BXP - Q2 2023

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to Q2 2023 BXP Earnings Conference Call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there'll be a question-and-answer session. To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference call is being recorded. I'll now like to hand the conference over to Helen Han, Vice President, Investor Relations. Please go ahead.

Helen Han (VP of Investor Relations)

Good morning, and welcome to BXP's second quarter 2023 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 an 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 (Chairman and CEO)

Thank you, Helen, and good morning, everyone. Today, I'll cover BXP's above expected operating performance in the second quarter, key economic and market trends impacting BXP, BXP's capital allocation activities, and a personnel and organizational announcement. BXP continued to perform in the second quarter, once again demonstrating sentiment in the office industry is worse than what we're experiencing. Our FFO per share was above both market consensus and the midpoint of our own forecast, and once again, this quarter, we increased our FFO per share guidance for all of 2023. We completed 938,000 square feet of leasing in the second quarter, with a weighted average lease term of 8 years, despite continued challenging leasing market conditions. We completed multiple company and asset-specific financings, both elevating our liquidity position and demonstrating BXP's sustained access to the capital markets.

The U.S. economic growth is challenging to forecast, as there are currently two competing and viable theories predicting very different trajectories. The first theory is that inflation is increasingly under control due to pandemic economic anomalies wearing off and Federal Reserve interest rate hikes, and the economy has and will remain healthy, with a strong labor market and continued GDP growth driven by consumption. The second theory is that inflation is already well under control, and the Federal Reserve has been overly aggressive in the magnitude and timing of its interest rate increases, which will create dislocation in sectors of the economy, as has already started to occur with regional banks and commercial real estate, and will result in a recession possibly as soon as later this year.

We are obviously hoping for the first outcome, but have prepared BXP for the second by increasing liquidity, currently at $3.1 billion, pursuing additional capital-raising opportunities, and being measured in discretionary capital expenditures and new investment activity. Whether or not we have an economic recession, U.S. companies are experiencing a recession in earnings, which, for the S&P 500, are predicted to drop over 6% year-over-year in the second quarter. With lower earnings, companies look to cut costs, including expenditures for space, which is the primary driver of our slower leasing in the first half of 2023 versus last year. Large tech companies, the most significant source of new employment and net absorption of space last cycle, are largely absent from the current leasing market.

In analyzing the market demand for office space, it is important to understand the behavior of underlying users, which, in the broadest sense, are bifurcated into two groups. First, there are knowledge workers who are client- and/or product-facing and execute the core functions of a business where creativity and collaboration are critical to success. Second, support workers who provide services to the core functions of a business in areas such as IT and accounting, where tasks are more repetitive and collaboration less of an imperative. Knowledge workers generally have dedicated workstations and are increasingly in the office as business leaders understand the importance of in-person work for this group and are enforcing firmer in-person work policies. In many cases, companies working remotely are announcing return-to-office plans. Companies working on a hybrid basis are increasing the number of days expected in the office.

Companies are tying year-end evaluations and bonus levels to office attendance. On the other hand, support workers often work in shared workstations with more workers than seats with, with much less prescriptive office attendance policies. This workforce bifurcation is creating the ever-increasing performance gap between premier workplaces and the balance of the office market. A primary tool companies utilize to increase knowledge worker attendance is to provide modern workspace, rich with amenities, in an easily commutable location, the definition of a premier workplace. Conversely, support functions are not as commonly located in premier workplace assets. Therefore, remote work and shared workstations puts more pressure on the market for lower-quality buildings and secondary locations. The divergent impact of AI on knowledge and support jobs could also continue to widen the building quality performance gap, as AI drives knowledge job growth and automates support processes.

We share in our IR materials every quarter, CBRE's report on the performance of the premier workplace segment. In the 5 CBDs where BXP operates, premier workplaces represent approximately 18% of the total space and 10% of the total buildings. At the end of the second quarter, direct vacancy for premier workplaces was 11.6%, versus 16.5% for the balance of the market. For the second quarter, net absorption for the premier segment was around 800,000sq ft positive, versus a negative 2.1 billion sq ft for the balance of the market. For the last 10 quarters, net absorption for the premier segment was a positive 6.7 millions q ft, versus a negative 31.9 million sq ft for the balance of the market.

Rents and rent growth are higher for premier workplaces, and we believe the segment, the segment captures most of all gross leasing activity. Including two buildings undergoing renovation, 94% of BXP's CBD space is in buildings rated by CBRE as premier workplaces, which has been important in driving the increasing office attendance statistics in our buildings and is a critical differentiator for BXP in the marketplace. Moving to private real estate capital markets, US transaction volume in the second quarter rose 43% from the first quarter to $9.6 billion, though volume is down 50% versus the second quarter last year. Interestingly, sales volumes for other asset classes is weaker, up less than office in consecutive quarters and down more versus last year.

Real estate values have reset down due to higher capital costs and demand challenges in specific sectors. Most sellers continue to be unwilling to accept lower prices, creating a slowdown in transaction activity, common in declining markets. New mortgage financing for office is not available from domestic lenders. Non-US banks will consider financing only for the highest quality leased assets and sponsors and at modest loan-to-values. Completed office sales and recapitalizations invariably involve buildings with long-weighted average lease terms and/or seller financing. Given the dearth of transaction activity, office asset pricing is difficult to determine. There were a small number of relevant data points this past quarter. A fund manager, backed by a private equity firm, purchased two lab portfolios in the Boston area from a public REIT.

3 buildings on Second Avenue in Waltham, comprising 329,000sq ft, which are 100% leased for over 6 years, sold for $266 million, representing pricing of $809 a foot and a 5.8% initial cap rate. In the deal, 2 buildings on Memorial Drive in Cambridgeport, comprising 99,000sq ft and vacated for redevelopment, sold for $99 million, which was a price of just under $1,000 a sq ft. Located in Santa Clara, next to BXP's Peterson Way development site, Campus at 3333, sold for $183 million, representing pricing of $742 a sq ft and a 6.1% initial cap rate.

The building comprises 246,000sq ft, is fully leased on a long-term basis, and was sold by a domestic pension fund to a domestic fund manager. Now, moving to BXP's capital market activity for the second quarter, we are being patient with new investment activity, as we believe acquisition opportunities will grow in number and become more attractive in this environment. We will remain opportunistic and solely focused on premier workplaces, life science, and residential development in our six target markets. We are considering additional capital raising through dispositions and joint ventures with our in-service residential assets and select pre-lease developments. This quarter, we placed fully into service 2100 Pennsylvania Avenue, a 476,000sq ft market-leading premier workplace in Washington, D.C., that is 91% leased.

In late June, we opened and placed into service View Boston, a three-story observation pavilion atop Prudential Tower in the Back Bay of Boston that offers panoramic views of the city, as well as an immersive experience showcasing Boston's many neighborhoods and cultural landmarks. BXP has been constructing the first phase of the Platform 16 premier workplace development adjacent to Google's Downtown West project in San Jose. BXP owns a 55% interest in the project, and the first phase includes a 390,000sq ft building, as well as a garage and foundation for all 3 phases, which in total will comprise 1.1 million sq ft. Unfortunately, market conditions in the Silicon Valley, including San Jose, have deteriorated meaningfully, with rising direct vacancy, few large space requirements, and technology companies, including Google, putting significant space in the sublease market.

As a result, we have decided to pause construction of the project at grade, with completion of the garage and foundation scheduled for year-end 2023. Though disappointing, as market conditions recover, we will have a project that can be delivered to users in under 2 years, which is 12-14 months more quickly than a ground-up development. This decision reduces our near-term development spend by approximately $200 million, thereby enhancing our liquidity. BXP recently accomplished 2 important milestones in the predevelopment of the 900,000sq ft, 343 Madison Premier Workplace in Midtown Manhattan. We completed a joint venture with a leading global real estate investor, who will own a 45% interest in the project. The joint venture completed a 99-year ground lease with the Metropolitan Transportation Authority for the 343 Madison Avenue site.

Under the terms of the lease, the joint venture is required to construct a direct entrance into the Long Island Rail Road's East Side Access Project, known as Grand Central Madison. The joint venture can terminate the ground lease and be reimbursed for its costs in constructing the access to Grand Central Madison. With direct access to transit in the relatively tight Grand Central submarket, 343 Madison is a unique offering, and preliminary discussions with potential anchor clients have been constructive. BXP continues to execute a significant development pipeline with 13 office, lab, retail, and residential projects underway. These projects aggregate approximately 3.1 million sq ft and $2.6 billion of BXP investment, with $1.6 billion remaining to be funded, and are projected to generate attractive yields upon delivery.

On a personnel matter, after a 25-year distinguished career running BXP's San Francisco region, Bob Pester has elected to retire early next year. We have asked Rod Diehl, who currently runs leasing in BXP's San Francisco region, to succeed Bob. Rod, an 18-year BXP veteran, is an accomplished leader with a strong track record of commercial success with BXP's clients. With this change, we are also adjusting our organizational structure. BXP has and will continue to execute its business in three regions on the West Coast. However, given that L.A. and Seattle are relatively new regions for BXP and currently under-scaled, we will manage these three regions with a unified organizational structure under Rod, sharing resources across the regions to the benefit of BXP's clients and shareholders.

Alex Cameron and Melissa Cohen will continue to be our senior representatives in the L.A. region, and Kelley Lovshin, our senior representative in the Seattle region. In summary, despite strong negative market sentiment, BXP had another productive quarter with financial performance and leasing above expectations and a stable dividend. BXP is well positioned to weather the current economic slowdown, given our leadership position in the premier workplace market segment, our strong and liquid balance sheet with access to multiple capital sources, our significant development pipeline providing growth, and our potential to gain market share in both assets and clients due to the current market dislocation. Let me turn it over to Doug.

Doug Linde (President)

Thanks, Owen. During our June NAREIT meetings, the most frequent topic of conversation was our leasing activity, since it obviously drives occupancy, top-line revenue, and on our net operating income. I'm going to focus my remarks here this morning. Owen highlighted the volume of signed leases during the second quarter. Just to remind everybody, during the last 9 months, we've been providing the leasing expectations embedded into our 2023 earnings guidance, between 500,000 and 1 million sq ft per quarter, which translates to 750,000sq ft on average, or 3 million sq ft for year 2023. During the first quarter, we signed 660. As of the end of the first half of 2023, we've completed 1.56 million sq ft, pretty much on target.

This quarter, the 938,000 sq ft of signed leases included 63 transactions, 37 renewals, 26 new tenants. There were seven contractions and five expansions. Three of the expansions were law firms, although we also had two law firm contractions, along with a nonprofit and a government agency. Breaking the volume down by market, 320,000sq ft in Boston, 280,000sq ft in New York, 235,000sq ft in D.C., and 100,000sq ft in San Francisco. We ended the second quarter with an in-service occupancy of 88.3, compared to 88.6 last quarter. As Owen said, we added 2100 Pennsylvania Avenue to the in-service portfolio.

The building is 91% leased, but only 61% occupied for purposes of revenue recognition, which is how we calculate our occupancy statistics. If you exclude the additional property, our occupancy actually remains flat for that quarter. As we sit here today, we have signed leases that have yet to commence on our in-service vacancy, totaling approximately 1 million sq ft, with 800,000sq ft anticipated to commence in 2023. That does not include the development portfolio, which is 3.1 million sq ft and 54% leased. We currently have 44 leases in negotiation, totaling 1.17 million sq ft, as compared to about 900,000sq ft as we entered the second quarter. A slight acceleration.

The one difference in this pool of transactions is that there was 1 large renewal over 300,000sq ft, versus the largest active negotiation last quarter, also a renewal, was just over 100,000sq ft. We also have a current pipeline of additional active proposals totaling over 1.7 million sq ft. If we complete 95% of the leases in negotiation and a third of the 1.7 million sq ft of proposals, we currently would have about 1.7 million sq ft of additional leases we hope to execute during the second half of 2023, which will bring our total leasing for 2023 to just over 3 million sq ft. Going back to our original embedded expectations, right on target. Our remaining 2023 expirations are 1.3 million sq ft.

We have 800,000sq ft of signed leases with an anticipated 2023 commencement. We'll be delivering 140 Kendrick Street, 104,000sq ft into the in-service portfolio in the third quarter, and 751 Gateway, 100% leased, 231,000sq ft in the fourth quarter. We will have additional 2023 activity across the portfolio, which will get our occupancy up slightly by year-end. As we get further into calendar year 2023, additional lease executions will impact occupancy after 2023. The New York region's second-generation leasing statistics jump out this quarter and need a little bit of explanation. The deals commencing included a floor that was previously leased to an existing tenant at a below-market rent, as they were rebuilding their space elsewhere in the building.

We subsequently relet the space under a long-term lease to a new tenant, and the impact is hitting this quarter. If you strip out that transaction, New York would be down 9.2% on a gross basis and 15% on a net basis. As I've said before, in general, we continue to have roll-ups in Boston and San Francisco, roll-downs in D.C. and Northern Virginia, while New York is very building and lease specific. The leases we signed this quarter on second-generation space were up 8% in Boston, 10% in San Francisco, down 11% in New York, and down 13.5% in D.C. The New York leases signed this quarter included a 120,000sq ft renewal in Princeton that was down 28% on a cash basis. The sentiment around office is worse than the reality, as Owen said.

To illustrate the point in our portfolio, we continue to see an incremental pickup in daily activity as we look at the month-to-month trend lines. We measure the unique client employees coming into our building every day against the number of workstations/office desks in our CBD buildings today. Using this methodology, we are seeing weekly usage of 80% in New York City, 75% in Boston, and 70% in San Francisco, and this excludes Salesforce.com and WeWork because they don't use our access card system. When we look at individual firms, there is a wide discrepancy in utilization. We have clients that are close to 90% of their daily high that they had pre-pandemic, while we have a few insurance companies back office that are as low as 35%, sort of making Owen's point on the type of work that's being done.

The frequency of work in the office is about 3 days per week across our markets, where we track the data, and this includes San Francisco, so the people are coming back to work 3-plus days a week. Fridays continues to be a real outlier for our clients. Contrary to popular sentiment, our clients are using their space. From a broad perspective, the office supply picture didn't improve in the second quarter. The third-party industry reports all noted negative, modest absorption across all of the major markets in the United States, all of them. You'll clearly read about high headline availability, very scintillating in every market in the U.S. for some time.

However, continuing the theme that the sentiment is worse than the reality, the New York City brokers reports also indicate that the Class A inventory in the Park Avenue submarket has an availability rate of 11%, and that net effective rents are rising, rising with higher face rates and flat or lower concessions. While it's not reported, the availability in the premier buildings is even tighter. Away from the Midtown market in the BXP portfolio, we are now in negotiations with our first multi-floor client at 360 Park Avenue South. Tenant demand in the San Francisco CBD has increased more than 50% since the fourth quarter of 2022, with new technology demand responsible for much of the increase. There are a significant number of AI companies actively considering space, and the requirements will all create net absorption.

Given their potential growth at these organizations, we would expect this demand to center on the well-built tech sublet space that is readily available in the market, not direct vacancies. Global investment in the AI field is rapidly increasing, it's going to result in job growth. San Francisco is the leading labor market for AI jobs, followed by Seattle and New York. New venture capital investment in AI is concentrated in San Francisco, CBD, New York, and Boston, with CBRE Research reporting that San Francisco is receiving more than 50% of the total invested money during the 3rd quarter. These are encouraging facts that can only be constructive in the eventual recovery of the San Francisco CBD office market. The concentration of user demand strength still is, broadly speaking, alternative asset managers, private equity, venture, hedge funds, specialized fund managers.

These companies are growing their teams and capital under management. This pool of clients typically wants to occupy premier workplaces. To illustrate this point, during the quarter, we did a multi-floor 10-year renewal with a private equity firm in Boston and a 15-year renewal for a full floor with an investment manager in New York City. In general, our strongest activity is at the General Motors building in Manhattan, 200 Clarendon in the Prudential Center properties in Boston, 2,200 and 2,100 Pennsylvania Avenue in D.C., the urban core of Reston Town Center in Northern Virginia, and our Embarcadero Center assets in San Francisco. We don't have availability at Salesforce Tower ourselves directly. The law firms are also active in our portfolio and important clients for BXP.

This quarter, we completed 3 law firm leases in New York, 1 in Boston, and 3 in our D.C. portfolio. We also have a number of active law firm transactions in the proposal stage at Embarcadero Center. In general, however, outside of Manhattan, the law firms are reducing their footprints. During the quarter, we completed 3 life science leases, a 55,000sq ft extension in Lexington, Massachusetts. We relet the 12,000sq ft suite at Eight eighty Winter Street, where we had a foreign biotech company shut down its operations in March. We did it on an as-is basis at a rent that was 9% higher than the prior rent, we completed our second full floor lease at 651 Gateway in South San Francisco.

We are also negotiating a third full floor lease at 651 Gateway. We intend to complete a speculative turnkey installation on an additional floor. The property will open in 2024. To date, each lease at 651 Gateway requires our partnership to complete turnkey buildouts. Activity in the life science market continues to be moderate across both Boston and South San Francisco. There is new unleased supply being added to the markets. There are a few large requirements that are touring, but as I have previously said, the bulk of the demand is from small, private companies that are looking for fully built space. Our new client at 880 Winter fits this profile.

I also want to note that we are seeing costs decreasing disinflation on our tenant improvement work relative to jobs completed in 2022, largely due to the falloff in transactions in our markets. The numbers are slightly different by market by market, but we are seeing a reduction in TIs that we are budgeting. BXP's portfolio is going to gain occupancy. We will continue to lease available space because our portfolio is fundamentally comprised of premier workplaces. The majority of the demand, new and existing clients in the market, wants to be in these types of properties, and we are investing capital in our building infrastructure, amenities, and tenant spaces. We are all seeing the stress that many buildings are feeling due to their current capital structure. The transition or recapitalization of these buildings is going to take an extended time.

While this is happening, many of these assets are not in a position to commit capital to existing or new tenants, which greatly impacts the leasing broker's interest in considering them for their clients. Returning to the theme of the sentiment is worse than the reality for BXP, much of the available space in our markets is not competitive with our assets, and some buildings are not in a position to compete due to their owners' unwillingness to invest capital while their capitalization is in the restructure mode. Our clients are using our space. Medium and small financial and professional service clients will make up the bulk of the leasing we complete in 2023.

We completed 57 leases during the first quarter, 63 during the second. We have had only 2 leases above 100,000sq ft this year, and each was a renewal.

Occupancy gains will be captured slowly through lots of small and medium-sized new leases and renewals. I'll stop here and turn the call over to Mike.

Mike LaBelle (CFO)

Great. Thanks, Doug. Good morning, everybody. I'm going to start with a few comments on our balance sheet, and then I plan to cover the details of our second quarter performance and the changes to our 2023 earnings guidance. We had a busy quarter in the debt markets. We continue to bolster our liquidity and opportunistically manage our interest rate risk. In the bond market, we issued $750 million of 6.5%, 10-year unsecured green bonds. We had strong support from our fixed income investors, and our deal was well oversubscribed, allowing us to upsize the transaction and reduce the pricing from initial guidance. When we issued the notes in May, the underlying treasury was 3.34%, and our credit spread was 320 basis points.

Our credit spreads have rallied significantly to under 250 basis points today, while the 10-year has increased to over 4%. Despite all the volatility, if we issued another 10-year today, it would be at a similar coupon. In the mortgage market, we refinanced our $105 million expiring mortgage on 500 North Capitol Street in Washington, D.C. We also exercised 1-year extensions for our mortgage loans on the Marriott headquarters in Bethesda and the Hub on Causeway office tower in Boston. Our remaining 2023 loan maturities are limited to a $500 million bond maturity that we expect to repay with cash, as well as a mortgage loan on our mixed-use Hub on Causeway podium building. The Hub on Causeway is held in a joint venture, and our share of the loan is only $87 million.

We're finalizing terms and expect to refinance the loan in the third quarter for two additional years, plus a one-year extension option. This quarter, we also entered into interest rate swaps to fix the rate on our $1.2 billion unsecured term loan through May of 2024. We fixed the Term SOFR rate at 4.64%. That's approximately 70 basis points lower than where Term SOFR sits today. Our liquidity is strong at $3.1 billion. It consists of $1.6 billion in cash and the full availability under our $1.5 billion line of credit.

Our liquidity needs through the end of 2024 include $1.1 billion of projected spend on our development pipeline, $1.2 billion of bond maturities, and $190 million of mortgages with final maturities by 2024. We do have another $390 million of mortgages and our $1.2 billion term loan that mature in 2024 and have extension rights into 2025 or 2026. Our financing plan is to pay off the $500 million bond expiring in September with cash, refinance our $700 million bond prior to its maturity in February 2024, either through the secured or the unsecured market, refinance our mortgage maturities, and continue to maintain ample liquidity. Turning to our earnings results.

For the 2Q, we reported funds from operations of $1.86 per share. Our results exceeded the midpoint of our guidance range by $0.06 per share. The outperformance was due to $0.02 of better than expected revenues in the portfolio, combined with $0.04 of lower than expected operating expenses. The stronger revenues were spread across the portfolio. It included earlier than projected lease commencements, higher service and parking revenues, and outperformance at our hotel. On the operating expense side of the ledger, the savings were split between lower energy costs from both lower consumption and rates, and the deferral of repair and maintenance expenses. We project that most of the benefit from lower maintenance expenses will be lost as the projects get deferred to later in the year.

For the full year 2023, we're raising our FFO guidance to $7.24-$7.29 per share. In our same property portfolio, we expect most of the second quarter performance to flow through to the full year. We're raising our assumptions for our same property NOI growth by increasing the bottom end of our range by 50 basis points. We're now assuming same property NOI growth from 2022 of 0%-0.5%. We're also increasing our assumption for same property cash NOI growth to 1.5%-2.5%. The other area we are seeing improvement is in net interest expense. By swapping the floating rate on our $1.2 billion term loan to a fixed rate, we have locked in interest savings.

While we issued new bonds to refinance our September maturity earlier than we had projected, the interest rate was lower than our assumption from last quarter, plus we're seeing better deposit rates and are carrying higher cash balances, so we are earning more on our liquidity. In conclusion, we're increasing our 2023 FFO guidance range by $0.10 per share at the midpoint. The changes are primarily from $0.05 per share of better Same Property NOI, and $0.05 per share of lower net interest expense. Overall, we had a strong quarter, with top-line revenue growth, earnings outperformance, improved leasing volumes, positive mark to market on our commenced leases, and timely capital raising activity. Our balance sheet is in excellent shape, and we are well positioned in an uncertain environment for any economic outcome.

Looking further forward, we do expect the high interest rate environment to continue to be a headwind as we refinance low-cost expiring debt at anticipated higher rates. For example, we have $700 million of 3.8% fixed rate unsecured notes that expire in early 2024, and we expect a refinancing rate of approximately 6.5%. In addition, we have $1.9 billion of floating rate debt that is impacted by changes in SOFR rates. Our floating rate debt does include our $1.2 billion term loan that has been swapped to a fixed rate through May of 2024. We expect that our same property portfolio stable, with occupancy improving over time, and we will continue to add to our income through placing developments into service over the next few years.

That completes all of our formal remarks. Operator, can you open up the lines for questions?

Operator (participant)

Thank you, sir. As a reminder, to ask a question, you will need to press star 11 on your telephone. To withdraw your question, please press star 11 again. We ask that you keep your questions to no more than one, please feel free to go back into the queue, and if time permits, we'll be more than happy to take your follow-up questions at that time. Please stand by while we compile the Q&A roster. I show our first question comes from the line of John Kim from BMO Capital Markets. Please go ahead.

John Kim (U.S. Real Estate Analyst)

Good morning. I think I'll try to ask a multi-part question on 343 Madison. Any additional commentary you could provide on the total costs of both the East Side access and the building itself, development yields that you expect, who the partner is, or at least what region they're domiciled in, and what level of pre-leasing you need to move forward with the project?

Doug Linde (President)

Let me, let me answer the, the first three parts of your question, and then we'll let Hilary answer the fourth. We're, we're, we're designing the building. The building hasn't been designed yet. We are not in a position to discuss the economics of the development, or the returns. Clearly, the capital markets are different than they were, so the return thresholds necessary to rationalize putting capital into a building are going to be higher than they would have been in 2019 or 2020. I will let Hilary talk about the demand side.

Hilary Spann (EVP of New York Region)

Thanks, Doug. The demand side for this building has been interesting in the sense that, as Doug pointed out, the building is still being designed, yet we're receiving inbound calls from clients who are interested in anchoring the development, even in spite of the fact that it would take several years to build the building. This has to do, as Owen mentioned, with the tightness in the Park Avenue District and the Plaza submarket, more generally, in the sense that there's very little Class A premier workplace available for folks to occupy. As businesses are expanding in that district, they're finding themselves boxed out of larger space options.

I would say, particularly given the fact that we have not had a very active marketing program in place for Three Forty Three, the interest in the building has been, has been very, very robust, with multiple clients ranging from, call it, 200,000-300,000sq ft, seeking information on the building.

Owen Thomas (Chairman and CEO)

John, it's Owen. Lastly, we are honoring our partner's request for confidentiality.

Operator (participant)

Thank you. I show our next question comes from the line of Michael Griffin from Citigroup. Please go ahead.

Michael Griffin (Senior Equity Research Analyst)

Great, thanks. Owen, I appreciate your comments kind of about the transaction activity and potential acquisition opportunities out there. I, I was wondering if you could get some color on kind of what the IRRs on, on those potential opportunities could be, and kind of how you weigh that, relative to maybe potential share buybacks.

Owen Thomas (Chairman and CEO)

Well, Michael, I think on IRRs, as I mentioned in my remarks, there's just not very many deals out there that are happening. I mean, I on this call, you know, every quarter I try to give a, you know, a spectrum of the deals that got completed, and frankly, it's really hard to find things right now. Look, I think in the premier workplace segment, you know, overall, the IRRs where transactions were occurring before, you know, interest rates went up, was probably in the 6s. You know, today, even though there's not many data points, given the capital's, you know, more expensive, they've clearly gone up, you know, 100 basis points or more, I would say. Again, that's that's conjecture.

You know, as it relates to buybacks, as we have been saying, we think our stock represents a tremendous value opportunity, but we also have uses for the capital, our development pipeline and opportunities that may present themselves. So, you know, we have elected not to pursue a buyback program at this time.

Operator (participant)

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

Blaine Heck (Executive Director and Senior Equity Research Analyst)

Great, thanks. Owen, I think you mentioned considering capital raising through dispositions and joint ventures. Can you just expand on whether the dispositions would be concentrated in non-core assets or higher quality properties? Then on the JV side, can you give some color on what potential investors are looking for in an ideal investment, and what sort of returns they're targeting in this environment, given those high capital costs that you just referenced?

Owen Thomas (Chairman and CEO)

Yeah. Well, you know, I mentioned in my remarks that we're looking at dispositions and joint ventures with our residential assets and also our leased development properties. I think those two asset categories would probably represent the least impacted in our portfolio in terms of increasing cost of capital and cap rates. You know, I think the residential asset segment today is more liquid than office. There are no premier workplaces selling, but it's certainly more liquid in office, so we're going to evaluate those opportunities, and we're also evaluating opportunities in our leased development pipeline.

Doug Linde (President)

Blaine, I would just, just make the following sort of analytic comment. An IRR is dependent upon, obviously, what the cash flow looks like, but they're, they're still very dependent upon what your expectations are for the future. So we are not smart enough to, to be able to read the minds of our potential partners and how they're thinking about what they view as the capitalization rates in 10 years, 8 years, 15 years, and how much growth they're viewing there is going to be in the underlying rents of the buildings that we might be, you know, offering to them. So it's really hard to sort of get into their minds. As Owen said, it's a lot higher than it was in 2019.

We, but we don't know if it's higher because they've lowered their expectations for those residual cap rates, they've lowered their growth rates on their rents, or, or some combination. But it's, you know, it's, it's not an easy question to answer.

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)

Yeah, thanks. I wanted to just maybe circle up on Platform 16. Owen, I realize you've kind of gone through this before with 250 West 55th in the past. Does the building have maybe other uses if office for that building just doesn't come back in near term? Can you switch to residential or, you know, I guess, how long are you prepared to hold this?

Doug Linde (President)

This is Doug. The answer at the moment is we haven't focused on not building the project that we currently have, and the project we currently have is three commercial premier workplace buildings. Clearly, we have a platform and a parking structure that is going to be able to hold three large, you know, suburban office buildings on it. The platform would allow for something other than that. At this point, we believe in the location, we believe in the rationalization of transportation through, you know, the Caltrain, which is why we picked this location in the first place. We believe in what eventually, you know, the user who owns most of the land around there will build, and so we're not pushing towards doing something different at this moment.

Fundamentally, we looked at the market and said, "2024 is pretty quickly coming, and owning a building that's going to deliver in that marketplace, probably given the availability of other buildings around there, is not going to be the best use of our capital today. We're just going to hold off and let the market recover some more and deliver at the appropriate time." That's the, fundamentally, the decision that we made today. Rod or Bob, I don't know if you'd like to add into, into that.

Steve Sakwa (Senior Managing Director)

Yeah, I don't have anything to add at this point.

Operator (participant)

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

Michael Goldsmith (U.S. REITs Analyst)

Good morning, and thanks a lot for taking my question. We recognize one of the key tenets of the BXP investment case is this long development pipeline, now, you know, you're pausing this one building. Like, how should we think about or what is your confidence level in the expected yields of some of your future projects? Are they at risk of also being delayed? Just, you know, your overall thoughts about when your development pipeline can be monetized and, you know, whether that is in the near term or kind of on the shelf for now. Thank you.

Owen Thomas (Chairman and CEO)

Yeah. Most of the balance of what we have is leased. The big projects are the ones that we have in East Cambridge, and one is fully leased by AstraZeneca, the other is fully leased by Broad. 360 Park Avenue South, another one, we're actually having some very constructive dialogues on that property and have a letter of intent with a client for part of the building. I think the Platform 16 was rather unique circumstances, given the amount of sublease space that's been put on the market in the Silicon Valley/San Jose area, made us feel that. And it was a completely speculative project with no pre-leasing. You know, that brought us to the decision that Doug described.

Doug Linde (President)

Again, everything that we, we currently have on that development pipeline that is not yet leased is almost finished. There is, there's no such thing as a delay of these projects. Relative to our future development, and, I mean, again, 343 Madison is future development, and as I said, we're our return expectations is, is higher than it would have been in 2019 or 2020. If we if and when we start those buildings, we would hope that we're gonna have an economic, you know, opportunity to, to, to achieve the kind of returns that are necessary to rationalize, you know, an incremental amount of capital going into those new assets.

Operator (participant)

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

Caitlin Burrows (VP)

Hi, good morning. I think you mentioned earlier about how the top question at Nareit was on leasing, because that's so relevant to your company. Following up on that, leasing velocity was up significantly in the quarter, but down year-over-year. I guess it can be volatile. What are your conversations, like now, and do you expect that pace of signings from 2Q can be maintained? The pickup that you saw in the second quarter, was there something in particular that drove that, or could it be continued? Thanks.

Doug Linde (President)

Yeah, welcome back, Caitlin. When we had our call during the first quarter, we had about 900,000 square feet of what I refer to as our leases in negotiation. As we entered the third quarter, that number was, you know, over 1.1 million square feet. I'd say, as I said, a modest acceleration in that. We're comfortable with our embedded expectations of, you know, somewhere just over 3 million square feet for the year. I would say quarter to quarter to quarter, it's gonna be really what we anticipated, and I'm guessing the third quarter will be slightly better than the second quarter, and the fourth quarter will depend upon how many early renewal the conversations occur for 2024, 2025 lease expirations.

Because again, as we get closer and closer to the end of the year, the, the leasing activity is generated from those types of, of, you know, conversations with our clients. We're, we're constructive. I mean, as Owen said, the tech demand, particularly on the West Coast, has not really, started to materialize. That was a big volume generator for all of the, the companies that are in our, our product mix. We don't anticipate that changing in 2023, probably not in 2024. Our comparisons to the prior years, we think, will be muted because, as Owen said, we believe we are in an office recession, relative to our clients. There's not likely to be, a massive acceleration in leasing activity. Again, we're gonna capture market share because of our asset quality, and.

our teams and their propensity to be creative about figuring out how to solve client problems, which will add to our occupancy, but the general market is not going to be what it was in 2022.

Owen Thomas (Chairman and CEO)

Doug, one additional comment on the activity is that we are seeing a tremendous increase in the amount of not only access, but time that we're spending directly with clients. Most of them are focusing on what is the workplace strategy for them going forward. We're even seeing title changes, where you have director of workplace strategy versus facilities people. These conversations are increasing weekly, and it has to do with the whole strategy and specifically on what premier workplace is going to be needed versus the other bifurcation of space that they had that you mentioned earlier. I think there's going to be an activity jump here in the, the future that's coming because it's been pent up because people have been kicking the can.

Operator (participant)

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

Alexander Goldfarb (Managing Director)

Hey, good morning, first, Bob, congrats on your retirement. I don't know if we're allowed to use the word retirement, maybe going to part-time, congrats there. Question for you, just continuing on the West Coast theme. What do you guys need to see to happen? Like, what's going on with the tech companies? If we think back to the credit crisis, like here in New York, you know, Wall Street was down and out for quite a long time. It took, you know, you know, many, many years before it came back. For the tech companies, is it they overhired? They're not sure what's going on with work from home. I mean, they certainly seem to be profitable.

They always come up with new innovations that they seem to need to hire and need space for. What are the things that you need to see for the tech industry on the West Coast to sort of reengage proactively on the office front?

Owen Thomas (Chairman and CEO)

Yeah, I think, Alex, I'll take a shot at that. I'd say, first of all, the tech company's trajectory of income growth has flattened out. I think there's a more, more focus on cost, which has an impact on space demand. As new technologies are created and the advertising cycle changes and the growth continues, then I think there'll be more space demand. I think that's part of it. I think there definitely could have been an overinvestment period, where, you know, there were lots of employees hired and also space that was taken in anticipation of growth that hasn't materialized. I think there's a digestion aspect to this.

Lastly, I think, the technology companies, as well as the federal government, by the way, have been behind the rest of corporate America in return to office. I think as those policies are rolled out with the tech companies, and we're seeing it happen. Amazon came back to the office on May first. There are other technology companies that have come back to the office. Others are suggesting things, like I said in my remarks, about evaluating performance and, and paying people based on their office attendance. You know, these policies are rolling out now, I think that will also increase the demand for space, and it's going to take some time.

Operator (participant)

Thank you.

Owen Thomas (Chairman and CEO)

Doug, Rod, anybody else have other views on this?

Operator (participant)

Okay, thank you.

Rodney Diehl (EVP of West Coast Regions)

This is Rod. I'll just comment real quickly.

Owen Thomas (Chairman and CEO)

Yeah.

Rodney Diehl (EVP of West Coast Regions)

Alex, I just would add, and I think both Owen and Doug addressed this point, which is one of the positive tech drivers now that we're seeing is the AI demand. It's real. We've seen those deals in the market. A few of them gotten signed, and it's not still by any stretch the majority of, you know, deals in the market, but it's happening. It's that opportunity of a new technology that has pulled us out of other downturns. This is getting a lot of attention, and I think rightfully so.

Operator (participant)

Thank you. I show our next question comes from the line of Nicholas Yulico from Scotiabank. Please go ahead.

Nicholas Yulico (Managing Director)

Thanks. Good morning. I just, I just wanted to follow up on, you know, all the commentary, Doug, you gave on leasing and the pipeline and activity. Just wanted to make sure we're clear on this. You know, if we look at your lease rate, it was down year-to-date, about 100 basis points. Are you suggesting then, in the back half of the year, based on the visibility you have right now, is actually going to be improvement in the lease rate? Second part of that is, you also mentioned in numerous times occupancy gains for the portfolio.

I just want to be clear that, you know, are you saying that occupancy this year is going to be at a bottom, and at this point, you think, you know, next year is actually a growing occupancy year for the portfolio?

Doug Linde (President)

I'll answer the second question first. Yes, it's going to be modest, but it's a yes. I'm not sure what you mean by leased rate. If you're talking about the amount of leasing that we are doing on a quarter-by-quarter basis compared to the previous years, it's going to be down for every quarter in 2023 relative to 2022. That's why, you know, I mean, again, we did build to suits in 2022 that we're not doing in 2023, including almost 1 million sq ft just in Cambridge with AstraZeneca and the Broad.

Again, we're doing a lot more leases in terms of numerical number of transactions, but the, you know, the, the check size is obviously smaller because of the nature of what the demand is coming from, and which is small professional services and law firms and the financial services firms that I described before. We feel good about our, our pipeline of activity on a relative basis, first quarter, second quarter, the third quarter, the fourth quarter of 2023. And again, it's gonna be within the construct of the embedded earnings projections that we provided, which is, you know, somewhere in the neighborhood of 3+ million sq ft of space.

Operator (participant)

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

Vikram Malhotra (Managing Director)

Thanks for taking the question. Just, you know, maybe building on use of the capital, you talked about the balance sheet, your ability to, you know, fund what you have so far. I'm just wondering, stepping back, given what we know about the transaction market or dearth of, today, how do you view sort of your implied value, given the run-up in office or the little run-up in office we've seen relative to perceived NAV? Related to that, just uses of capital. If the premier, you know, workspace trend is sustainable over, say, a five, seven, ten-year period, is this a unique opportunity for you to do something more strategic in the premier space?

Doug Linde (President)

Vikram, you know, NAVs are hard. They're, they're based on a lot of judgments that Doug talked about earlier, which are, what's your assumption on rent growth and residual cap rate and all these things? I think the simplest way to think about it is, what is BXP's look-through cap rate? Today, that is around 8.25%. You know, I did highlight one premier workplace that sold in the Silicon Valley, and its cap rate was 6.1%. I can't tell you what the proper look-through cap rate is for BXP's assets, but I don't think it's 8.25%, and so I think that it does represent, you know, significant value.

Look, I think we are always gonna be interested in looking at, expanding in the premier workplace segment, in the life science segment, and in the residential development segment. That's one of the reasons why we have the liquidity that we have, and we're so focused on our balance sheet because we wanna have capital available during this time of discipline, available to make these kinds of investments, and we're gonna stay actively involved in our market, looking for them.

Operator (participant)

Thank you. I show our next question comes from the line of Camille Bonnel from Bank of America. Please go ahead.

Camille Bonnel (Director of Equity Research)

Good morning. You've had a lot of leasing activity over the past year in your Boston CBD portfolio, which is well leased. Could you speak to how tenant demand is trending for your suburban markets? More generally, any comments on how your leasing pipeline breaks down between life sciences and more traditional office users would be great.

Doug Linde (President)

With regards to the Boston suburban market, you know, they're depending upon how you define things, we have Cambridge, which is where the bulk of our value is, we have no available space there either, including, you know, the new developments that we're doing, which are 100% leased. We have this, this group of assets that were once the sort of perfect solution for a growing technology company on, you know, 128, which was called Technologies Highway, that were, you know, created in the '80s, '90s, 2000s. Those locations are fabulous locations still. What we have been doing over time, as we've been converting some of those buildings from office locations to life science locations.

If you look at our development pipeline, the bulk of our available opportunity set is in Waltham, Massachusetts, and it's in life science. That, that is, you know, I'd say our focus for growth because we see more likely growth over time with life science demand in the greater Boston market than we necessarily do with traditional technology office demand. Doesn't mean there isn't, isn't demand out there, because we are actually doing leases, both renewals and new deals, in the greater Waltham, Lexington market on the office side. I will tell you that in general, the suburban Boston office demand market is slower than, than the CBD market by a material amount right now. We are, you know, we are well positioned to capture incremental demand as the life science market recovers.

As we've said time and time again, we're not gonna simply build for the sake of building. We're gonna wait for the demand to come to us and for the market to tighten to the point where it makes economic sense to do this. We have such a low basis in these buildings because we have effectively free land or buildings that were purchased for $150 or $250 a square foot, where we can rationalize incremental investment and get a strong return when the market is a, quote, unquote, "stable market" from a life science perspective.

I would say that the demand in general for traditional office space in the greater Boston suburban market is light, but it's there is some there, and we are capturing it because we happen to have the best, absolutely the best properties and the best locations in what Bryan has, has, has sort of termed our urban edge locations. It's not no longer viewed as suburban. Bryan, I don't know if you want to make any additional comments.

Speaker 20

Yes, 2 early things that I could point to that may lead to a trend is, we have already completed 1 transaction with a downtown tenant who has put a spoke into their urban edge in 1 of our assets. We're talking to 2 more about that strategy, which gets back to this workplace strategy in the future for these companies that are really focused on their knowledge workers. Then we're seeing a, let's say, early trend, Doug, in what some people are calling tough tech, which is some portion of the space needs bigger clear heights for workbenches, et cetera. Maybe it's displays for sales, but that use has picked up over the last 6 months, for certain.

Operator (participant)

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

Ronald Kamdem (Managing Director)

Hey, just staying on the life science theme. Just, you know, we've sort of heard about sort of funding, a lot of these smaller companies having to come back for funding and could impact what you think. We just would love to hear just both in, on, on the demand side, what your expectations are in terms of activity over the next 12 to 24, how you guys are thinking about it, and then also hear your, your thoughts on the supply side. I mean, I think a lot of the brokers have a lot of supply in the pipeline. Maybe if you could talk about what you're seeing and, and which is competitive to your portfolio. Thanks.

Doug Linde (President)

So I'm gonna, I'm gonna try and truncate the my answer to this. I'm not gonna talk about all the things that ARE and Healthpeak talked about on their calls relative to sort of overall large scale demand in life science, and particularly biotech relative to gene therapy and all sorts of new discoveries that are going on. If you, if you simply look at where the money is going, and where it was, the amount of capital that was put into the, the life science market from a VC perspective, had an enormous spike in 2019, 2020, and 2021, and it was way outsized.

If you look at what's going on in 2023, it's pretty normalized and slightly higher than what, where it was in, call it 2014-2019. So I would say that there is lots of available capital, but the capital is, is being very thoughtful, and it's taking advantage, quite frankly, of dramatic drops in, in valuations for companies that were funded by people who probably shouldn't have given them capital, and gave it, gave it to them at valuations that were not appropriate for whatever the, the discovery was in the stage of those businesses. So we, we believe, and we believe we will see this, what I refer to as sort of small life science demand, continue in the marketplace.

The issue is that there are not a lot of big demand drivers other than some, you know, 1 or 2 consolidations that are occurring with some pharma companies that have acquired some medicinal biotech companies over the last few years and are starting to put those requirements together in both South San Francisco and in the greater Boston marketplace. But you hit on the sort of the issue, which is there's more supply. When that money was going into the sector, lots and lots of people who had property said, "Aha, this is the, the, you know, the, the perfect way for me to solve the problem of lack of demand in, in the office side.

I'm gonna take this building and convert it, or I'm gonna take this land and build a new building. We're gonna have to deal with the rather large amount of supply that's gonna be in the marketplace for the next couple of years. It is clear that there are winner locations and there are loser locations, and these ecosystems matter a lot. So we think that we are really well positioned with our particular assets in terms of their locations, both in South San Francisco at 651 Gateway, as well as the two Waltham properties that we have under development, you know, on the Totten Pond Road interchange, which is where the sort of cluster of the large, large, larger life science requirements have gone to over the past three or four years.

We believe we'll lease these things up. Are the economics gonna be what we had hoped? They're not, and I've said this before, we're gonna have to do more turnkey installations for these companies, as opposed to give them an allowance and them putting their own money in. We will deal with that, and we have the capital to do that, which again, many of, I believe, our competitors with product may or may not have the desire or the capability of doing. We're, we're gonna get these buildings leased as the demand comes. The demand is gonna get better, not worse. We just, you know, it's gonna take a little bit of time. I, I can't give you a projection of whether it's 12 or 24 months, but that's, that's the way we're thinking about it.

Operator (participant)

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

Dylan Burzinski (Senior Analyst)

Thanks for taking the question, guys. I guess just looking at BXP's portfolio in terms of office concentration, are there certain markets where you see your guys selves adding incremental capital to or possibly even reducing your concentration to over time?

Owen Thomas (Chairman and CEO)

Well, the way we operate is, strategically, we set a perimeter, which are the six markets that we're in, and the way the capital gets allocated is bottoms up. What deals arise in those locations that make the most sense for our shareholders, and we execute on them. We pay attention to the top line, what's the contributions from the different markets, but we think it's very important to be nimble and opportunistic as we think about allocating capital across those regions. There have been shifts over time. You know, if you look at the last five years, there's clearly been a shift of capital and allocation out of the CBD of Washington. You know, that, that would be a change that I would point out.

That's the way we operate the, the business from a capital allocation standpoint.

Operator (participant)

Thank you. I show our last question in the queue comes from Anthony Powell from Barclays. Please go ahead.

Anthony Powell (Director of Equity Research)

Hi, good morning. I think you mentioned that variable revenues, including parking, was a source of upside in the quarter. Could you remind us, where you are in parking revenues on a Same Property basis versus pre-COVID levels, how rate and utilization trended, and could you push parking rates as more people come back to the office going forward?

Mike LaBelle (CFO)

I mean, I think we're doing pretty well on parking. You know, we are overall, I would say, on parking, if you kind of exclude the fact that we removed a parking garage in Cambridge from service earlier this year, we're actually where we were before. I do think there's still opportunity to grow that because we're better than where we were before, because we've-- we have increased rents. We have had occupancy come back into these buildings and into these cities. I do think there's still room there, but for parking, we're already there. You know, the increase that we had in this quarter for parking was modest. As I said, the kind of the revenue beat was a little bit across the board. It was a little bit in a bunch of different places.

On the retail side, I, I'd, I'd say every place but San Francisco, we're back. The San Francisco retail contribution before the pandemic was a few million dollars. Hopefully, that will come back at some point. At this point, I'd say it's still difficult, and we're helping our retailers along. We do have some retail still returning, for example, in Boston, where we closed down the Lord & Taylor, and we're putting in a Dick's Sporting Goods that's gonna open next year. I mean, that's gonna be additive to us from a retail perspective. The hotel, you know, still a couple million dollars below where it was. You know, I don't know where that's gonna stabilize at.

I mean, it's doing pretty well, hopefully, it will continue to, you know, improve over time and get back to where it was and, and above where it was.

Anthony Powell (Director of Equity Research)

Thank you.

Mike LaBelle (CFO)

Thank you.

Operator (participant)

I'm showing no further questions in the queue. At this time, I'd like to turn the conference back to Owen Thomas, Chairman and CEO, for closing remarks.

Owen Thomas (Chairman and CEO)

Well, that concludes our remarks. Thank you all for your interest and attention for BXP. Thank you.

Operator (participant)

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