Shares of Boston Properties, Inc. (NYSE:BXP) rose 10% in generally a bullish day for the market after the latest economic readings suggested that inflation was coming down quicker than expected, boosting hopes for a lower interest rate environment. This, of course, is good for any real estate investment trust, or REIT.
The other news was that the company announced a substantial divestment as well, serving a dual purpose of deleveraging and underwriting carrying values of the real estate.
About That Sale
Boston Properties announced that it has reached a deal to sell a 45% interest in two life science development properties in Cambridge, Massachusetts to Norges Bank Investment Management. The two developments total 810,000 square foot and the valuation of the projects is pegged at $1.66 billion, with valuations just in excess of $2,000 per foot.
Pre-leased assets and the deal with Norges mean that the development financing requirements for BXP during the development have been cut in a huge manner (of course, the same applies to the future rental streams as well). Overall, this seems like a substantial deal which furthermore underwrites high valuations for life science real estate developments.
The Impact On Boston Properties
Like any office REIT, Boston Properties shares have been hit hard by a combination of factors, with rising interest rates and lower occupancy rates (and thus lower office demand by tenants) in the post-pandemic era being among the most critical for the business. Founded in 1970, and having been public since 1997, this is, of course, not the first period of turmoil which the company has faced in its corporate history.
As of the third quarter, Boston Properties owned and managed about 190 properties (although it does not hold a 100% stake in all of them). These properties entail some 53 million square feet, most of them offices with life science representing about 10% of the footprint. About 90% of these properties are let, with a long duration of 7 years and change, with the company’s shares of revenues totaling more than $3 billion per year.
Focusing on premier workspaces, many of these properties are located in key cities like New York, Washington, Boston, Seattle, among others. The focus on premium is key, as premium is what attracts more tenants as such properties see lower vacancy rates, while rent levels are much higher as well. The top three cities – Boston at 37%, New York at 26% and San Francisco at 18% – combined make up about 80% of the portfolio.
Clients include well-known names like Salesforce, Google, Biogen, Fannie Mae, Microsoft, among others, although I noticed that troubled WeWork (OTC:WEWKQ) is responsible for about 1% of the annualized rental income, a negative, of course, given the recent news flow.
To put the divestment into perspective, a 45% stake in an 810,000 square feet development measures less than 400,000s square feet effectively sold. It however makes a big dent in the current 5.5 million square feet of life science properties in the portfolio (or being developed), although in the grand scheme of things (including regular offices) the deal is relatively small.
About The Numbers
For the year 2022, Boston Properties reported a balance sheet of $24.2 billion, and as with any REIT, pretty much all these assets are comprised out of real estate assets, either directly or through investment in joint-ventures, as well as a $690 million cash position. The company is somewhat aggressively financed with $6.1 billion in equity, or $8.3 billion in equity if we factor in units in the limited partnerships or equity from partnerships.
The company reported $3.1 billion in revenues and $2.0 billion in expenses, the latter of which comprised three-quarter of a billion depreciation expenses and the remainder in (cash) operating expense. This resulted in pre-tax profits of about a billion (and of course higher cash flows if we add back depreciation expenses), with interest expenses reported at $437 million, but rising quickly of course.
In April, BXP reported a 6% increase in fits quarter sales to $803 million, yet that was about the good news as higher interest rates weighted on profitability. The core funds from operations (“FFO”) metric in real estate came in at $272 million, at $1.73 per share, down 9 cents on the year before, as interest expenses rose from $101 million to $134 million. The quarterly dividend of $0.92 per share, which has been flat for a few years now, surpassed GAAP earnings, resulting in a small decline in the reported equity base.
A month later, BXP issued $750 million in 6.5% notes due in 2034 in so-called green bonds, although that these carry a much higher rate than the average cost of debt paid by the firm so far. In August, the company posted a near 6% increase in second quarter sales to $817 million, with FFO down 8 cents to $1.86 per share, driven by higher interest expenses. Interest expenses rose to $142 million, still relatively modest in relation to about $17 billion liabilities, of which some $15 billion are interest-bearing.
Early in November, BXP reported a 4% increase in third quarter revenues to $824 million, with inflationary pressures subsiding, which hurt rental growth as well, with FFO being down 5 cents to $1.86 per share. The company incurred a nearly quarter of a billion loss from unconsolidated joint ventures which drove GAAP losses as these losses made the shareholder equity of $5.8 billion deteriorated a bit in relation to a $24.7 billion balance sheet, as interest expenses rose to $148 million.
These interest expenses now trend around $600 million, but assuming a 6% cost of debt on all liabilities, this might increase to a billion over time if the yield curve stays the same. This would create continued headwinds as refinancing continues to take place, as a small decline in interest rates is comforting in this respect.
The Impact
The deal with Norges bank will forfeit hundreds of millions in development costs to be incurred and the coming years (with completion of the buildings seen in 2025 and 2026) needed to avoid a further ramp-up in net debt. That is a substantial amount, but equal to just a low percentage of the current balance sheet, it is far from a game changer.
Even as a $150 stock pre-pandemic has fallen to lows of $50 in recent days, shares still trade at a premium to book. With 157 million shares outstanding, the company commanded a $7.8 billion equity value on the stock exchange, a near $2 billion premium compared to the book value of the firm. That tells you that a $24.7 billion balance sheet it really valued at $26.7 billion by the market.
This values the properties at over 8 times rent of $3.2 billion, but this is too simplistic as well, given the large costs incurred by owning and operating this type of property. If we adjust for directly attributable building costs, this multiple has increased to 13 times net rent, of course ahead of general overhead costs, interest costs, etc.
And Now?
The reality is that the latest deal is not a game changer for Boston Properties, Inc., but the divestment and promising inflation numbers provide some short term avail. This comes as the business struggles to overcome its challenges. That said, I typically avoid office properties, as the direct costs to operate such properties are relatively high in relation to rent, which means that any vacancy hurts the economics greatly in terms of the building P&L, and this is exactly that the company is seeing, in combination with lower rates.
That said, the premium positioning of Boston Properties, Inc. stock is comforting, as a 7% dividend yield looks rather compelling. Of course, the business is hugely susceptible to higher rates and economic conditions, but a lot of the bad news appears to be priced in, as life science and top-notch real estate are positive drivers. While dividend investors would not welcome a cut, the current dividend is high enough to sustain a cut, after which it would still pay out a solid dividend, while that would help BXP to deleverage as well.
While there is a very active and lively debate whether REITs have a bright future or not, we can agree that a lot of bad news has been priced in, yet the question is what is enough and, of course, how the economy and rates will develop from here.
Generally said, premium assets and companies will survive and BXP is just that, although with high leverage. That said, at these levels, long term investors might have a look provided they understand the risks despite quality induced by uncertain macro and high leverage, although the recent divestments are just a testament of the premium assets owned by the business.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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