Boston Properties Inc (BXP) — Q3 2023 Earnings Call Transcript

Good morning, and welcome to BXP third 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 that 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. I would now like to turn the call over to Owen Thomas for his formal remarks.

Thank you, Helen, and good morning, everyone. Today, I'll cover BXP's operating outperformance in the third quarter, key economic and market trends impacting our company, and BXP's capital allocation activities for the quarter. BXP continued to perform in the third quarter despite escalating negative market sentiment for the commercial real estate sector. Our FFO per share was once again above both market consensus and the midpoint of our own forecast. We completed over a million square feet of leasing in the third quarter with a weighted average lease term of over eight years, and increased portfolio occupancy despite a weaker operating environment for most of our clients. We completed multiple company and asset-specific financings both elevating our liquidity position and demonstrating BXP's sustained access to the capital markets. Moving to the economy, notwithstanding the Federal Reserve having increased the discount rate by five and a quarter percentage points and the 10-year U.S. Treasury having risen nearly 3% all since March of 2022, the U.S. economy's headline statistics remain remarkably strong, with GDP growth at 4.9% in the third quarter, 336,000 jobs created in September, and the unemployment rate steady at 3.8%. This rosy economic picture is misleading, as it does not accurately reflect the market tone and operating environment for many of our clients. Assuming forecasts for negative earnings growth in the third quarter are accurate, S&P 500 annual earnings growth has been negative for the last four quarters. Much of the recent strength in GDP has been consumption-related, and job creation has been in the leisure and hospitality, healthcare, education and government sectors, not in the office-seizing sectors such as information and financial services. Our clients are corporations that actively manage their headcount and operating expenses in times of weak or negative earnings growth. As a result, they're more cautious in making new space commitments. Though remote work is obviously not helping space demand, we believe economic conditions are the primary driver of our slower leasing activity in 2023, and leasing will rebound when earnings growth returns. We continue to be encouraged with the return to office trajectory we are experiencing in our buildings as well as the rhetoric and actions of many of our clients with respect to their in-person work policies. We believe the broadly reported turnstile data from Castle systems indicating buildings are generally 50% occupied versus pre-pandemic levels over the course of a week is a measure of aggregate human activity important to cities. But it's not an accurate measure of premier workplace space utilization. We collect turnstile data for approximately half of our 54 million square foot portfolio. As of mid-October, for Tuesday through Thursday, our New York City buildings experienced 95% of the turnstile activity achieved before the pandemic. Those figures for Boston and San Francisco were 74% and 45%, respectively. There's been an improvement in space utilization data in all our markets. Workers in premier workplaces are returning to their offices in greater numbers, and it's difficult for users to reduce space if all employees are expected in the office on specific days of the week. Lastly and importantly, all office buildings are not the same. We share in our IR materials every quarter CBRE's report on the performance of the premier workplace segment of the overall office market. In the five CBDs where BXP operates, premier workplaces represent approximately 18% of the total space and 10% of the total buildings. At the end of the third quarter, direct vacancy for premier workplaces was 12.4% versus 17% for the balance of the market. Also, for the third quarter, net absorption for the premier segment was a positive half a million square feet versus a negative 600,000 square feet for the balance of the market. For the last 11 quarters, net absorption for the premier segment was a positive 8.1 million square feet versus a negative 30.8 million square feet for the balance of the market. Asking rents are 44% higher for the premier workplace segment, including two buildings undergoing renovation. Ninety-four percent of the BXP 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 leasing marketplace. Now moving to private real estate capital markets, U.S. transaction volume for office assets in the third quarter was muted, dropping 48% from the second quarter to $4.4 billion, the lowest quarterly level of office transaction activity since the first quarter of 2010. Investors in the sector face material uncertainties in both office demand due to factors previously mentioned, as well as the cost and availability of debt financing. The 10-year U.S. Treasury has been and is rising and approaching 5%, and consensus market sentiment currently believes rates will be higher for longer given pernicious inflation. Most U.S. lenders are trying to reduce their exposure to commercial real estate loans and have limited available lending capacity for repayments. No sales in BXP's core markets were completed in the third quarter of significant assets that would be considered premier workplaces. In Boston, there were three completed office transactions, all under $100 million of reasonably well-leased assets, sold for $290 to $690 a square foot and cap rates of 6.7% to 7.5%. In Santa Monica, the Pin Factory, a fully leased 220,000 square foot redeveloped creative office complex, sold for $178 million, representing pricing of over $800 a foot and an 8.4% cap rate. The existing leases in the asset have turned but are significantly above market and seller financing was provided. In New York City, a user is under agreement to purchase the 400,000 square-foot vacant Neiman Marcus store at 20 Hudson Yards for $550 million or $1,375 per square foot. In the financial district of San Francisco, there are sales either completed or pending for buildings that are or nearly vacant. Each sale is for under $65 million, and pricing ranges from $120 to $320 a square foot. These deals reflect many characteristics prevalent in today's non-premier office sales market, entrepreneurial, in many cases family office buyers attracted by the low per square foot values relative to historical levels, small transaction sizes requiring less capital, and likely not involving debt financing and renovation plans designed to take advantage of future leasing market recovery. Moving to BXP's capital market activity for the third quarter, we completed a restructuring of our investment in Metropolitan Square, a recently renovated 657,000 square foot office building located in Washington, DC. BXP owned a 20% interest in this asset and provided leasing and management services for the property, which was encumbered by a senior loan of $305 million and a mezzanine loan of $115 million. The existing mezzanine lender now owns 100% interest in the property, with BXP continuing to provide management and leasing services. Further, a new undrawn $100 million mezzanine loan has been structured to fund future leasing, operating and other expenses of the property on an as-needed basis. BXP has a 20% interest in the new mezzanine loan, which is subordinate only to the $305 million senior loan and will receive interest at a 12% annual return. BXP will continue to earn leasing and property management fees as well as an attractive return with potential incentive fees for providing additional capital to stabilize the asset. We also experienced a $36 million gain as a result of the transaction. In the coming quarters, given the negative sentiment toward the office industry, which spills over into the much better performing premier workplace segment, we believe BXP will be presented with unique opportunities to expand its portfolio on an attractive basis. Our balance sheet remains strong, and we have maintained access to capital primarily through the unsecured debt markets, which is available to few public and private competitors. Our portfolio is outperforming peers due to its attractiveness in the market when competing for clients, the hallmark of a premier workplace portfolio. In anticipation of the current market distress in our sector, we have been positioning BXP to play offense for the past year by raising $4.1 billion in gross funding and currently holding $2.7 billion in liquidity. In search of opportunities, we're maintaining continuous dialogue with lenders that are foreclosing on or restructuring assets as well as owners seeking to reduce their office exposure. Our focus will remain in our core markets on premier workplace assets, life science and residential development. During the last major downturn caused by the global financial crisis, BXP was able to acquire the General Motors Building, 200 Clarendon Street, 100 Federal Street, and 510 Madison, all at attractive prices at the time. On dispositions, we continue to pursue additional capital raising through joint ventures with select pre-leased developments and to consider incremental asset sales. Our development portfolio continues to create FFO growth for BXP. This quarter, we placed fully into service a 104,000 square foot renovated and fully leased building at 140 Kendrick Street in Needham, Massachusetts. This redevelopment, completed for a client with stringent sustainability objectives, was delivered with net-zero carbon performance and generating an 18% first-year yield on incremental capital invested. We also delivered into service 751 Gateway as part of our Gateway Life Science Park, which is a 231,000 square foot lab building that is fully leased. BXP owns a 49% interest in the asset, which was delivered at a 6.7% first-year return on cost. BXP continues to execute a significant development pipeline with 11 office, lab, retail, and residential projects underway. These projects aggregate approximately 2.8 million square feet and $2.4 billion of BXP investment, with $1.4 billion remaining to be funded and are projected to generate attractive yields in the aggregate upon delivery. 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. Over to Doug.

Thanks, Owen. Good morning, everybody. Client demand across our portfolio has remained pretty stable over the last quarter, but final leasing decisions are taking longer, which is consistent with what Owen's talking about relative to challenges regarding the profitability of corporations. Our buildings continue to see the most activity from financial services, professional services, law firms, administrative services, and asset management. Traditional technology demand continues to be absent from our markets, and more often than not, renewing technology clients are reducing their leased premises. This is most prevalent in our West Coast properties. Pretty much the same picture I painted last quarter. Growth from the AI organizations in the city of San Francisco is real. More than 700,000 square feet of leasing has occurred in the past few weeks, and there have been billions of dollars of recent investment into this growing ecosystem. For now, that leasing is focused on large, well-built opportunities that are available at significant discounted terms relative to the rents being achieved in premier buildings. Reducing availability is a positive for the broader San Francisco market, but it's not going to impact leasing in Embarcadero Center in 2024. The concentration of strongest user demand, often with growth for our assets, is still broadly speaking alternative asset managers, private equity, venture, hedge funds, and 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 the point, during the third quarter, we completed a 15,000 square foot expansion for a hedge fund in Manhattan and a 52,000 square foot multi-floor lease with a private equity firm growing in our portfolio in Manhattan. A 70,000 square foot asset manager is growing in our portfolio in Manhattan, and an expansion for a 21,000 square foot private equity firm in DC. Our strongest activity remains in our Midtown Manhattan portfolio, 200 Clarendon and the Prudential Center in Boston, the urban core of Reston Town Center in Northern Virginia, and our Embarcadero Center assets in San Francisco. We don't have direct availability at Salesforce Tower, but we hear through the market that Salesforce has interest in their 150,000 square foot sublet opportunity. Law firms are also an active portion of our portfolio and important clients for BXP. We are in active lease negotiations or LOI discussions with seven distinct law firms in Manhattan, DC, and San Francisco. Owen highlighted that just over one million square feet have signed leases during the third quarter. Last October, we provided the leasing expectations embedded in our ‘23 guidance, between 500,000 to a million square feet per quarter, aka 750,000 square feet on average, or 3 million for 2023. Through the first half of the year, we were at 1.56 million. So, to date, we're at 2.7 million square feet. We currently have an additional 1.2 million square feet of transactions and active lease documentation. I would say we have high confidence that we will be beating our leasing target embedded in our 2023 guidance of 3 million square feet. This quarter, the executed leases included 52 transactions: 32 renewals, 20 new tenants, there were five contractions and five expansions among our existing clients, with a net reduction in that pool of about 33,000 square feet. There were no particular patterns relative to industry or size, given who is expanding and contracting, bringing the volume down by market we did about 439,000 in Boston, 240,000 square feet in New York, 100,000 square feet in DC, and 278,000 square feet in the West Coast market. The mark-to-market of the leases that commenced this quarter was down 3% as reported in their supplemental report, the mark-to-market of leases executed this quarter was positive 4%. The starting cash rents on leases we signed this quarter on second-generation space were up 60% in Boston, about 1% in New York, and then down 13% in DC, nine in San Francisco, 14% in LA, and 6% in Seattle. We ended the third quarter with an in-service occupancy of 88.8% compared to 88.3% last quarter. As Owen said during the third quarter, 140 Kendrick Street and 751 Gateway were added to the portfolio, and Metropolitan Square was taken out. If you remove Metropolitan Square from the second quarter, that comparative occupancy period went from 88.7 to 88.8. So again, a modest, relevant increase. I would also note that we terminated WeWork and 44,000 square feet in the third quarter. We expect to have additional portfolio vacancy stemming from WeWork defaults as we move through the fourth quarter and into 2024. Just to remind everyone, WeWork leased 493,000 square feet as of October 1, 2023, and the BXP share of 2023 annualized revenue is $33 million. We don't expect WeWork to exit all the assets, nor do we expect them to remain in place in their current footprint. This will be a drag on occupancy and same-store contribution in 2024. The development portfolio now sits at 2.8 million square feet and is 52% leased. We've recently signed a 70,000 square foot office lease with an asset manager at 360 Park Avenue South, bringing it to 18% leased, and another floor at 651 Gateway that is now 21% leased. Assets totaling 335,000 square feet were removed and put into service, which accounts for the change in our total lease and the supplemental report. At the end of the quarter, we had signed leases that have yet to commence on our in-service vacancy totaling approximately 750,000 square feet, with about 425,000 square feet anticipated to commence in the fourth quarter of 2023. For the remainder of 2023, we have about 925,000 square feet of expirations. Much of this is uncovered, so we expect a drop of a few basis points of occupancy at year-end. In 2024, we have a very manageable 5.7% of our total portfolio expiration or 2.7 million square feet. We believe our occupancy will be stable in 2024, defined as up or down 1% quarter-to-quarter, relative to where we're going to end the year in 2023. We will provide a leasing volume outlook for 2024 along with guidance next quarter. From a broad market perspective, the office supply picture didn't really improve much in the third quarter, with almost every market continuing to experience net negative absorption, Manhattan being the one place where there was some positive. The city-specific office brokerage reports are starting to characterize the markets in ways that acknowledge the bifurcation between the haves and the have-nots and the distinctive trends for premier assets. But they are not publishing their data broadly. The availability in the premier building that Owen described is depicting a more constructive picture, and BXP's relevant view of office supply. What's clear is that new speculative construction, which presumably would be premiere, is non-existent in the marketplace today. Any new construction starts are going to require economic rents and concessions that are vastly different from the current transactions. The major inputs to new building or construction are hard costs, capital costs, and leasing velocity. Construction costs started dramatic increases over the past five years with annual increases in the high single digits. We've seen the rate of increase slowing down but have not yet seen any reduction of costs. Construction financing could be found at SOFR plus 200, and SOFR was 25 basis points to 50 basis points. Today, construction financing for office space is simply not available from traditional lenders. SOFR is at five and a quarter. And non-traditional lenders might lend at double-digit current interest rates with additional points upfront and lower loan-to-cost caps. Speculative leasing assumptions also assume a longer lease-up. You put all this into a development pro forma, and you need rents that are materially higher than what is supported by current market rents in every one of our cities. This quarter, we completed a 313,000 square foot 10-year renewal in the Back Bay of Boston four years prior to expiration, and a rent level that both parties found attractive. Our client is using all their space and believes it's a critical component of their overall business strategy. When they looked out into the market, they did not believe that any new construction was likely to be built on a speculative basis. This meant they would need to pay replacement cost rents and sign a lease now, using all the inputs I just outlined to be a new construction in the Back Bay in four years. There are no 300,000 square foot blocks of high-rise space available in premier buildings in Back Bay today. New life science activity in the portfolio continues. During the quarter, we completed our third lease at 651 Gateway for another floor. The property will open in 2024, and each lease requires our partnership to complete turnkey spaces in Waltham, where we have our other life science new development availability. We are seeing some tour activity, but there is no urgency for these requirements. There are a few large requirements that are touring, but as I have discussed previously, the bulk of immediate demand is from small private companies looking for fully built space. BXP's legal teams continue to lease space and outperform the market because our portfolio is fundamentally comprised of premier workplaces. The majority of the demand from new and existing clients in the market want to be in these types of properties. We're investing capital and building infrastructures, amenities, and client spaces, which allow our teams to meet client needs. We're all seeing the stress that many buildings are feeling due to their current capital structure and the reality of the supply and demand fundamentals reflected in the leasing market activity. The transition, recapitalization, or re-equitization of these buildings is going to take an extended period. Many of these assets are not in a position to commit capital to existing or new tenants, which greatly impacts leasing brokers interested in considering them for their clients and offers us the opportunity to further increase our market share. I'll stop here and turn things over to Mike.

Great, thank you. Good morning, everybody. I'm going to start my comments with some discussion on the debt markets and our activity. Then I will go over the third quarter performance and the changes to our 2023 earnings guidance. We have another busy financing quarter this quarter; we extended or refinanced mortgage facilities totaling $570 million. The two largest of these related to our Hub on Causeway, a premier workplace and retail mixed-use project that's in Boston. First, we exercised the first of two one-year extension options We have on the $337 million mortgage loan on the office tower. And second, we completed a three-year refinancing of the $155 million mortgage loan secured by the low-rise, creative office and retail component. We also expanded our corporate line of credit by $315 million to $1.8 billion. We were honestly surprised by the market's reaction; we issued a press release on this earlier this quarter as it increases our liquidity at a pretty modest cost. We had three new banks approach us, seeking to expand their relationships with us and up-tier the quality of their own client base. With so much uncertainty and illiquidity in the bank markets, our view is expanding our roster of banking relationships is a smart move. Last week, we closed on a new five-year $600 million mortgage loan from a syndicate of banks on a portfolio of three premier workplaces in Cambridge. The credit spread at SOFR plus 225 basis points is attractive in today's market, and we expect to use the proceeds to repay our upcoming $700 million bond maturity in February next year. Given the significant recent move in interest rates, we are happy with the timing of our last couple of bond deals, both of which have been below market coupons today. We have no more financing needs in 2023, and we've taken care of a large piece of our 2024 maturities, which is the $700 million bond I just mentioned. Our other 2024 maturities include our $1.2 billion term loan and $400 million at our share of floating-rate mortgages. The term loan is also floating rate, though we have swapped SOFR to be fixed at 4.64% through May of 2024. We expect to exercise one-year extension options that are available on both the term loan and the majority of the maturing mortgages. As you think about our interest expense moving into 2024, you need to account for higher borrowing costs. We are refinancing $1.2 billion of bonds that expired in August of 2023 and February of 2024 that had a weighted average interest rate of 3.5%, with new financing at an average rate of 7%. Additionally, we've been running with an average cash balance of approximately $1 billion in 2023. In 2024, we expect to fund our development pipeline with available cash and run with an average balance closer to $400 million. At our current earnings rate, this projects to a decrease of approximately $30 million of interest income in 2024. Now I want to turn to our third quarter earnings results. For the quarter, we reported funds from operations of $1.86 per share, which was $0.02 per share above the midpoint of our guidance range. The outperformance all came from better-than-projected portfolio net operating income. Revenues were higher than our assumptions from a mix of better rental revenues, client service income, parking, and hotel performance. Our operating expenses were in line with our assumptions. While not impacting our FFO, we did record non-cash impairment charges totaling $273 million this quarter related to four of our unconsolidated joint ventures. The GAAP rules for unconsolidated joint ventures dictate that if we believe a loss in asset value below our basis is not temporary, the asset is marked to fair value. The definition of temporary is somewhat subjective, but as the length of the current market dislocation extends, it's harder to justify a temporary loss in value. The charges relate to Platform 16, which we discussed last quarter, as well as 360 Park Avenue South, 200 Fifth Avenue, and Safeco Plaza. Given the cyclical nature of the real estate business, the value of assets like these will recover in the future when interest rates normalize and corporate economic conditions improve. We expect to hold these assets through their recovery. Our past experience reflects this recovery after the GFC, when we took a similar impairment charge and ultimately sold the assets a few years later at a significant gain, not only to the impaired value but to the original book values of the buildings as well. I want to turn to our guidance for the rest of 2023. We have narrowed our 2023 guidance range to $7.25 to $7.27 per share, with the midpoint relatively unchanged from last quarter at $7.26 per share. There are two key changes to our guidance from last quarter. First, we're projecting $0.03 per share of higher termination income in the fourth quarter from lease terminations with WeWork at Madison Center and Dock 72, as they have stopped paying rent in both locations. We have security deposits to cover a portion of the lost rent, which we will recognize as termination income. The revenue loss is approximately $6.5 million per year until those spaces are re-leased to other clients. They comprise approximately 200,000 square feet that equate to about 40 basis points of our occupancy. Second, we anticipate our net interest expense will be higher by approximately $0.03 per share due to lower projected capitalized interest and closing the new $600 million mortgage financing earlier than we had previously expected. We expect to invest the funds in cash equivalents until we repay our bond expiration at the beginning of February, and the negative arbitrage on the funds is about $3 million in 2023. The remainder of our assumptions for the portfolio performance has not changed. As Doug described, we continue to execute leases in line with our expectations, and net of the lease terminations, our outlook for occupancy remains stable. As we look ahead into 2024, we have several developments that delivered during 2023 or will deliver in 2024 that will add incremental FFO next year. These include 2100 Pennsylvania Avenue, 651 and 751 Gateway, 140 Kendrick Street, 180 CityPoint, and View Boston. However, as described earlier, we expect our overall earnings trajectory will be negatively impacted by the persistent high-interest rate environment that will result in higher net interest expense in 2024. We will provide detailed earnings guidance for 2024 on next quarter's call in January. That completes our formal remarks. Operator, can you please open the lines up for questions?

Great. Thanks, good morning. Can you guys just talk about the acquisition or investment environment a little bit more? It still seems like we haven't seen the waves of opportunities that some well-capitalized potential investors, including yourselves, have been hoping for. I guess, are there any signs that opportunities are emerging? And if not, do you have any sense what needs to happen to shake things loose and when that might happen? Lastly, in general, how much further does pricing need to adjust to make those investment opportunities more attractive from a risk-reward standpoint?

It's Owen, and I'll address that. As I noted in my earlier comments, buyers are worried about two key issues. First, they need to consider how to manage lease-up and lease growth amidst the economic uncertainty their clients are experiencing. Second, they are concerned about their cost of capital, especially regarding financing and its availability. Currently, many of the transactions taking place involve small, private investors, who are likely not using much, if any, debt financing. Overall, I see a significant amount of restructuring activity occurring in the market, even if it isn't widely reported. This is particularly prevalent with over-leveraged loans maturing frequently, leading borrowers to engage in discussions with their lenders about potential solutions. For buyers to become more active in the market, they will need greater clarity regarding the uncertainties I mentioned. I believe that the recent behavior of interest rates may provide some relief, as a stabilization in rates would help buyers feel more secure in making transactions. Regarding pricing, particularly for the high-quality buildings we focus on, it's challenging to determine how much prices need to fall since there aren't many comparable transactions to reference. Nonetheless, our perspective is that the prevailing negative sentiment surrounding office properties seems to irrationally extend to premier workplaces, which may present opportunities for BXP.

Thanks. I was hoping we can maybe get a feel for the impairments that were done to the JVs. If there's any sense on how much the unlevered asset values may have changed in that impairment analysis?

Sure, Nick, this is Mike. I won’t go into the details of our supplemental document right now, but it includes information about the changes in net equity values for those assets, which will help you understand the situation. From our viewpoint, this is an accounting adjustment made in line with the accounting rules for our consolidated joint ventures. I don’t believe it indicates a significant change in the outlook for these assets, except for Platform 16, which we mentioned last quarter, where we are halting construction. We review all our joint ventures every quarter, and given the current higher interest rates, we believe they will remain elevated for an extended period. We assessed everything, and three other ventures were also adjusted slightly. However, Platform 16 is by far the most significant, as the discounting cash flows for a land development project before construction requires a high discount rate, significantly affecting its value.

Thank you.

Thank you. Doug, in your remarks, you mentioned that occupancy is expected to remain stable next year, despite a favorable backdrop with 2.7 million square feet expiring and a pipeline of 1.2 million square feet, which aligns with your quarterly average. I'm curious about the known move-outs you anticipate for next year. Are there any other tenants, apart from WeWork, that could pose a challenge in breaking out of the 88% to 89% occupancy range?

There is a distinction between known move-outs and tenants that are challenges for us. The only major tenant in our portfolio facing financial difficulties is WeWork. There are a few smaller tenants, around 25,000 or 30,000 square feet, who lack a viable long-term business plan and eventually vacate their space, but these cases are minimal. The significant lease expirations next year are not extensive, with a few in the West Coast and the greater Manhattan area, including about 250,000 square feet in Princeton and just over 200,000 square feet at our building on Folsom in San Francisco. We will also lose around 75,000 square feet due to the expiration of Trulia, Zillow at 535. Besides this, our joint venture at Times Square Tower will see O'Melveny & Myers relocate, which is about 250,000 square feet, but we have already accounted for 75,000 to 100,000 square feet of that space. Therefore, there's no significant factor affecting our stability. We are engaged in three types of leasing: leasing available space usually requires a build-out, which can delay occupancy for six to twelve months, during which we can't book revenue, leading to the increase in our leased but not yet in service statistic, expected to rise in 2024. The second type involves tenants renewing within the next 12 months, which shows immediate impact. The third includes leases set to expire post-2024. For instance, we secured a 300,000 square foot deal for 2028 this quarter. I believe our leasing activity will stay strong in the current economic environment, but boosting occupancy in the short run will be challenging. I've mentioned in calls and meetings that our West Coast portfolio is crucial for increasing occupancy. The available spaces at Embarcadero Center, Folsom Street at 535, and recent lease terminations in Seattle and Madison Center, as well as Colorado Center in West L.A., represent significant opportunities for growth. Currently, we are maintaining occupancy around 88% to 89%. We expect some slight improvements, although we may face temporary setbacks with certain tenant relocations, but we're managing to recover. This summarizes our perspective as we approach 2024.

Great. Thank you. Morning down there. So, question on development. In the release, you guys talked about an extension until February '24 for your 25% stake in the 3 Hudson, in the land loan that's under 3 Hudson. At the same time, you articulated your optionality on the MTA site. Just looking at the two projects, the MTA site would seem to be like the winner just given the focus on Grand Central, Park Avenue, whereas 3 Hudson just seems like a more challenged deal given the economics of trying to lease up that building at the necessary rent given the size of that building. So, as you guys think about the upcoming land loan on 3 Hudson, is that something that you would consider just sort of exiting instead of pursuing, and mentioning the MTA optionality, should we take that as considering that maybe you guys would not proceed forward with the MTA site?

Yeah. So Alex, this is Doug. I'm going to let Hilary give you the most detail on this. I would just make the following comment, which is we don't think one is a winner versus the other. It's clear that the timing opportunities associated with one are probably shorter than the other in terms of when we might actually get something going. But I'll let Hilary describe the demand for space in new buildings and also the challenges associated with getting those deals going. Hilary?

Thanks, Doug. Hi, Alex. As Doug noted, the two buildings are very, very different opportunities. 3 Hudson Boulevard is a 1.8 million square foot building, whereas 343 Madison is currently still in the design process, but let's just call it an 850,000 to 900,000 square foot building. Some of the demand that is currently in the market actually could not be satisfied by 343 Madison. There are a few tenants in the market that are 1 million square feet who are actively looking for space, and they would need a larger building than what can be constructed at 343 Madison. To Doug's point, in order to build such a building, those clients would have to be willing to pay a rent that generated an acceptable return on cost to us at 343 Madison. Those decisions in this capital market environment take time for clients or prospective clients like those to make. The prospective client base at 343 Madison, by definition, is somewhat smaller. There's plenty of demand among clientele in that square footage range as well, and again, the question really comes down to who’s willing to commit to the project at the rents needed to launch the development. I view them as distinctly different opportunities that serve different segments of the market. Hopefully, that answers your question. But I agree with Doug; I wouldn't characterize one as better than the other. They're just very different opportunities.

Great. Thanks. I think in your prepared remarks, you mentioned some assets you're considering for sale. I'm just curious if you can quantify what kind of IRRs buyers are looking at and kind of where pricing would need to be in order for you to effectuate on any of these potential sales.

Well, I think it varies widely, depending on the quality and location of the asset, the leasing status of the asset, the walls of the asset. I think borrowing cost is today, with the 10-year, I guess it's dropped a little bit today, but pushing 7%, for the highest quality assets, you're definitely above that. For an asset that has a lot of leasing and other risks associated with it, I think you're looking at double-digit return.

Good morning. Thanks a lot for taking my question. Owen, you mentioned in the prepared remarks about how BXP's tenants are more cautious in their space commitments, while many of the traditional macro indicators may not accurately reflect what's going on in your business. Recognizing that different cycles have different drivers, what metrics do you think might more accurately reflect the business now, and are the ones that you're monitoring so that we can follow along at home?

Well, I think this is part of something that's been confusing in the marketplace because generally, when you have a recession, companies' earnings are down, and they lease less space, and that's how cycles have traditionally operated for office companies, because leasing slows down when you have a recession. Here, it's confusing because it's very different. All the economic indicators look favorable—GDP growth, employment statistics—but if you dig into those statistics, a lot of it's consumption-related, and a lot of the job creation isn't in office-using jobs. If you look at earnings, which is what our clients are looking at, is their own earnings trajectory, it's negative. It's been negative for the last year, assuming the third quarter is negative. So that is the driver of client behavior. If you're the CEO of a company, and your lease is coming up or you're thinking about your space requirement, your decisions about that are going to be very contingent upon what you think the future prospects of your business are. Many businesses are negatively impacted by rising rates and some of the uncertainty in the economic environment. Coming back to your question, I think lower rates will help, and I think as earnings generally rise, I would expect that our leasing activity will rise with it.

And Michael, this is Doug. I would just say that the best measure of corporate activity as it relates to the business that we are in is job growth. Job growth typically is a little bit murkier. You can look at the employment numbers, but you really have to get into the specific industry categories, right? So, government and hospitality are not going to be favorable to office, but financial services or technology or life sciences are going to be. As you start to see the job listings start to perk up a bit, as you start to see hiring announcements by many of the larger technology companies and some of the financial institutions, which do, in fact, broadly talk about those things, you will clearly see a more conducive environment for office leasing going forward.

Good morning. You said in your prepared remarks, you don't expect WeWork to exit all of their assets. So, just wondering where you expect them to stay. And then you previously said that WeWork's security deposits average eight months of rent. Is that a good number to think about when looking at termination income moving forward?

I'm not going to speculate on WeWork's decisions regarding their operations. As Mike mentioned, they have currently halted rent payments for two of our locations, Madison Center in Seattle and Dock 72 in Brooklyn. We also have three additional locations with them in San Francisco. The future of these locations will take time for them to determine, and then we will have to decide whether we are comfortable with their proposals or if we need to reclaim the space. Therefore, I can't predict where they will exit or remain.

You are right about the security deposit, as we have mentioned before, we hold about eight months of security. If a tenant defaults, we issue a lease termination and proceed with that process. If there is a security deposit, we recognize it on the day we receive it. If the client plans to remain in the space for another 90 days or six months, we may need to spread that amount over that timeframe. Additionally, in our fourth-quarter termination income guidance, there are two components. One is the termination income I just discussed, and the other involves Madison Center in Seattle, where their lease is significantly below market, which we will report as income.

Yeah, thanks. I just wanted to circle back, Owen, on the distressed opportunities. I guess I'm just trying to get a sense from you as to kind of where you would need to peg stabilized yields in order to deploy new BXP capital given your trading 10 times cash flow and north of an 8% implied cap rate. From a market perspective, could any of those opportunities take you to any new markets like, say, a San Diego or Austin to be, in addition to the existing markets?

I'll answer the second part first and come back to your first question, Steve. We don't think we need to go to any new markets. We have a very significant footprint in our six core cities. One of the things that's going on now, which we have been talking about for several years is that the vacancy rates in certain areas of the Southeast and Southwest are actually higher than many of our core markets because of all the new development that's going on. We don't see a need or reason to expand outside of our footprint. Going back to your question about returns, we're going to focus on the premier segment of the market. It's likely that the types of assets that we'll get involved in are un-stabilized, so I'm not sure that the way to look at it is cap rate, but the way to look at it is total return. I think the total return requirement on a particular acquisition that we would look at would be pushing double-digit returns.

Hi, good morning. Earlier, you guys talked about how you're opting to repay the $700 million of unsecured debt with mortgages collateralized by Cambridge properties at SOFR plus 225. So, what did you consider when opting for secured floating-rate debt beyond just price? Was it price mixed with kind of BXP's mix of debt or anything else? In that decision, you were considering 10-year bonds. What pricing do you think you could issue a 10-year bond at today?

We evaluated all different markets when we decide how we're going to do refinancing, and the credit spreads in the secured markets for very high-quality assets with long lease terms. We found that our bond spreads right now for 10 years is about 285 for five years; it's probably around 270-kinda area. We’re saving a lot in credit spread. We’re doing a floating-rate deal; we haven't fixed it. We do have the opportunity to fix it via swap, and we’re going to evaluate when and if we do that. It provides some flexibility that way. A floating-rate mortgage is prepayable, so if the market gets better for long-term debt two years from now, we can prepay this into a long-term fixed-rate deal at that time. It has some advantages that we looked at when we decided to do this bank financing.

Great, thank you. Doug, you went through some of the supply and sublease space availability in your prepared remarks. Given the elevated levels of supply and some of these spacing your markets, potential tenants have a lot more to look at today. Do you have a sense of how much of the available space is in direct competition with your buildings? Even though some of them may not be premier buildings, potential tenants may be looking at them. I'm trying to get a sense of why tenants might be deciding to choose between your building versus others in today's environment. Are they being more price sensitive today versus something else?

This is what I refer to as one of the sort of layup questions that I'm going to allow our regional teams to answer because I think that they will be more passionate about their responses. In general, what I would tell you is not all space is the same. There are many buildings that have either direct availability or sublet availability that are literally not part of the conversation. As you think about micro submarkets, getting down to a market like Park Avenue between 43rd Street and 59th Street or you're talking about an asset in the CBD of Washington, DC that has views and is in a premier building; you'd be surprised at how small the universe of opportunities may be.

Hello, everybody. There is definitely sublease space, a lot of it as everybody knows, in San Francisco. Some of it is higher-end space. In fact, that's where a lot of the bigger deals over these last two years have actually happened. Some of them have been in our own buildings. At 680 Folsom, for example, macys.com had roughly 240,000 feet available. They leased all of it during the pandemic subleases. The good space that has been out there has attracted some attention. But by and large, there's so much more that is not high quality and has either got no term left on it or it's got poor sponsorship with weak sublessors. Those spaces are very difficult, and they're not going to compete with us for sure. If a tenant's interested in those types of spaces, they're not going to go to any premier building.

I would echo the same thing. I just had a brokerage dinner last night with tenant rep people, and each of them expressed the same issue: for their top-end clients, premier clients, they're having trouble with fewer locations to review. It's not only about the amount of locations that they think are appropriate. They have a lack of desire to do a sublease. Most of our sublease space tends to be in lower floors in this market right now. There's also the question of, for the first time, I'm seeing tenant rep people really underwriting the landlord's capability to fund TIs, and that hasn't happened in a long time.

Good morning, guys. And thanks for taking the question. I guess just going back to your comments on acquisition opportunities. Are there certain markets that you guys are looking at that you're getting more excited about deploying capital in today's environment?

The way we think about this is, we set top-down parameters, which we have, which is our six markets. In terms of specific investments, that is a bottoms-up process and a more opportunistic process. We're open for business everywhere, and it just depends on the opportunity. We want to allocate capital to the best opportunities. That said, as you've heard from our remarks and see in our results, it's easier to underwrite leasing activity in our East Coast markets, particularly in New York and Boston, than it is in our West Coast market.

I would like to add one more point before turning it over to Hilary to comment on the situation in New York. The overall demand in the Park Avenue District of New York, which I define as the area between 43rd and 59th Streets, including Park, Madison, Lexington, and a bit of Fifth Avenue, is the strongest market in the country in terms of demand. However, there are still significant challenges in this market that need to be addressed regarding the capital structures of these buildings. Many of the existing mortgages on these properties, including B loans, mezzanine capital, and preferred equity, cannot be replaced at the same levels, indicating a need for equitization. This situation could lead to opportunities, similar to our acquisition of the General Motors Building in 2008 and 510 Madison Avenue. Hilary, would you like to provide some insights on what’s happening in Manhattan?

Sure. Thanks, Doug. As Doug mentioned, there are a number of high-quality assets in really desirable submarkets, the Park Avenue corridor, from where the General Motors Building is that are underwater on their financing and having difficulty rationalizing putting capital into the buildings to support leasing opportunities. We're really getting a lot of inbounds from the perspective of clients; they know that we have a strong balance sheet. They know that we’re not over-leveraged, and they know that we can commit capital to leasing. That's interesting to our benefit, and we're watching those situations where capital stacks are upside down, which may potentially present an opportunity for us. But again, to the point that Owen and Doug have raised, we would only really be interested in the highest quality assets that are premier workplaces consistent with what we already own. I would tell you there's at least a handful of those situations in Midtown that we're tracking.

Yes. Thank you. One or two of your peers have mentioned just potentially some pressure on operating margins going forward, as return to office mandates have more of an effect than more people are in the office. Just wondering if you could talk about that, potentially, how we should think about that for your portfolio moving forward?

I'm going to get to be somewhat tongue-in-cheek. We don't have any peers. We are who we are. We operate our buildings in a very different way. We've been operating our buildings with an expectation that our buildings are to be fully occupied for the last couple of years. So, return to work and increased occupancy, in my opinion, are not going to have any impact on our margins. What will have an impact on our margins are what I refer to as the atmospherics out there. How will the labor rates associated with union contracts for janitorial work their way out? Will the insurance markets continue to be challenging relative to the number of weather-related events and how that impacts the desirability of the insurers to provide insurance? What will municipalities do relative to their tax burden and valuations? Valuations are clearly coming down, right? How will that be reflected in their desires to increase their rates? All of those things, I think, are going to have some degree of pressure on margins. They're not going to have pressure on margins on an incremental basis. It's going to be over a period because either our leases are triple net or there are growths with our operating base, and that operating base is step-based upon the existing lease. Until you get the rollover, you don't really have that impact on your overall flow. If you look back historically, over the past decade, my guess is that the margins for BXP are somewhere in the mid to high 60s, and they haven't really fluctuated very much, so I don't think that is an issue.

Good morning. So, despite your FFO payout ratio picking up this quarter, I know your FFO is on track this year to deliver one of its best years. As we head into year-end using the third quarter as a base, are there any factors we should be considering that could impact it after considering the FFO changes you highlighted? Can you help us understand how your FFO growth has generally kept pace or outpaced FFO given how office is such a capital-intensive business?

Thank you, Camille. I'll address that. You're correct that our FFO has remained strong. I expect it to be between 5% and 10% higher than last year. This is mainly due to two factors. First, we had a significant amount of free rent that ended last year from substantial leasing activities, which converted to cash rent this year, positively influencing our FFO. Additionally, our lease expirations in 2023 were lower, requiring less leasing to sustain our occupancy. Our lease transaction costs are also slightly lower. I anticipate an increase in CapEx in the fourth quarter. The CapEx in the first three quarters hasn’t aligned with our typical run rate, but our team is working hard to complete pending projects. I believe the CapEx will be somewhat higher in the fourth quarter. Overall, we are looking at FFO guidance in the range of $5 to $5.20, which seems solid. The run rate in the fourth quarter will be a bit less due to the need to catch up on planned CapEx projects that are still outstanding.

Hey just wanted to zoom in on the life sciences segment. If you could talk about what activity or the pipeline is looking like? If you can comment on large tenants versus middle and smaller users, that would be helpful. Thanks.

Sure. Our life science activity is primarily centered at 651 Gateway, which we are developing in partnership with another entity. The most significant demand we've observed comes from small tenants looking for single-floor, turnkey spaces. Additionally, we have two buildings in the Greater Boston area: 180 CityPoint, which has just been completed and impresses visitors with its life science infrastructure and amenities, and 1034th Avenue, which continues to see a couple of tours each week. These potential tenants are more like shoppers than buyers; they are exploring options, with some influenced by lease expirations and others considering opportunities in drug discovery and commercialization, which would allow them to expand their workforce. Overall, there is a cautious approach, and the decision-making process is taking longer. Most immediate demand is from small private companies seeking fully built spaces.

For Boston, Doug's description is spot on in terms of the underwriting of what we're seeing. I would add, over the last two weeks, we have seen some encouraging amounts of tour uptick. In size as well, not huge but midsized 30,000 to 60,000 feet, a couple. We've been encouraged by the quality of these clients as well as by the uptick.

Hi, yes. Good morning, everyone. Just if you could make any quick comments about your outlook on life sciences. Is this an area you think you might dive into more as we go into 2024, fundamentals still somewhat uncertain, and it's an area where you may not do as much in? Any commentary would be appreciated. Thank you.

We're not planning on starting any new life science activities in any of our marketplaces given current conditions. We have opportunities to build some fabulous life science buildings on land with virtually no basis in it. Therefore, we have a cost advantage at some point. If there is demand, we will sequentially start to think about how we might be attractive to tenants looking for buildings where the economics would justify new construction. In the short term, 2023 and 2024, there's no expectation of us to be starting a new life science building. There are a couple of places in our portfolio where we have existing office installations where there's actual interest in life science demand. If a tenant shows up and says they want 40,000 square feet in this location, we would consider putting the infrastructure in to allow us to do light or heavy lab research. Absent that, what you see is what you get relative to our existing life science platform.

Great. Thanks for taking my questions. I guess since I'm last, maybe if you guys don't mind, if you humor me, I can ask two. First is, you mentioned San Francisco back to 45% of its turnstile activity. How do you think that plays out over time? That's a meaningful difference from what you said New York is at 95%. And secondly, what are partners saying, like capital partners saying in terms of wanting to put money to work in office? Is it more conversion activity? Are there certain markets? Just, are they starting to think about writing checks here more aggressively?

So, Jamie, I'll take a crack at it. Definitely, the Bay Area and actually the West Coast is seeing that turnstile activity is slower. I think that is primarily driven by the behavior and policies of the technology client base. They have been less forceful and less prescriptive about having workers come back to the office. All being said, the activity is increasing and I think it's going to continue to increase—just more slowly. The second part of your question was about private equity. I would say there is much more limited interest in the private equity industry today generally for office. That's why you're not seeing much transaction activity. As I mentioned in my remarks, most of it is being driven by smaller investors and family offices that are seeing the deep discounts offered in the market.

What I sort of add is the capital currently aggressively thinking about office is thinking about trading. They're looking at an opportunity for us to get in and then get out at a much higher basis and these are trading sardines, not eating sardines. We're in the eating sardine business in general in our portfolio. Finding a capital partner that is saying, okay, now I want to jump in and invest money for 10, 15, or 20 years is certainly more problematic in terms of desirability due to the nervousness associated with the overall fundamentals. However, there are some partners, right? Owen and James Magaldi went to various parts of the globe this summer and had constructive conversations. We're having constructive conversations with capital from other parts of the world coming into the United States, but it’s a slow process. I can't tell you that there's a transaction that will get consummated with BXP with one of those capital partners in the next couple of months, but there are opportunities. As Owen said earlier in his original comments, we're talking to some joint venture partners about putting capital into some of our assets.

Yeah, so thanks for using Jamie's logic; maybe I could sneak in three questions since I'm last.

Four if you want.

Yeah, I'm not going to rule anything out, but I do think the reason that BXP has 94% of its portfolio in premier workplaces is that the portfolio has been curated one asset at a time, either through acquisition or development also through our disposition activity. I don't think we're likely to enter into a major acquisition process because of the turbulence in the marketplace, so I think single-asset activity is more likely. It’s really difficult to put a dollar value on what we're looking at. Our job is to be in dialogue with owners and lenders of assets we’re interested in, and these dialogues are fluid.

Thank you. We have no more formal remarks. I want to thank everybody for their time, attention, and interest in BXP.