Boston Properties Inc (BXP) — Q3 2020 Earnings Call Transcript

Great. Thank you. Good morning, and welcome to Boston Properties’ third quarter 2020 earnings conference call. The press release and supplemental package were distributed last night and furnished on Form 8-K. In the supplemental package, the company has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with regulatory guidelines. If you did not receive a copy, these documents are available in the Investor Relations section of our website at investors.bxp.com. A webcast of this call will be accessible for 12 months. We want to inform you that some statements made during this conference call, which are not historical, may constitute forward-looking statements under the Private Securities Litigation Reform Act. Although Boston Properties believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that these expectations will be met. 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 occasionally in the company’s filings with the SEC. The company does not have a duty to update any forward-looking statements. I’d like to welcome Owen Thomas, Chief Executive Officer; Doug Linde, President; and Mike LaBelle, Chief Financial Officer. During the Q&A portion of the call, Ray Ritchey, Senior Executive Vice President, and our regional management teams will be available to address any questions. Now, I’d like to turn the call over to Owen Thomas for his formal remarks.

Thank you, Sara, and good morning, everyone. I’m joining you today from BXP’s New York office, where I’ve been working since New York opened in June and have more recently been commuting on public transit. New York City is slowly coming back to life with more open shops and restaurants, and our building census is over 15% and rising each week. All of our markets and BXP offices with the exception of those in New Jersey and Los Angeles are opened at bearing capacity limits set by local guidelines. Despite a challenging recessionary environment, BXP continued to perform well in the third quarter, demonstrating the durability of our business. In the quarter, we collected 99% of our office rents and 97% of rents overall. We completed 811,000 square feet of leasing, 40% being either new requirements or expanding existing customers, and we increased our average net rental rates on our second generation leases by 20%. We entered into an option agreement to joint venture CityPoint South, a large scale multi-phase development site in Waltham, Massachusetts, that can accommodate both office and life science demand. And we completed the previously described acquisition of a 50% interest in the Beach Cities Media Center site in El Segundo. And since quarter end, we signed a 200,000 square foot 20-year lease with Volkswagen Group of America for their U.S. headquarters at our Reston Next development in Reston, Virginia. With the VW lease and previously secured anchor tenant, Fannie Mae, this 1.1 million square foot property is now 85% pre-leased. I am proud of our team at BXP’s resilience and fortitude in both assisting our customers and safely returning to work while delivering results for shareholders in a challenging time. Well over 50% of our employees are opting to work in the office subject to local occupancy restrictions. Now moving to the economy. The course of the U.S. and global economic recoveries remain heavily impacted by the course of the pandemic. New COVID-19 cases are hitting record highs in the U.S. Fortunately for BXP, new cases per unit of population in the states where we operate remain at levels below the national average. While we anticipate a vaccine will likely become available by year-end, it is unlikely to be a magic bullet that immediately eliminates the pandemic given broad deployment will face issues around manufacturing, distribution, uptake, and efficacy. Though difficult to assess, we think economic conditions for the first half of 2021 will remain sluggish, but expect a more pronounced reopening of the economy and return to the office in the second half of 2021 due to distribution of a vaccine, better therapeutics, and more individual adoption of health safety protocols as we all learn how to combat and live with COVID-19. With many office workers still working remotely, there continues to be much speculation, not surprisingly, about the future of work and use of office space. To understand the current market environment and contemplate future demand, I will revisit the four key drivers of office demand I discussed last quarter, namely employment, location, density, and occupancy, or better known as work from home. Job losses and the slowdown in economic activity due to the pandemic have been and will be the most important drivers of office market conditions for the foreseeable future. Recovery has commenced with almost 4 million jobs created in the third quarter, and unemployment has dropped to 7.9%, which is 6.8 percentage points below the peak in April, but 4.4 percentage points above the low in February. We are confident of economic recovery and believe our properties and markets will perform well over time given their proximity to resilient and growing tech and life science demand. Regarding location, there continues to be speculation about companies moving from major urban environments to secondary markets or suburban locations. To-date, we have seen no evidence of pandemic-driven movement among our customer base to secondary cities or suburban locations. On densification, it is clear that the pandemic has reversed the trend of increasingly dense work environments as companies are spreading out their employees for health security purposes. Doug, in his remarks, will provide case studies in BXP’s portfolio. With many companies not back in their offices, it is impossible to quantify this trend today. But we believe the reversal of densification will be a material tailwind for office demand over the longer term. Finally, on work from home. We remain convinced that successful companies will work in person. It is increasingly clear to our customers and other business leaders that there are significant gaps in conducting business on a fully remote basis in terms of creating and maintaining culture, creativity, and productivity as well as onboarding, training, and development. Again, Doug will provide several examples among our customers. Following the pandemic, work from home will become more accepted, likely as a benefit offered to employees. However, space savings cannot be achieved unless employees schedule their work from home days and utilize floating workstations when in the office, which could be more difficult with the type of workforce employed in our premium assets. Now moving to private equity market conditions for office assets, transaction volumes are down 60% for the third quarter versus last year and 42% year-to-date. Buildings in tech-heavy markets with long weighted average lease term are selling for pre-COVID cap rates. And life science-related assets are also in strong demand. However, there is limited activity for assets with lease-up and/or rollover risk due to bid-ask spread and pricing. Buyers want a discount for lower rents and slower lease-up, and sellers believe in a full market recovery and can inexpensively hold on by refinancing. Some of the fewer deals completed in the third quarter of note are, Genesis Towers in South San Francisco sold for $1 billion, nearly $1,300 a square foot and a 4.75% cap rate. This 780,000 square foot two-tower complex is 96% leased, built for life science use, and it’s sold to a healthcare REIT. This deal illustrates the high level of liquidity available for life science-related assets. Reservoir Woods East in Waltham sold for $330 million to a REIT. The property is comprised of a 313,000 square foot leased office building, a 202,000 square foot soon-to-be-vacated office building that will likely be converted to lab use, and land with development potential of approximately 440,000 square feet. Assuming a land price of $80 per developable square foot, the buildings, one of which is essentially vacant, would be valued at $575 a square foot. In Santa Monica, 2041 Colorado is under agreement to sell for $166 million, which is $780 a square foot and a 4.3% cap rate. This recently repositioned 93,000 square foot property is 100% leased with a long weighted average lease term and is being sold to a domestic life insurance company. In Reston, Patriots Park was sold for $325 million or about $450 a square foot and a 5.6% cap rate. This 724,000 square foot asset is fully leased and sold to an asset management company. BXP built and subsequently sold Patriots Park in 2014 at roughly the same valuation. In the Bellevue, Washington Spring District, two new buildings comprising 540,000 square feet long-term lease to Facebook are under agreement to sell for $565 million to a fund manager. Pricing is approximately a 4.5% cap rate and $1,050 a square foot. Moving to BXP capital activities. Last quarter, I described a relative dearth of new investment deal flow due to the early phases of the pandemic and low refinancing costs. This past quarter, we’ve experienced a modest uptick in new acquisition opportunities and expect our pipeline to grow into 2021. Though nothing is imminent, we are actively looking at new investments with private equity joint venture partners. We did complete an option agreement to become a 50% joint venture partner with a local developer in CityPoint South, which is a 42-acre site supporting 1.2 million square feet in Waltham proximate to our CityPoint asset. The deal structure includes a favorable fixed land price with the option to close on individual sites in a phased manner based on market conditions and our ability to secure pre-lease commitments. As part of this development, we will be completing new interchange improvements onto the I-95 Route 128 enhancing access to our entire Waltham portfolio. Waltham, already a mature life science market, has recently seen a significant increase in leasing interest from life science tenants, and this site allows for the development of both office and lab properties. This investment provides a significant boost to our growing life science business and will create more life science critical mass for the opportunities we have already identified for potential lab development and redevelopment in Waltham. We also continue to invest in our development pipeline, which currently stands at 8 development and redevelopment projects comprising 4.3 million square feet and $2.4 billion in total investment. The commercial component of this portfolio is now close to 80% preleased, with aggregate projected cash yields at stabilization of approximately 7%. Our development pipeline is an underappreciated asset of BXP that we expect will add approximately $200 million to our NOI by the end of 2024. This quarter, we placed into service two residential projects, Hub50House, the 440-unit residential component of our Hub on Causeway mixed-use development in Boston, and the Skyline, a 402-unit multifamily asset located at the MacArthur Transit Station in Oakland. Both assets are heavily amenitized and of the highest relative quality in their local markets. Initial lease-up has been slow given the operating environment, but both assets will provide BXP NOI growth in future quarters. And a final word about the investment opportunity in BXP shares. Our office portfolio continues to demonstrate resilience with an outstanding base of creditworthy tenants across sectors. With the future delivery of our leased development pipeline and recovery potential in our parking, hotel, and retail portfolios, we have a solid growth story. From the peak in early 2020, our FFO per share is down 14%, but our share price is down 50%. Our dividend yield has gone from 2.7% to 5.3%. At BXP’s current share price, our underlying asset cap rate is around 7% and private market cap rates, as I described earlier, are materially lower. Clearly, at our current stock price, we think the value story is obvious and glaring. To conclude, 2020 continues to be a challenging time for many types of real estate, including office, as the pandemic continues to take its toll on the economy. However, all pandemics and recessions eventually come to an end, and we are confident in BXP’s market position with long lease terms, minimal near-term lease rollover, and strong liquidity to invest opportunistically. BXP has the franchise, capital, and business strategy to emerge from the pandemic and recession with strength and momentum. So let me turn it over to Doug.

Thanks, Owen. Good morning, everybody. I think I might have misheard what Owen said when he was talking about one of the asset sales. The building near Colorado Center in LA was $1,700 a square foot, not $700 a square foot. So if I misheard that, I apologize. My comments this morning are going to focus on our office and our life science leasing activity. But first, a couple of remarks on our ongoing operations. So as Owen said, government and public health leaders continue to encourage businesses to work from home. And with very few exceptions, business leaders have not required their employees to return to the office. Massachusetts was the first of our markets to pull back restrictions. And while office occupants are allowed to be at 50%, our urban census has been pretty steady at about 9% for the last few months. Our suburban Boston portfolio includes about 5 million square feet and 33 single-story to six-story buildings. Virtually every tenant employee drives their own car to work. The census here is about 5%. In Northern Virginia, the second market that relaxed restrictions, companies are actually required just to social distance and there are no limits to the occupancy threshold, and employees drive to their office. We estimate our census is well under 15%. At this time, the return to work is not about transportation constraints, and it’s not about elevator constraints either. Our New York City towers have the highest census at about 16% daily, and more than 23% of the people who have badges in our CBD New York City buildings are going to work at least once a week. While a number of our retail tenants have reopened with volume restrictions, traffic is subdued and many food service and other amenities still remain closed. While there is some urban retail street activity, we suspect it is more from local walkable residents and not from people coming to work every day. Monthly parking passes have not yet begun to rebound, and transient parking continues to be pretty light. If people are not coming to the office, then they’re not paying for monthly parking, and they’re not shopping or dining in the areas close to our buildings. We opened our Cambridge Hotel in October, and it’s running under 10% occupancy, and we are simply trying to cover incremental operating expenses and put people back to work. Room sales are predominantly leisure guests, not business travelers, and there are no food and beverage operations being offered at the property. As you’ve heard or read from a lot of brokerage reports, market leasing activity is very light. In the context of the comments that Owen and I just made and the continued uncertainty regarding the public health issues, this should be expected. What I hope will be very encouraging for everybody on this call, investors and analysts here, is the level of Boston Properties activity right now. This is what really matters for our performance. In previous down cycles, our portfolio and our operating team have outperformed the market, and we believe this is happening again. I’m going to start with our Boston area operations. This quarter, we completed a post-COVID lease with Columbia Threadneedle Investments for 83,000 square feet at our Atlantic Wharf property on a space that is currently leased and does not set to expire until the end of 2021. While Columbia had targeted Atlantic Wharf as a great option, we were actually not originally considered since we didn’t have available space that could meet their occupancy window. We were able to structure an early termination of an existing tenant who is expiring to accommodate the new tenant’s timing, and we quickly completed a 13-year lease. The cash rent on this lease will be 30% higher than the expiring rent fully grossed up, and there are future rent increases. This is important because even though the markets are seeing higher availability, and rents and concessions may change, our leases continue to have significant embedded growth, particularly in our Boston and our San Francisco portfolios. In suburban Boston, our life science activities continue to accelerate. We are close to completing a lease with a single tenant for the entirety of our life science conversion at 200 West Street, a 138,000 square feet. We’ve actually grown the building. To preempt the question, we have spent about $140 a square foot upgrading the base building for lab use. And if you amortize a portion of the lab TI against the lab rent, we will achieve an incremental return on cost of about 10%. The base building is just being completed, and this tenant will be in occupancy in mid-2021. We are in the final stages of completing a full building as-is extension with an early stage life science company at 100 Hayden Avenue, 56,000 square feet, which will kick in when our direct lease with Shire Pharmaceuticals expires in mid-2021. This one only has a 40% increase in rent. We also have an LOI with a healthcare company for the entirety of our 63,000 square foot building at 195 West Street in Waltham. As Owen said, we have a 1.2 million square feet joint venture at CityPoint, and we’ve also put our plans together to develop 180 CityPoint, 310,000 square feet as a life science building. We’re also studying the conversion of some of our Winter Street office assets in Waltham to life science and are pursuing permits for additional life science or office buildings on existing land holdings in Waltham and Lexington. Finally, in Waltham, we are close to completing a 75,000 square foot lease with a technology company that will bring 20 CityPoint’s office space to 100% leased. That was a building that was put in service earlier this year. Turning to Northern Virginia. This quarter, we completed 2 additional leases with Microsoft to expand and extend their premises in Reston Town Center. They leased an additional 45,000 square feet and extended the 2028 expiration on 164,000 square feet to 2033. We’ve also completed another 96,000 square feet of leases, 8 transactions during the quarter there. We are in negotiation on 5 more leases, totaling 65,000 square feet for vacant space in the Town Center. As Owen said, we signed our 20-year lease with VW at Reston Next. And while we had to contract Fannie Mae’s premises in order to accommodate VW, we’re now 85% leased, and both of the tenants have rights for short-term growth. Just as an aside, if you look at our development properties and include the leasing at 200 West Street, the office portfolio lease percentage will be 80%, and this includes Dock 72 at its current leasing of 33%. Moving to New York. In New York, on July 1, we completed a 110,000 square foot 15-month extension at the General Motors building with a tenant that had an early 2022 expiration. The tenant was negotiating for a relocation, and COVID-19 resulted in a reevaluation of that decision. The General Motors building is our most active single asset in the entire company. Since June 1, we’ve had 15 unique in-person tenant tours for tenants ranging from 3,000 square feet to 40,000 square feet, and we’ve converted 2 to leases. For comparison purposes, we had about 20 tours in our entire Boston CBD portfolio and 16 at Embarcadero Center since June 1. We’ve made some progress with Ascena/Ann Taylor at Times Square Tower. We expect them to continue to lease about 150,000 square feet of office and retail space, with cash rent commencing in January of 2021. We completed a one-year extension for a 70,000 square foot tenant at 510 Madison, bringing their expiration into early 2023. And we’ve done 4 small tenant transactions at 250 West 55th Street, totaling 17,000 square feet. Two weeks ago, we completed a full floor post-COVID lease renewal at 601 Lexington Avenue for 30,000 square feet. In Princeton, we’ve seen absolutely no New York City outmigration tenant inquiry. But we’ve completed 5 transactions, including 2 expansions for about 40,000 square feet, and we have an aggregate of about 100,000 square feet of active conversations at Carnegie Center. Our California properties have been subject to essential worker-only restrictions until yesterday in San Francisco. In Santa Monica, we continue our renewal negotiations with our 2020 and '21 expirations. In the Silicon Valley, we’ve signed an LOI for 68,000 square feet with a life science tenant to utilize available office space at 601 Gateway in South San Francisco beginning in the fourth quarter of '21. Our Gateway JV is planning the conversion of 651 Gateway, which is a 293,000 square foot office building to lab, and we hope to start that construction in late 2021. We are finalizing a lease with a 31,000 square foot life science tenant in our North First buildings down in San Jose, and we’ve also seen life science tenant interest for our Mountain View Research Properties that are single-story structures that in the past have had both wet benches and clean rooms. Activity at our San Francisco CBD assets, where we’re just under 96% leased and have 415,000 square feet of tenants expiring in the remainder of '20 and '21, has been greatly impacted by the governmental restrictions, as I said, which were lifted yesterday on a partial basis. The third quarter only produced 3 transactions totaling about 23,000 square feet at Embarcadero Center. However, we have 114,000 square feet of new near-term expirations that we have gotten contractual commitments on renewals that have been exercised, and they are simply subject to a rent reset. The expiring rent on that 114,000 square feet is $61 a square foot fully escalated gross. I want to end with a brief comment on space utilization. Since we’ve seen a number of REIT analysts make some assumptions about reductions of office space utilization going forward, largely due to work from home. I’m not going to give you our opinion. Rather, I’m going to provide a series of decisions that our customers are making in our Boston market post-COVID. First, one of our large tenants in Cambridge had a contractual right to give back 190,000 square feet of office space in July. The right expired unused. Second, one of our large tenants in Boston has completed a space planning process as part of a total reconfiguration of their premises, that takes into consideration COVID planning considerations and their seat count in that premises is down 30% from pre-COVID, 30%. Third, Columbia Threadneedle was downsizing from 156,000 square feet pre-COVID. They signed a 13-year lease for 83,000 square feet, which was in line with their original search requirement. Fourth, we’re trying to find space in our Back Bay portfolio for a 75,000 square foot private equity firm, and we are actively asking tenants if they would consider early terminations. This tenant is currently leasing 60,000 square feet. Fifth, we’re managing the build-out of a large multi-floor installation for a technology tenant in one of our new buildings. We continue to move forward with the space build-out on the entire premises as planned. Sixth, we have a 70,000 square foot technology tenant in Waltham with a 2031 expiration. We’ve made a proposal for them to relocate into 100,000 square feet in June, with an expectation that they’ll take another 100,000 square feet over the next few years. Finally, to show I’m being objective, we have a 77,000 square foot consulting firm as a tenant in the CBD portfolio with the June 1, 2021 expiration. This entity is part of a large corporate merger that was announced in late 2019. Pre-COVID, we were discussing a two-year extension. Today, we’re having no discussions, and it’s unclear if they will do anything prior to their lease expiration. Despite being in the midst of this COVID-induced recession and the corresponding slow repopulation, we continue to have leasing activity, and tenants continue to make long-term space commitments. In previous down cycles, as I said before, our portfolio has outperformed, and this will happen again. This concludes my remarks. Mike?

Great. Thank you, Doug. Hello, everybody. Good morning. I’m going to cover the details of our earnings for the quarter and I’ll also provide some insight into our expectations for the fourth quarter and some comments on how we are thinking about 2021. For the quarter, we reported FFO for the third quarter of $1.57 per share. Our earnings were in line with consensus estimates if you exclude the $0.06 per share of charges for the write-down of $6 million of non-cash accrued rent and $4 million of accounts receivable. The $10 million of tenant write-offs this quarter were substantially less than last quarter. And once again, they were focused on our retail clients. In particular, our theaters and health clubs are not demonstrating the ability to pay rent consistently, and we’ve elected to write off unpaid rent and recognize all rent going forward from these two categories on a cash basis. Our office portfolio remains strong, and we continue to see no meaningful credit weakness among our office tenants. As a reminder, the office portfolio comprises over 92% of our current revenue, and collections continue to be strong at 99% of our third quarter billings. Similar to last quarter, we have provided a page in our supplemental financial package that describes all the COVID-related impacts to our portfolio. Occupancy this quarter did decline by 90 basis points as we expected, primarily from a known tenant move out of 234,000 square feet in Princeton and 100,000 square feet of transitionary vacancy between tenants in Reston Town Center. We’ve already signed leases for this space in Reston, and we expect it to be occupied in 2021. We partially offset the impact of the occupancy decline with revenue growth from a full quarter of contribution from our 100% leased 1750 Presidents Way development in Reston that we delivered in the second quarter, and $2 million of growth in our parking revenues. Parking revenues grew by 15% from last quarter. And while this is on a small base, it is a good sign of increases on our building census and mobility in our cities relative to the second quarter. I want to start my discussion of our expectations for the fourth quarter and 2021 with comments on our leasing exposure for the rest of the year. We report 1.6 million square feet of leases expiring in the fourth quarter. We are actively working on renewals for over 525,000 square feet, and we currently have approximately 400,000 square feet of space that we anticipate will be vacating. In addition, we have 675,000 square feet in this grouping of the tenants whose leases we have terminated, but they have not yet vacated their space. So they’re still in occupancy. We expect that these tenants will remain in place until a resolution is reached. We have not been recognizing revenue from these tenants in Q2, Q3, or Q4. So there’s really no financial impact until we either negotiate a lease amendment, such as within Ann Taylor, or we get the space back and obtain a replacement tenant. We expect our year-end same-property occupancy to be between 90% and 90.5%. We also will be adding Dock 72 to the in-service portfolio next quarter, which will negatively impact the headline occupancy rate but have no impact on our NOI run rate. We expect these changes in occupancy will result in a portfolio NOI run rate for the fourth quarter that will be relatively flat to the third quarter, inclusive of the $6 million of accrued rent write-offs. This assumes we have no new charges in the fourth quarter. Looking ahead to 2021, we have 580,000 square feet of signed leases in our same-property portfolio that are not currently in our run rate. We expect that these tenants will commence occupancy and revenue recognition in the first quarter of 2021. This includes 170,000 square feet at 399 Park Avenue, which will reach a 100% leased and 40,000 square feet of space at the GM Building. Including these leases, our New York City portfolio is 97% leased, and it has moderate near-term rollover exposure outside of Ann Taylor, which Doug described. As a reminder, we’re currently recognizing zero revenue from Ann Taylor. So their extension and a portion of their space will add to our earnings in 2021. This group of signed leases also includes our 125,000 square foot lease with IDG in 140 Kendrick Street in Suburban Boston, and the next phase of our lease with Microsoft in Reston that totals 165,000 square feet. We also have deliveries in our development pipeline that we expect will add to our revenue in 2021. We expect to commence revenue for our 200,000 square foot lease with NYU at 159 East 53rd Street in the first quarter. And later in 2021, we expect to deliver our 630,000 square foot Hub on Causeway office tower that is 94% leased, and our life science lab conversion at 200 West Street in Waltham that Doug described. Outside of the office portfolio, while we’re encouraged that our hotel has reopened and our parking revenues are growing, we still expect a slow ramp-up from these areas next year. The other item to keep in mind for 2021 is in our interest expense line. We expect to repay our $850 million, 4.3% unsecured bonds in the first quarter of 2021 with cash. We do anticipate lower capitalized interest next year as we deliver developments, but the net impact is that our interest expense should be lower in 2021 than 2020. So to sum it all up, we expect our fourth quarter funds from operations to come in closely aligned with this quarter. This assumes no additional tenant write-offs. For 2021, we expect to return to earnings growth. We have signed leases that are coming in the revenue; we expect a positive mark-to-market, particularly in our Boston and San Francisco leasing; we have several lease developments delivering, and we expect to benefit from lower interest expense. That said, we do have a manageable 6.5% of the portfolio subject to expiring leases next year. We’re working on renewals to cover many of these leases. But for those that vacate, we anticipate an active marketing program that will include white-boxing vacant space and completing turnkey improvements in certain cases. And this could result in modestly lower occupancy in 2021 as we wait for tenant spaces to be built out to commence revenue. While we would love to provide earnings guidance as we have in the past on this call, there remains significant uncertainty as to the pandemic’s length and severity and the impact on the overall economy. We hope to return to providing detailed forward-looking guidance again in the future. That completes my remarks. Operator, I’d appreciate it if you could open up the line for questions.

Just on the work from home trends changing the dynamics of the business. We do have strong historical data on the cyclical impacts of recession on offices. But there does seem to be some evidence of a secular shift here as well. How do you view, and could you address further the possible work-from-home secular risks and office space demand? And this is specifically as you speak directly with business leaders.

Yes. Why don’t I? Well, as I mentioned in my opening remarks, we continue to think that successful companies will primarily conduct their business in-person. The customers that we talk to, the other business leaders that we talk to, I think it’s becoming increasingly clear to them that they’re missing something with everyone working from home. Building culture, creating strategy, I hear, loss of productivity, and loss of creativity, and then of course, all companies hire and onboard new employees. How do you do that when you’re working from home? So, I think the importance of the in-person workplace is clear. That being said, I do think there will be more work-from-home offered to employees as a benefit. And as I mentioned in my remarks, I think for companies to save office space as a result, employees will have to schedule their work-from-home, not everybody can be out on Friday. And then, when the employees come to work, they’ll have to have flexible workstations and they won’t be fixed. And we do have premium assets, and the kind of workforce in those assets may be less inclined to participate in such a program in that manner. So, that’s the way we see it shaking out at this time.

I want to emphasize that in our Boston market, recent decisions have clearly disproven the idea that working from home reduces the utilization of office space. These are established facts, not just opinions from commentators in the media. Additionally, back in 2017, many experts predicted that single vehicle use would decline due to autonomous cars, leading to underutilized parking garages. I believe that perspective was largely misguided. While it's valid for people to share their thoughts on work from home policies, I think there's another perspective, which Owen mentioned. We firmly believe that people will return to work in large numbers and actively use their office spaces. By 2022, we should have a clearer understanding of this situation.

That’s great. Switching gears. So you completed 2 developments in 3Q, both residential, obviously, a small part of your business. But given the environment, how do you anticipate lease-up and stabilization timing and your thoughts on achievable development yields versus initial underwriting?

I’ll share my thoughts on this, and Owen can add his input. The lease-up process is currently much slower than we had anticipated because people are not relocating significantly in urban areas. In fact, we’ve observed some outmigration. We now anticipate that the lease-up will take longer; rather than being fully leased at the Hub on Causeway by the end of 2021, we now expect it to happen in 2022. Similarly, for Skyline, we initially projected a lease-up period of 18 to 24 months, but it will likely extend beyond 24 months. I'm not sure how much pressure there will be on rents; it mainly seems to come in the form of offering free rent in urban areas. Consequently, I believe our yields will be lower than expected. Our yields could be 20 basis points or 50 basis points lower, depending on the lease-up progress.

Yes, I agree with that answer. I believe both of these products are the best or among the best in their market regarding quality, amenities, and offerings. I think they will perform very well as the recovery described by Doug unfolds.

I guess, can you mind just giving a bit of perspective on what you’re seeing in rents in your markets? How much are they down? I mean I think this is one of the big questions everyone is trying to figure out is, what is kind of the fallout in rents been so far? And whether things could get worse as leasing activity is not really picking up here in the back half of the year?

The answer to your question is that nobody knows. There are simply too few transactions to really gauge the situation. I don’t think it’s due to a lack of pent-up demand for leasing; rather, the health crisis has prolonged decision-making. We are having success leasing space in three out of the five markets we are in, specifically in Boston, both urban and suburban, Northern Virginia, and New York City. While there is some activity, it’s not sufficient to determine the direction of market rents. There are more sub-leases in the market, which will impact rental rates in the short term because sub-let space generally gets discounted, affecting the overall marketplace. However, we cannot currently predict how much rents may decline. In fact, in some of our markets, we’re uncertain if they will decrease at all. I don’t anticipate a drop in rents in Cambridge, Massachusetts, and I’m not sure about Reston, Virginia. There will be areas facing pressure, though. Importantly, market rents don’t primarily drive the growth of our net operating income in the medium or short term; occupancy does. Whether our rents fluctuate by 5%, 7%, or 10%, it doesn’t significantly impact our total revenue; occupancy is what matters. If we can maintain high occupancy levels even in a weaker market because people prefer better buildings, I believe we can perform relatively well without a significant decline in revenues due to falling market rents.

Second question is just about kind of strategic thinking here. You talked earlier, Owen, about value not being reflected in your stock price. It is at a 10-year low. It’s not just a Boston Properties issue; it’s happening to other office REITs as well. I guess I’m wondering at what point do you guys start thinking about doing something more strategic, like looking to joint venture assets, thinking about a stock buyback? I mean one of the points we are hearing is that longer-term lease assets with good credit tenants are selling for strong cap rates in certain markets right now. So at what point do you start looking at pieces of your portfolio in either joint venturing them or outright selling them? Thinking about recycling capital, not just into development, but maybe into your stock price or into your stock buyback, doing something along those lines?

Let me address that important question regarding capital sources and their uses. To begin with the sources of capital, we've been selling assets, although we didn't mention it in our opening remarks because there's nothing actively occurring this quarter. However, year-to-date in 2020, we've sold over $700 million in assets. I agree that we will continue to do this selectively with certain assets. One challenge we've faced in the past is that our major assets have significant tax gains. Selling them means we can't retain all of the capital, and it often requires a regular or special dividend. Now, since our income has decreased and our dividend remains flat, we're able to incorporate some gains from asset sales into our regular dividend, alleviating that issue. To reiterate, we've sold $700 million this year, and I expect that we'll elevate our asset sales in the upcoming quarters. Regarding the use of capital, we do consider stock buybacks, taking into account several factors: the potential impact on our earnings, the effect on our credit ratings based on the buyback size, the ongoing pandemic and our upcoming capital needs, and how much capital we want to allocate for new investment opportunities. We've noticed an increase in these opportunities in the past quarter, and I expect this trend to continue. We've also partnered with joint venture partners to assist in funding new investments. However, after weighing all these factors, we have decided not to allocate our capital for stock repurchases at this time.

It's Michael Bilerman here with Manny. Owen, you provided an outlook for the return to the office in the second half of '21, which seems more realistic now based on current densities. How do you see the situation evolving between now and then? What key indicators are you monitoring to reach that point? Do you think it's a target date that might arrive sooner, or do you see it potentially extending into 2022?

Yes. Michael, we are closely monitoring the virus's progression, particularly the daily infection rates, to evaluate when a recovery might happen. This is the most crucial factor. As we consider 2021, we expect that a vaccine will receive approval and will be effective for many individuals. However, new doses will need to be produced and distributed, and it's likely that not everyone will take the vaccine, nor will it work for everyone. This process will take time. Additionally, it's important for the nation to adhere to health and safety guidelines more strictly, as we are observing a rise in cases in areas where these protocols are not being followed. I am optimistic that more people will do so, which will contribute positively. It is challenging to make accurate predictions, but our best estimate suggests that recovery might occur in the middle of next year. To answer your question, while we hope it happens sooner, there is a possibility of delays. Nevertheless, the most likely scenario points to sometime in the middle of the year.

Your organization, along with many other office companies, is returning to the office at a quicker and denser rate than other businesses. Doug mentioned some leasing examples from the pandemic, demonstrating that some tenants are ready to occupy space. In your conversations with other leaders, what do they seek in order to encourage opting out rather than opting in? What can you as a landlord do to assist your tenants? For instance, shopping center landlords with restaurant tenants, who are seeing reduced business, realize they need to partner with them to ensure their survival. What measures can you take, or are there any initiatives you're exploring with tenants who are more inclined to return?

Yes, I’ll begin and then hand it over to Doug for further insights. There are a few points I'd like to address. Firstly, we believe we have developed a leading health security plan in collaboration with external medical experts. This plan is available on our website, and we have engaged with hundreds of our customers. We do not want the office environment to be a barrier for individuals or companies returning to work. Based on the statistics Doug and I shared in our comments, I believe the office is not the hindrance for people wanting to return to their jobs. Additionally, as a company, we aim to set a positive example. While not everyone is in the office, many of us are, and we are utilizing public transportation. Thankfully, we have not faced health issues. However, as business leaders assess this situation, they must consider factors such as the virus's trajectory, local infection rates, and whether it is safe to ask employees to return, especially considering any potential health security concerns along their commute.

Michael, the key difference between retail and office is that our customers aren't experiencing the same significant drop in revenue since they aren't all struggling simultaneously. They are less productive, less effective, and in many cases, not growing, but they aren't facing the same challenges as businesses like restaurants or retailers that rely heavily on physical foot traffic to generate income. Leaders are dealing with issues related to schools, and this isn't something that Boston Properties or any private company can address. Until there is clear evidence that school systems nationwide, both private and public, can operate in-person, business leaders will hesitate to require their employees to return to the office. That's simply not going to happen. Regarding your first question about potential improvements, if the vaccines prove to be highly effective, I believe there will be a higher vaccination rate. Conversely, if their effectiveness is lower, we may see a slower rate of vaccination. Depending on how effective these vaccines are, we could see a surprising shift in how quickly people are willing to get vaccinated and how soon they feel comfortable returning to public life while continuing social distancing and wearing masks as precautions.

So I have a few questions. First, Doug, you talked about leasing activity and what you’re implementing at the GM building, and I suggest you keep that approach. However, I was particularly struck by your average lease term of seven years. When speaking to brokers, especially in New York, I've been hearing a lot about short-term deals with tenants opting for short-term extensions. It seems like your agreements this quarter are leaning more towards long-term contracts. Could you provide more insight into whether this reflects a general trend in leasing or if there are specific factors with the tenants you’re engaging that make them more inclined to opt for long-term agreements instead of short-term ones?

I believe our customers typically view their office space as a long-term asset and consider the pandemic to be a temporary issue that won't affect their long-term space usage trends. Therefore, they are making lasting decisions. Fortunately, we have many such customers across our markets with whom we have established relationships. For instance, with Ameriprise and Columbia Threadneedle, they didn't need to approach us, yet we created space for them, and they were delighted to occupy our building. This reflects not only the type of customers we attract but also our operational expertise. We excel at this and consistently navigate both strong and weak markets by responding to rental rates and concessions to finalize deals.

Okay. Regarding the second question about California, you mentioned that San Francisco is now allowing employees back in the office, while it seems that Los Angeles is still closed. Some other companies have raised concerns about rent collection due to eviction moratoriums, where tenants may feel it's optional to pay rent. Could you provide an update on the subleasing situation in San Francisco? Also, what are the general office trends? If a large number of people are still working from home, how do you expect that to evolve? Additionally, what do you think the long-term effects will be of these continually extended eviction moratoriums?

Yes. Owen and Mike indicated that our collections from office tenants were nearly 99% this month, and that trend is ongoing. We haven't seen any increase in discussions or issues regarding collections from our office tenants, so we are not facing eviction challenges on the commercial side. Concerning sublet space in San Francisco, historically, sublet space represented about 40% of the total inventory in 2001 and around 20% during the Great Recession in 2009. Currently, it is again near the mid-40s. This suggests that the situation resembles the dotcom era more than the Great Recession in terms of available sublet space. However, unlike previous downturns, the current health of companies is quite robust. The key question now is when these companies will feel ready to make significant business decisions, bring employees back to work, and start hiring in larger numbers. This is particularly relevant in San Francisco, a market heavily influenced by technology companies that are currently performing well. We remain hopeful that as we move past pandemic-related issues, there will be an increase in activity in San Francisco.

I guess, first, I wanted to just touch on the life science, Doug, you guys have spent a lot of time highlighting a number of either new parcels you’ve picked up, conversions. Just maybe kind of big picture, give us a sense for kind of where life sciences today, where do you think it’s going in Boston, in particular. I know that there’s a lot of space either under construction or to be built, you may be part of that pipeline. But what concerns do you have about the increasing supply in life science?

So, I think today, we’re about 6%.

Yes. 6% of the Company is leased to life science companies.

I believe the current focus on life sciences stems from the demand in specific key markets such as Cambridge, Waltham, Lexington, and Boston, which are among the leading locations in the country. There is a significant number of companies at various stages of development seeking space for their operations. This strong tenant demand is what creates opportunities for new buildings to be constructed. Our approach involves taking our office buildings and designing them with features that cater to both office needs and life science utilization, including necessary infrastructure for HVAC, loading, chemical storage, and neutralization. Depending on tenant requirements, we can construct either a life science installation or an office space, and we are adaptable in that process. We are confident in our capabilities to handle these conversions, with tenant demand influencing the final product mix. Many companies are exploring these types of conversions, but their success is uncertain. As the focus shifts, we notice that locations are becoming more diverse; for instance, the central areas of Cambridge seem largely developed. We are actively seeking new permits to expand our portfolio in Kendall Square, while companies are also looking further out to areas like Watertown, Somerville, and the southern parts of Boston, in addition to Waltham and Lexington. Our primary focus is on Waltham and Lexington because we own land there, we have strong connections with brokers representing tenants, and there is significant demand in those western suburbs, which are also more affordable.

One of the additional comments from the Boston region that we’re finding is that we clearly have the competitive advantage with our basis, not only in land or in the buildings that we’re converting. And the strategy of taking these incremental pieces of buildings that we already own has really played out. And what we’re hearing over and over again from these companies is predictability is so incredibly important to them. And that gets back to Doug’s comment on operating prowess and then our ability to not only get the permits in these existing assets but deliver in a very predictable basis. It’s been said over and over again recently that this is so important to them. So, it plays well for our strategy in Boston.

Okay. And just as a quick follow-up, is there any sort of update on your joint venture with Alexandria in South San Francisco?

I made two comments. First, we have a tenant and signed a letter of intent with an office tenant for the 601 Gateway Building to occupy about 70,000 square feet of space. Our plans are for the venture to vacate 651 Gateway and convert that building into a lab building, as it is currently an office building. Then, there is a new building under design for about 180,000 square feet, which is the next building, but we’ll likely be able to deliver 651 as a lab building before we start on that other building.

I just want to touch on the rent write-offs taken so far. Do you have a sense of how much percentage of the uncollected rents do they account for? And were there any reserves taken on your co-working tenants?

In terms of uncollected rents, I’m not sure what the exact percentage is on the existing AR. We do have deferred rents that we described in the quarter, which are rents where we are accruing for those tenants, and that was $18 million. So, those are, I guess, rents where we wrote off $6 million of AR, and we still have $18 million that came in this quarter that were deferring. So, I think that will give you a sense. We did have one co-working tenant that we wrote off this quarter, but it was a smaller exposure that we have. So, we do still have a couple of co-working tenants in the portfolio that continue to pay us on a current basis, and that we have not taken write-offs for.

Well, I think, there’s a difference between our light science customers versus our co-working customers, and that’s that the co-working is a tough business for them. And we’ve had some very constructive conversations with them about while they may very well need to downsize their space needs in many cases; they also acknowledge that they still need to have a presence in business, so that’s a tough balancing act in the long run. What we’re dealing with is they’ve got some short-term carries before they get back to a long-term success rate with regard to those customers.

Thank you, operator. I think that concludes our remarks, concludes all the questions. Thank you for your interest in Boston Properties.