 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 Q1 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 $10,000,000 or 1.3%, and our share of portfolio NOI is also higher of $6,000,000 or 1.2% from last quarter. High interest rates are our biggest earnings challenge. This quarter, our interest expense increased $7,000,000 sequentially. It's important to point out that more than half of this increase was due to higher non-cash, 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 Q1, and it was equal to our Q1 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 till later in 2024. This was offset by higher than projected net interest expense of $0.02 per share, primarily from higher non-cash, 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 additional $0.05 per share of non-cash, fair value interest expense in 2024 relative to the estimate we used when we provided our guidance last quarter.

This non-cash 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 4 rate cuts commencing in the Q2, 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, 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 Q2, before improving in the back half of the year. Our assumption for same property NOI growth of -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 reasons for the reductions are $0.05 of higher non-cash, 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 15th May. If you've 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?

Operator (participant)

Thank you, sir. As a reminder, to ask a question, you will need to press star one one on your telephone. To withdraw your question, please press star one one again. We ask that you please limit yourselves to one question, and if you have any follow-up questions, please feel free to rejoin the queue. Please stand by while we compile the Q&A roster. I show our first question comes from the line of Nick Yulico from Scotiabank. Please go ahead.

Nick Yulico (Managing Director)

Thanks. Yeah, I guess just a bigger picture question maybe for Owen. You know, how you're thinking about all the different, you know, opportunities out there. You know, you mentioned that there could be some acquisition opportunities. You did just launch 121 Broadway, which is a substantial, you know, capital commitment. You have, you know, a stock price I'm sure maybe you're not, you know, happy about. So I'm just trying to understand, like, how we should think about, you know, the investment focus right now for the company and you know, how you expect to fund that via, you know, whether you're looking to issue equity, would you buy back stock? You know, anything along those lines would be helpful. Thanks.

Douglas Linde (President)

Yeah. Yeah, so, Nick, a couple of things I would say. First, let me start with 121 Broadway. It's a fantastic, new building, residential building that we're building in Cambridge, but it was also launched as part of the requirements to achieve 1 million sq ft of commercial entitlements in Cambridge. It was a requirement of that, of receiving those entitlements. And those entitlements allowed us to commence the 290 Binney Street development, and we still have FAR available for, 1 or 2 additional, commercial buildings. But, again, you have to think about that development as tied into the 290 development that we commenced, last year. In terms of new investment opportunities, as I described in my remarks, there's a tremendous amount of dislocation going on in the office sector.

You've got lots of overleveraged assets, and you have also a number of institutional owners that wanna decrease their exposure to office. And this is gonna create opportunities for us. You know, when we look back at prior down cycles in real estate and in office real estate, those were periods of time where BXP significantly enhanced its portfolio with acquisitions like 200 Clarendon Street, GM Building, and others. So we wanna participate. We think that's gonna happen again this cycle, and we wanna participate in it. And as we do that, we are paying very close attention to obviously accreting our earnings over time and also watching our leverage. And, you know, I think each transaction will have to stand on its own in terms of how we fund it.

Operator (participant)

Thank you. I show our next question comes from the line of Steve Sakwa from Evercore ISI. Please go ahead.

Steve Sakwa (Senior Managing Director)

Great, thanks. Doug, I guess I wanted to just maybe follow up on your, you know, positive commentary on leasing and just, you know, maybe get a sense for, you know, how much of this is for the existing portfolio, how much of this is for the development pipeline. And I realize, you know, we're getting sort of close to the middle of the year, so any of the leases being signed are, are probably really more of a 2025 beneficiary than they are gonna be a 2024. But, you know, just how do you think about building up the occupancy on the existing portfolio and, you know, as importantly, filling up, you know, the vacancy within the development pipeline?

Douglas Linde (President)

Yeah. Thanks, Steve. So, of the activity that we have in our pipeline, and I'm gonna, you know, give you two different sort of pipeline numbers. So of the 875,000 sq ft of stuff that we have going on, about 20,000 sq ft of that is development, and the rest of it, the other 865,000 sq ft or 55,000 sq ft, are all existing portfolio deals, and the majority of it is on available existing space. So the world as I sort of think about it is we have the leases that we signed this quarter, then we have our pipeline of stuff in process, and then I have a... What I have is sort of my tracking list.

And my tracking list right now has another 1.7 million sq ft of deals that we are- that are active in our teams across the regions. And these are not, you know, a tenant is looking at the market and might call us. These are, paper is moving back and forth, and there is a legitimate opportunity potentially for a deal to occur. Again, on all of that, it's almost exclusively on our in-service portfolio. So if you think about our development pipeline today, it really consists of 360 Park Avenue South, and Hilary can comment on activity there. And then the life science buildings that we have in Waltham, of which there's no active conversation going on that's part of my pipelines.... And then the building that we have in our joint venture in South San Francisco.

Again, there's nothing really going on there as well. So the vast majority of the activity that we have is about increasing, first maintaining and then increasing, albeit slowly, the occupancy in the existing in-service BXP core portfolio. Hilary Spann, if you want to comment on 360 Park Avenue South.

Hilary Spann (EVP of New York Region)

Sure. Thanks, Doug. Hi, Steve. In terms of the leasing activity in Midtown South, I think we saw a slowdown in the first part of this year. I will say that we are starting to see more activity as 360 Park Avenue South has come online, and clients can actually see the very high quality of the finishes and the lobbies and the common areas and the amenities that we put in place. And so we are starting to see a pickup in tour activity there.

It remains the case that the businesses that are interested in locating at 360 Park Avenue South span across industry sectors, and so while Midtown South in general has historically been home to tech and media tenancies, we're seeing everything from corporates to financial services, and as Doug mentioned, an asset management firm come into that building and show interest in occupying that building. I think, you know, anecdotally, while the leasing activity is picking up a bit, you know, it remains to be seen where that will settle out in terms of executed leases in the coming quarters. But we feel encouraged by the fact that the volume of interest in the building has stepped up meaningfully since we completed it and opened it.

Operator (participant)

Thank you. And I show our next question comes from the line of Anthony Paolone from J.P. Morgan. Please go ahead.

Anthony Paolone (Executive Director)

Yeah, thanks. I guess my question is, you mentioned earlier some demand from the AI space and at the same time, just tech companies having overexpanded and shedding some space. Just wondering if you could put some more dimensions around, you know, how that nets out, exactly how big is the AI demand, and maybe perhaps, you know, how much more is there to go before the rest of tech is right-sized?

Douglas Linde (President)

Yeah. So I'm gonna give you a simplistic view of it, and I'll let Rod Diehl give you a more comprehensive view. So the simplistic view of it is, on the East Coast, where there really isn't much in the way of incremental AI demand, net-net, most technology companies are, when they're renewing a lease, taking less space. On the West Coast, predominantly in the greater San Francisco marketplace, and then skewing down into the CBD of San Francisco, there is more incremental absorption overall in technology. It's all coming from AI, and I would say it's taking the place of what were traditional technology companies. But Rod, you can, you know, you can go sort of flush that out a little bit more.

Rodney Diehl (SVP of San Francisco Region)

Yeah. Thanks, Doug. So yes, last year, of course, was a big year for AI in San Francisco. There was two very large leases that were completed. I believe that made up about 27% of the overall leasing activity for the year, which was pretty substantial. So, coming into 2024, there's still been activity on the AI front. There's one of those larger tenants that did the deal last year is also in the market again for more space, so we're watching that closely to see where that goes. So I think it's definitely a bright spot and, and, you know, these different companies often define themselves as AI, but it's broad across the spectrum of that technology.

As you see that down in the Silicon Valley, in fact, there's some AI companies, many of them, which are tied into the automotive industry. We have a couple of them in our own portfolio, and some of those are in the market as well. So it's definitely a consistent point of additional optimism and demand for the Bay Area.

Operator (participant)

Thank you. And I show our next question comes from the line of John Kim from BMO Capital Markets. Please go ahead.

John Kim (U.S. Real Estate Analyst)

Thank you. You've been making a very compelling case between the bifurcation between premier workspace and commodity office in the CBD portfolio, which really benefits BXP. But that same bifurcation exists in your portfolio between CBD and suburban, where there's a 15 percentage point occupancy gap. So I'm wondering, just given that performance difference, does that make you reconsider your commitment to the suburbs?

Douglas Linde (President)

This is Doug, and I'll let Owen, you know, make a comment as well. We're committed to the geographic locations that we currently have occupancy and vacancy. The truth of the matter is that the majority of our availability is in suburban. Part of it was self-inflicted. So part of it was, during 2020 to 2022, when we were looking at the highest and best use for some of our Waltham suburban assets and our Lexington suburban assets, we deemed that the value of those assets over the long term as life science facilities would be better than as, quote-unquote, "traditional office facilities." And so we effectively cleared out some buildings.

So 1050 Winter Street is an example, and Reservoir Place, and the other Bay Colony buildings, which are where the predominant amount of our availability is, were effectively cleared out for those purposes. And unfortunately, the market, you know, has not been helpful to us, and so we're managing that availability. But quite frankly, we've had the opportunity to lease some of that space to office companies, and we've made the decision, at least in one case, that we think we're better off holding off that building and doing it as a life science building when the appropriate economic model makes sense, AKA, we have a tenant that wants to pay the right rent for that building.

Then our other large availability is in Princeton, and our Princeton portfolio is premier property, defined by the other assets in the greater Princeton area. And we are—we have probably on a, on an activity level, more activity in Princeton right now than we do anywhere else in our New York portfolio on a relative basis. I can't explain why the pickup has occurred during the first and the Q2s of 2024, but it has. It's predominantly associated with the pharmaceutical and life science industries, but not lab. It's companies that are in that business, but are, that have an SG&A function. And Hilary, you can comment on the Princeton market, then I'll let Brian comment on the Waltham market.

Hilary Spann (EVP of New York Region)

Sure. Thanks, Doug. As Doug said, we've seen an incredible pickup in leasing activity in the Princeton market in the first and Q2s. While, you know, and that includes signed leases, but also leasing activity that continues now, and we expect to be executed in the Q2 and Q3s. A lot of it, as referenced, is new activity. Some of it includes clients that exist in the portfolio of Carnegie Center today, and who have expressed needs to expand both from consolidation of business units or expansion of lines of business, and from an increased experience of return to office. And so it's a pretty diverse set of reasons that people are expanding.

But to Doug's point, the campus is pretty highly concentrated with pharmaceuticals, and in particular, foreign pharmaceuticals, and that is where the bulk of the demand is coming from. And so we're incredibly encouraged by the amount of leasing activity, and we expect to see additional signed leases coming out of it in the coming quarters.

Bryan Koop (EVP of Boston Region)

This is Bryan Koop for Waltham. I'll continue to echo what Doug talked about, and we intentionally call it an urban edge market because it is less than 10 miles from downtown Boston. And that's an attribute that shouldn't be taken lightly in terms of the commute and also the density of the population surrounding that Waltham market. Some further color on what Doug brought up. We are seeing a difference between our the east side of I-95, which is all the attributes of a urban project, and maybe for the analysts who are very familiar with this, attributes that we have in Reston: taller buildings, more amenities, et cetera. And we continue to see access on the highway is gonna improve there. We put a new ramp in last year, and there is a forecast for more there.

Where we are seeing some weaknesses in those assets that Doug mentioned, like the Bay Colony, which have attributes that are very similar to the conventional suburban office building, spread out, feels more rural, but actually the location is very close. That's where there is a little bit of weakness. But we continue to believe that Waltham is an urban edge market and quite different than the conventional suburbs that most real estate people would describe.

Operator (participant)

Thank you. Our next question comes from the line of Blaine Heck from Wells Fargo. Please go ahead.

Blaine Heck (Executive Director and Senior Real Estate Equity Analyst)

Great. Thanks. Good morning. Just following up on an earlier question, and maybe taking out the element of timing on occupancy and just focusing on the lease rate this year and potential progression there. You've talked about the large expiration still remaining at 680 Folsom Street and 7 Times Square. But when you think about those in conjunction with your leasing pipeline, which, Doug, you said was 875,000 sq ft plus, and Owen's characterization of the pipeline is growing in the back half of the year and into 2025, I guess, how much do you think you can move the lease rate up by as you look towards the end of the year?

Douglas Linde (President)

So you're... When you use the word lease rate, you're talking about occupancy rate, right? Not economic rent rate, I'm assuming. So, again, I think that it's gonna be slow and steady. So our projections when we gave our guidance during the call in the Q1 was that we were gonna hopefully be flat to where we ended 2023, at the end of 2024, and then we'll continue to make additional progress on that. If you look at our expiration schedules, they're pretty manageable, right? I mean, we have, you know, 5% to 6% expiring every year for the next four, five or six years. And so, you know, we need to lease space, we need to gain market share, which is, again, my sort of point.

And we are gaining market share in our markets, but it's, you know, we, when we do have technology companies expiring, we have to fight that, you know, that water coming at us. And so it's a challenge to dramatically increase occupancy in the short term. But we, we are getting to the point where we believe occupancy will continue to moderate upward.

Operator (participant)

Thank you. Our next question comes from the line of Michael Goldsmith from UBS. Please go ahead.

Michael Goldsmith (US REITs Analyst)

Good morning. Thanks a lot for taking my question. What are the economics of the new multifamily development, and how do you think about your cost of capital? And then along the same lines, what is the thought process on the new Commercial Paper program, and what upsize options do you have? Thanks.

Douglas Linde (President)

Let's let Mike answer the commercial paper question, and then, Owen, answer the question on our return expectations for multifamily. So, you know, we decided to enter into this commercial paper program because you know, we're always looking for additional markets to access, especially in this environment, and it's the cheapest form of floating rate paper that we can issue. Historically, we've been primarily fixed rate. We're gonna continue to be primarily fixed rate, but I think we will have a moderate amount of floating rate debt on a consistent basis over the foreseeable future. You know, right now we have about $1.2 billion of unsecured floating rate debt, and we have about $700,000,000 of joint venture unsecured debt.

I think it will go down from there going forward. But we view using this commercial paper program as a consistent piece of our debt structure over the next several years. And you know, because we can save, you know, 75 basis points by using it, it's a very liquid marketplace. We've got high credit ratings, so our access has been good, and now we've experienced it for the first couple of weeks, which has been very, very positive. So we're building an investor base in it. So we just felt like, you know, additional arrow in our quiver from a capital perspective, and lower cost of capital. Both drove that decision.

Owen Thomas (CEO)

Yeah, it's. Oh, and let me address the 121 Broadway development. You know, as I described in my remarks, this is a notable building. It's the tallest building in Cambridge, and it's also a very high-quality residential tower, given the finishes and our design and planning. Due to coordination with the development of The Vault for Eversource, the project's not expected to deliver its first units until late 2027 and expected to stabilize, and not until the Q2 of 2029. So again, you have to think about this project as part of the overall East Cambridge development that we've been working on and talking to all of you about for the last two or three years. So the forecast returns on the 121 Broadway development alone are below our typical thresholds for a development.

However, if you look at the yields that we're receiving from the entire entitlement package, so that includes 121 Broadway, it includes 290 Binney Street, and it includes what we think we can get with the remaining commercial entitlements that we still have, those projected returns do meet our development hurdles.

Douglas Linde (President)

Then to the extent that we are looking at new stick build, our expectations that those returns are going to be meaningfully higher than an urban development. So we're talking about yields well in excess of 6%. That's what we need to consider starting a new residential development in 2024, 2025.

Operator (participant)

Thank you. I show our next question comes from the line of Ronald Kamdem from Morgan Stanley. Please go ahead.

Ronald Kamdem (Executive Director and Head of US REITs and CRE Research)

Hey, thanks so much. Just a quick two-parter. So the first is on the occupancy expectations for a pickup in the back half of the year. You talked about sort of the strength in Back Bay and Park Avenue, but those markets are, you know, have relatively higher occupancy versus the rest of the portfolio. So I guess I'm trying to understand, where is the biggest sort of occupancy gains expectations in the back half? Is it the stronger markets, or is it other parts of the portfolio, like the suburban? That's part one. Part two is just a quick, any sort of update on life sciences demand. Obviously, we're seeing a better fundraising environment. Curious what you guys are seeing on the ground. Thanks.

Douglas Linde (President)

So the answer to your first question is, it's pretty, what I would refer to as granular. It includes occupancy pickups in buildings like the General Motors Building, where we are in active conversations with tenants right now to take some space pretty quickly in 2024. It's in Princeton, where, as Hilary described, you know, we have a pipeline of activity, and we believe some of those transactions will happen in 2024. It's in the greater, you know, metropolitan Washington, D.C., market, primarily in Reston, Virginia, where we have a significant pipeline of active, smaller deals that are going to occur in 2024. It's the activity that I described in Waltham.

Almost all of that activity is expiring or vacant space, and the majority of that will land in 2024. And so it's kind of everywhere, and there's no really what I would refer to as big ticket that's gonna dramatically change things one way or the other. And so we're, you know, again, that's why we're saying we think we're gonna get back to where we were, which is effectively, you know, the 88% plus or minus occupancy by the end of 2024. And look, I hope that we see some positive surprises in addition to that, where tenants move into space earlier. The leases. We believe the leases will get signed.

The question and, you know, you've heard me say this before, is we just don't necessarily have a good handle on what the timing is going to be for when we can start recognizing revenue relative to whether the space has been demolished or we're doing a turnkey build-up, where we're in control of it, and getting decisions made by the, you know, by our clients in terms of what they want in the space, and having all that work to the point where they're actually physically able to occupy the space in 2024, which would mean that it would be able to be in part of our occupancy roll, you know, numbers. On life science, I think life science demand is relatively slow.

I'll let Brian describe the life science demand in the greater Boston market, and I'll let Rod take a poke at, you know, talking about what's going on in South San Francisco.

Bryan Koop (EVP of Boston Region)

So in the Waltham market, which is the only spot we have vacancy, we don't have any in Cambridge. I'd say it's the same as it was in the previous quarter, but maybe a little bit more encouraging. Where we are encouraged is, as you noted, was, yes, there is more funding coming back into the life science sector, but also when we talk to clients, we are encouraged by the fact that they are call it, producing the things that they said they were gonna do to their investors, and there is encouragement in terms of the possibility of products down the pipeline. So that's where we're getting most of our encouragement, is that the clients we have are very excited about what they have going on.

Rodney Diehl (SVP of San Francisco Region)

Yeah, and out on the West Coast, in South San Francisco, our one project is the 651 Gateway Building, and that is the—it's basically a converted office building, 16 stories, and that building is completed, and we've done three deals in there, three full floor deals. And those tenants are in various stages of moving in. But in terms of new activity, it's been very slow. The few deals that are in the market tend to be smaller, call them, you know, 10,000 to 20,000 sq ft, not the 200,000 sq ft deals that were in the market several years back. So that section has been quiet. But our building's actually very well positioned to attract that demand that is in the market.

We have some space that is gonna be built on a spec basis. We're gonna do a full floor, which is gonna be ready to accept that tenant when they're out there. So, but the larger tenants have not been.

Operator (participant)

Thank you. I show our next question comes from the line of Richard Anderson from Wedbush Securities. Please go ahead.

Richard Anderson (Equity Research Analyst)

Hey, thanks. Good morning, everyone. You know, first a comment. I'd say if you were most any other REIT, you would have normalized out your $0.06 or a lot of it, and be up today, not down 3%. So I commend you for commitment to FFO as defined by NAREIT. I think you'll be rewarded for that over time. Onto my question, you know, just taking a peek at the Kastle data, and still utilization in the office space is sub 60%. I don't know how that compares to your premier asset type, but utilization still, you know, not near where it was pre-pandemic. Is there a scenario where the BXP story can still work long-term if we're looking at, you know, sort of a permanent condition of underutilization of office?

Or do you feel like you need to get fully back to have a long-term story to tell? I'm just, I'm just curious, you know, you know, what, what you think about, you know, so the very long term when it comes to office utilization. Thanks.

Owen Thomas (CEO)

Yeah, let me. That was a lot to unpack there, but let me take a stab at it. So first of all, Kastle data is highly used in the media, and I think in the financial community, and I think it's a very imperfect measure of office demand. It's a decent measure of perhaps footfall, you know, in an urban area over a period of time. So what do I mean by that? Many of the owners of Premier Workplaces don't use Kastle Systems in their buildings, so we're, we're not really exactly sure which buildings are being measured. It doesn't take into effect that the office market is less occupied today from a leasing standpoint. And it also looks at data over the course of a whole week, which is less relevant for office occupancy. What you really need to focus on is peak days.

So I know everybody uses it, but it's not really a reflection of our experience, which is the following: We have turnstile data for roughly half of our 55 million sq ft under management, and we have carefully picked out same-store data for buildings that are essentially the same level—has the same level of leasing as they did in March of 2020 as they do today. And when you look at that data, in New York, our buildings are basically at the same level of turnstile swipes Tuesday to Thursday as they were in March of 2028. So, so New York is basically back. The other thing that's interesting is Friday was already slow before the pandemic, and Monday is coming up.

So there's I actually say New York is basically back to the way it was, certainly three days a week. Boston is at about 75% on that measure, and the only place where it's really lagging is in San Francisco, which is about 45% or 50% for those peak days. And peak days are important because if you're a user of space, you need to have space for your people when they're all coming in. So it's not across the whole week, it's what is it on the peak days. So again, we see improvement. As I tried to say over and over in my remarks, we think the issue, the reason our leasing is slower today, is actually not because of work from home, it's because of the earnings growth of the clients that we serve.

We are a provider of services to businesses, not consumers. Those businesses are not growing their earnings, and if they're not growing their earnings, they're not hiring people, and they're not taking space. I think as earnings start to grow again, which frankly, we're seeing right now in the Q1, our leasing will pick up. And I think Doug did a very good job of articulating some of those green shoots that we're already seeing that we should experience later this year.

Douglas Linde (President)

Rich, just to, from a sort of macro thesis perspective, I think what is 100% clear is that new construction is not part of the vernacular in 2024, 2025. Which means unlikely you're gonna see buildings delivered that aren't already under construction, and there is stuff under construction, but you're not gonna be seeing new buildings delivered in any of these metropolitan areas.

... for the next 5+ years, right? That's how long it takes to build a building. You know, look at the time frames associated with these press releases about a potential new building in Midtown Manhattan. So if our thesis is continues to be accurate, and Owen has described the difference between the premier and sort of the other portions of the office inventory, there is gonna become less and less premier space, and the premier space will continue to pick up its its occupancy, its leased percentages, and we will see the fruits of that in the properties that we have in all of our marketplaces. And again, you know, I harp back to sort of this dislocation that's occurring.

What we're seeing in Washington, D.C., relative to the number of buildings that people would deem to be, quote-unquote, A to A-minus buildings, that are incapable at this point of making a leasing transaction because there is no capital available, because the buildings are, quote-unquote, underwater, defined as there's too much debt, and the equity holders are saying, We're not prepared to put capital in for the benefit of the lender. It's changing the characteristics of how leasing is occurring. And Jake, maybe you can spend a minute talking about sort of the dynamic of where tenants can look if they want to go into a building in a market, by the way, which has a very significant availability problem still.

Jake Stroman (SVP of Washington, DC Region)

Yeah, I would just maybe second what Doug just noted in that we are seeing really great activity across all of the buildings in our DC and Northern Virginia portfolio. You know, the weight of the troubled assets and the dislocation in our region is really kind of playing to our favor. You know, most of our buildings, you know, are preeminent workplaces, and there's definitively a flight to quality, but there's also a real flight to certainty across the brokerage community who wants to do deals with somebody who can do deals. So we're seeing that playing out in our favor in our region, for sure.

Operator (participant)

Thank you. And our next question comes from the line of Caitlin Burrows from Goldman Sachs. Please go ahead.

Caitlin Burrows (VP)

Hi, good morning. Maybe just occupancy at 535 Mission Street, which is a newer build, LEED Platinum, has fallen below 60%, I think, related to WeWork. So Doug, I know you talked about how South of Market is lagging a bit, but can you talk about the demand at that vacancy? And then bigger picture, how does that inform your view of the health of demand at the highest end of the market in SoMa, ahead of first-generation leases rolling over at that building and Salesforce in the coming years?

Douglas Linde (President)

Yeah, sure. Sure, Caitlin. I'm gonna. I'll let. I'll make a brief comment and let Rod describe it. So, WeWork actually is in, in negotiation to, to remain in all the space that we have with them at that building. And we have an expiration with Zillow, Trulia/Zillow, that consolidation, which occurred earlier, and that's where the majority of the availability is. And, Rod, you can describe sort of leasing prospects there and how things are looking in our portfolio South of Market.

Rodney Diehl (SVP of San Francisco Region)

Yeah, so that's right. The space that you're referring to is in the low rise of that building, and it's the former Zillow/Trulia space. So we've had some activity on it. We've had better activity on a couple of floors up top. In fact, we just completed a full floor of spec suites up on the 11th floor, which is getting excellent response from the market. So we expect to get that leased up quickly. The balance of the SoMa portfolio, I mean, earlier on the call, the 680 Folsom availability was mentioned. That's the 200,000 sq ft. We just got that space back, technically today is the first day we have it as a vacant space. However, we've been marketing it for some time and we've had activity on that.

We've been trading paper with various groups. There's another tenant that we're chasing right now. So we're getting good looks, we're getting our shots at seeing these deals. I would say that we've had more activity on North of Market. So I'd say our Embarcadero Center property, frankly, is getting a little bit more attention than some of the South of Market stuff is. Just, I think that's just the nature of where the demand's coming from. More of the traditional companies tended to be attracted to Embarcadero Center, whereas tech is still focused more south, South of Market. You know, there is some space that is on the sublease market at Salesforce Tower that Salesforce has, and they've been marketing it, and it's getting good looks as well. So I mean, there are groups out there.

I'm very confident that we're gonna get that space leased up.

Operator (participant)

Thank you. Our next question comes from the line of Vikram Malhotra from Mizuho. Please go ahead.

Vikram Malhotra (Managing Director, Senior Equity Research Analyst)

Thanks for taking the question. Just two quick ones. One, just, I guess, Mike, I just want to clarify, you know, in the guidance adjustments, do you mean just sort of where the curve has shifted overall, or were you actually baking in sort of some sort of rate cuts in your guidance? And then secondly, I guess, you know, just in terms of achieving that occupancy uptick in the H2, you know, is sort of the Q1 leasing run rate, do you also anticipate that to move up just given where expirations are? Thanks.

Douglas Linde (President)

So on the interest rate expectation, you know, we have included an additional rate cut in our expectations late in the year, and I think if that rate cut does not occur, it won't have a meaningful impact on what our guidance range is because of when it is within the year. So we'll just have to see, you know, what happens with the inflation numbers and the Fed as we kind of think about where rates might be going both later this year and next year. But I don't think, you know, if there's no cuts this year, it's gonna have a significant impact to our guidance.

Michael LaBelle (CFO)

... What was the other question on leasing?

Vikram Malhotra (Managing Director, Senior Equity Research Analyst)

Occupancy.

Michael LaBelle (CFO)

Well, I didn't. Can you restate the question?

Vikram Malhotra (Managing Director, Senior Equity Research Analyst)

Q1 on lease.

Michael LaBelle (CFO)

The Q-

Vikram Malhotra (Managing Director, Senior Equity Research Analyst)

The Q1 on lease.

Michael LaBelle (CFO)

So the occupancy for Q1 was down a little bit, and for Q2, it's gonna be down a little bit again because of the two expirations that Doug talked about, which is the expiration of 680 Folsom and Suncore Tower. And then we don't have significant expirations of individual size in the back half of the year. And that's when many of the signed leases that we already have done, which Doug talked about, which is, I think, it's 815,000 sq ft for the company, of which over 650,000 sq ft is in 2024, plus the LOIs that we have will start to take hold. And so that's what gives us confidence that the occupancy will stabilize after the Q2 and hopefully start to move northward after that. That's our expectation.

Operator (participant)

Thank you. Our next question comes from the line of Omotayo Okusanya from Deutsche Bank. Please go ahead.

Omotayo Okusanya (Managing Director and Head of US REIT Research)

Hi. Yes, good morning, everyone. I just wanted to go back to the guidance for the year. So if we take Q1, we take the midpoint of the Q2, you're about at $3.44. Midpoint of guidance is $7.04. We're talking about rates higher for longer, occupancy probably picking up in Q4 or so of the year. So could you just help us, walk us through the acceleration of earnings in the back half, what, what the drivers of that will be?

Michael LaBelle (CFO)

So, tell you what, there's really three, I think, you know, impacts that are gonna help us in the third and Q4. The first is we expect NOI from the portfolio to be up, and we expect that to occur because the occupancy improvement that we have talked about. So I would expect that both third and Q4 will show higher portfolio NOI than what we have in the first and Q2. The other is G&A. So G&A is seasonally high in the first and Q2 because just the timing of the vesting schedules, as well as taxes that are paid on payroll. So, you know, that's a pretty meaningful move between quarters.

It could be, you know, between $0.05 and $0.07 lower in the Q3 and the Q4 from where it is today. And then the last piece is we do expect to have interest income be lower than it is today as we fund our development pipeline. I mean, that is offset a little bit by capitalized interest, but I see our interest expense as being slightly lower next quarter and then stable, and our interest income will drop a little bit sequentially by quarter as we spend on our development pipeline. So those are really the three things that are driving the improvement in our FFO in the third and Q4 to achieve the midpoint of the guidance range.

Operator (participant)

Thank you. And our next question comes from the line of Michael Griffin from Citi. Please go ahead.

Michael Griffin (Analyst)

Great, thanks. You know, just maybe on the debt side, Owen, I'd be curious to get your thoughts. I mean, are banks willing to lend on new office development projects yet? And if so, you know, what kind of interest rate you think they would lend at, and what kind of yield would you need to have to justify undertaking the development?

Michael LaBelle (CFO)

So this is Mike. I'll respond to this, and the rest of the team can add on. Lenders in general are not getting payoffs. So you know, typically, they have volume requirements that are pretty significant because they're constantly getting paid off, and they need to replace and hopefully grow that. You know, in this environment, you know, their borrowers are not necessarily paying them off. So they're not excited about increasing their exposure to commercial real estate and office properties right now. So I think as a whole, banks are you know, not excited to provide lending. I think they would be more likely to lend on a stabilized piece of property at an appropriate debt yield than do a construction loan.

I think there's very little in the way of construction financing available out there, particularly anything speculative. But if you came to a bank, and you had a fully leased property, you know, maybe you could get that done. But again, the pricing is gonna be, I don't know, 300 to 400 over, SOFR. So SOFR's at 5.3%, so you're talking about 8% to 9% money. So it's really, really hard to, you know, make sense of that when that is the case. So again, you know, Doug talked about very little in the way of new construction going on, and I think the bank financing market is another limiting factor, to that, that picture.

Michael Griffin (Analyst)

Yeah.

Owen Thomas (CEO)

Just to add to that, on your question on development yield. So, you know, let's divide this between, you know, office life science versus residential. So on office life science, you know, our targets when rates were very low were in the 6% to 7% range, and I'd say those have gone up, you know, at least 200 basis points. And as Mike described, it's very difficult to get financing. And also, as I described in my remarks, you know, the cost of development has gone up, and part of those costs are the inflation that Doug described, but also part of it is the yield requirements, you know, given higher rates. So that's contributing.

Then on the residential, the way we've always thought about it was, you know, 100 basis points over exit cap with no, with untrended rents. And so today, a little hard to gauge, but, you know, there is some evidence of high-quality residential trading, say, in the mid-5s. So I think in terms of development yield, you've probably at least in the mid-6s on residential. And for us to engage in that, we need a joint venture partner, as we have at Skymark, which is our development that's going on right now in Reston.

Michael LaBelle (CFO)

I think just one other trend in bank financing that's important to note is there's an uptiering going on, and there's a analysis of profitability going on by these banks of their relationships. So if you have a broad relationship, where you're providing other kind of fee services and other things with these banks, and they can see a profitable relationship today and growing going forward, they're gonna be willing to provide capital. Where they're not seeing that, they are exiting relationships. So that, again, that benefits us because we have a very broad set of, you know, relationships that we have, and we do these bond deals where these banks get, you know, fee income and things like this. And so the relationship profitability we have is acceptable. So we are...

You know, we continue to have banks wanting to add to our, you know, our stable and our financing, and you've seen that. I mean, last year, we added three or four new banks to our facility. We continue to have banks that are interested in looking at what we're doing and are calling on us.

Bryan Koop (EVP of Boston Region)

Mike, additional information in the market that we are wondering also is that as their risk just goes down, their criteria for making a loan, of course, goes up. And the underwriting of the actual development firms that have a particular property has been incredibly closer, and also the criteria for pre-leasing plus credit and the capital stack of equity, and it's just not there right now. And they're passing on everything that is, in any way, weak on the development front.

Operator (participant)

Thank you. I show our next question comes from the line of Dylan Burzinski from Green Street. Please go ahead.

Dylan Burzinski (Analyst)

Hi, guys. Thanks for taking the question. Just wanted to go back to tech leasing and some of the comments that you made, uh, in your prepared remarks, Owen, about a lot of these companies over-committing to space during the pandemic and then being currently in a digestion process. I guess, you know, if we sort of weigh that with how much earnings have grown for a lot of these companies over the last several years versus the headcount that has grown, despite some of the layoffs that have gone on, I mean, how long do you expect this digestion process to last? Is this sort of a 2025 event, a 2026 event? Just curious how you guys are sort of thinking about that in your discussions and maybe in your discussions with a lot of these tenants, what they're telling you guys.

Owen Thomas (CEO)

Short answer, I mean, you're touching on a very key issue as it relates to the health of the op. The answer is we don't really know. You know, but I agree with what you said. Our instinct is, yes, there was some overcommitment, there's some digestion, there's some shedding going on. Several tech companies have taken charges, put sublease space out in the market. That seems to have slowed down recently. But our instincts and what we've seen in past cycles is, at some point, those companies are healthy. They're in the center of all the innovation that's going on in the nation. They have a bright future. They're gonna grow their earnings, and I think they will be back in the space market, but trying to figure out the exact timing of that is very challenging.

Operator (participant)

Thank you. I show our next question comes from the line of Alexander Goldfarb from Piper Sandler. Please go ahead.

Alexander Goldfarb (Analyst)

Hey, good morning. Morning. Owen, or, or Doug, or whoever wants to take it. So I'm gonna ask a two-parter, but it's all related to the same. As you guys think about investment at, you know, future investment to grow the company, a multipart, you know, whether your land holdings in Northern Virginia still have any potential for data centers? If there's any office-to-resi conversion because of the new laws, that may present opportunities to you, whether it's existing assets or to invest in an asset that would be convertible. And three, what do you think it takes for Lexington Avenue next to Grand Central to finally benefit from what's going on west of Grand Central to come east of Grand Central?

Owen Thomas (CEO)

Well, there's a lot there. You violated Helen's rule of one question, but that's okay, Alex. We'll still answer them all. So, anyway, I'll just start. Lexington Avenue is doing well. I mean, where we are at 53rd Street, it's right where the subway station is, and 601, and is fully leased or very close to it, and 599 is well on its way. So, 399, I mean, it's on Park Avenue, but it's back end is on Lex, right at the same location, and those buildings are performing extremely well. I think that location on Lexington Avenue is also unique because of the access to the subway. So, on residential, so I don't think there's any asset...

I don't want to say any asset, but I don't think there's gonna be a significant opportunity in our portfolio of existing assets to convert them to residential. I mean, frankly, the only ones that are empty are ones that we've emptied out for life science conversion, and some of-- they all have some level of leasing, and I'm not sure they have the physical characteristics for it. That all being said, we do have land parcels that you see in our supplemental, and in several cases, we are working with local communities to rezone that land from commercial to residential. And given some of the regulatory overlay that's going on in many of our communities and states, you know, that process is a little less challenging than it used to be. So I think that's where we will benefit.

And then I do think there may be opportunities, and we're certainly looking at them, for our residential team to get involved in office building conversions of buildings that we don't currently own. You know, we've, we've always felt that this is gonna be an important in commercial real estate. It's certainly one that's gonna unfold slowly, but you're seeing it unfold right now, and there's increasing number of projects in many of our markets.

Douglas Linde (President)

Yeah, and just to put a little bit of meat on the sort of carcass of that, on the residential conversion side for us. So at 17 Hartwell Avenue in Lexington, we have a 30,000 sq ft office building that we will demolish, and we are getting entitlements to build 350 ± residential units. In Shady Grove, which is a piece of land that we bought, hopefully, to have thought about doing some life science. We've said we're gonna pivot, and we're gonna do, hopefully, some life science at some point, but we're gonna do residential. And so we're selling a piece of parcel to a townhome developer, and we're also working on a residential portion of that development.

And then third, we bought some older, relatively inexpensive office buildings with an existing parking structure in Herndon, Virginia, and we just received approval to convert that site to multifamily, both townhome and multifamily apartments. And we are likely to sell the townhomes and potentially either sell or develop the residential. So we are actively doing that. And then jumping to the other side of the country, our assets at North First, which we've owned for quite some time, which we had hoped to build some kind of office on, we are now working with the city of San Jose on converting a portion of that site to a residential entitlement, and we would build some residential and potentially provide a parcel for affordable housing to somebody else who would build that.

And then, obviously, down in Santa Monica, there's a real question about what Santa Monica Business Park will become over the next, call it, you know, decade or two. But it would not be unlikely to see not just office development there, but to also see other uses, including some kind of residential, you know, on that site. So this is sort of something that we are working actively on as we speak. It's not about converting an office building in Times Square to residential, or an office building in the CBD of Washington, D.C., to residential, or an office building, you know, in Back Bay or in the Financial District of Boston to residential.

Our buildings do not line up with the kinds of assets that likely would be potentially convertible if the economics actually worked, which they don't right now, but, you know, over the next, call it 4- to 5 years.

Operator (participant)

Thank you. I show our next question comes from the line of Upal Rana from KeyBanc Capital Markets. Please go ahead.

Upal Rana (Analyst)

Great, thanks for taking my question. Just real quick, you know, Doug, thanks for your color on the existing pipeline and the update on the Carnegie Center. I wanted to see if you can give us an update on the ongoing backfill at 680 Folsom and 7 Times Square.

Douglas Linde (President)

Why don't I let, I mean, I think, Rod, you mentioned 680 Folsom Street before, but you can reiterate that, and then, Hilary, you can talk about 7 Times Square.

Owen Thomas (CEO)

Yeah, just real quick on 680. Yes, we, we have 200,000 sq ft on the low-rise portion of that building, and, it's excellent space. It's some of the best space in the market. It's a nice floor plate size. It's 34,000 sq ft, and it's got high ceilings, and, it's excellent space. So we've been marketing it, and we've had proposals that we've been pursuing, and, so we're gonna continue to do that on that space. But it's very, very high quality space in our portfolio.

Hilary Spann (EVP of New York Region)

On 7 Times Square, I think the team here in New York has done a fantastic job of converting some of the space that was sublet by the major law firm tenant in that building to direct tenancies. And in the Q1, we signed a direct lease at 7 Times Square for 27,000 sq ft. So we're continuing to chip away at the pending vacancy. I will say that the Times Square submarket, unique more or less among markets in Midtown, is exhibiting reasonable sort of weakness in terms of demand, and that just has to do a little bit with the streetscape and some of the other things that are going on there, which we are working very hard with the city and other folks in the neighborhood to address.

But, you know, I think we are encouraged by our ability to convert sublease tenants to direct tenants. We are pursuing every tenant that's in that submarket that makes sense for the building, and we're just gonna continue to chip away at it. But at the moment, you know, I wouldn't describe it as a submarket that's got lots of, you know, large tenant demand sort of breaking down the doors, just chipping away at it, lease by lease.

Operator (participant)

Thank you. I show our last question in the queue comes from Camille Bonnel from Bank of America. Please go ahead.

Camille Bonnel (Analyst)

Thanks for taking the question. Municipalities are looking for ways to manage their revenue streams, and recently, the mayor of Boston has been talking about raising commercial property taxes. I understand you can pass a lot of these costs through to tenants, so not much of an impact to your operating margins, but do you get a sense that these potential tax increases could change a tenant's view on whether they take a lease in the market versus going somewhere else? And does this make investing in Boston less attractive, adding upward pressure to cap rates?

Douglas Linde (President)

... So let me take a stab at that, and I'll let Brian, you know, provide his perspective as well. We don't think passing expenses on to tenants is a good way to treat our ten-- our clients. And we do everything we possibly can to reduce our operating expense escalations every single year, and we spend hours and hours finding ways to, you know, change the things that we're doing, so that we do not have to have dramatic increases. The commercial property sector currently bears a disproportionate portion of the benefit or the burden of taxes in the city of Boston.

As assessments change and residential assessments go up and commercial assessments go down, obviously, we all know, understand what's going on with regards to overall, environmental issues associated with interest rates, valuations, occupancy, capital costs. It's very hard for us to think it would be a good thing for the commercial office property sector to bear a higher proportion of those expenses than they currently are bearing. And so, you know, we're, we don't think that those type, these types of policies are good for our business or good for the companies that occupy our buildings.

We're hopeful that, you know, these types of ideas will not, you know, rule the day, and that there will be pushback from the constituents in the various communities that will sort of see that it probably isn't the right time to be asking the commercial sector to pay, to have a larger proportion of the burden on any kind of regulation, given the challenges associated with our business. Brian?

Bryan Koop (EVP of Boston Region)

Really no further clarification, Doug, other than we have made it quite clear to political leadership our position.

Operator (participant)

Thank you. This concludes our Q&A session. At this time, I'll turn the call back over to Owen Thomas for closing remarks.

Bryan Koop (EVP of Boston Region)

Yeah, no further comments. Thank you all for your attention and interest in BXP.

Operator (participant)

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.