Boston Properties Inc (BXP) — Q1 2024 Earnings Call Transcript

Good morning, and welcome to BXP's First Quarter 2024 Earnings Conference Call. The press release and supplemental package were distributed last night and furnished on Form 8-K. In the supplemental package, BXP has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Reg G. If you did not receive a copy, these documents are available in the Investors section of our website at investors.bxp.com. A webcast of this call will be available for 12 months. At this time, we would like to inform you that certain statements made during this conference call, which are not historical, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Although BXP believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be a change. Factors and risks that could cause actual results to differ materially from those expressed or implied by forward-looking statements were detailed in yesterday's press release and from time to time in BXP's filings with the SEC. BXP does not undertake a duty to update any forward-looking statements. I'd like to welcome Owen Thomas, Chairman and Chief Executive Officer; Doug Linde, President; and Mike LaBelle, Chief Financial Officer. During the Q&A portion of our call, Ray Ritchey, Senior Executive Vice President, and our regional management teams will be available to address any questions. We ask that those of you participating in the Q&A portion of the call to please limit yourselves to one question. If you have any additional query or follow-up, please feel free to rejoin the queue. I would now like to turn the call over to Owen Thomas for his formal remarks.

Thank you, Helen, and good morning, everyone. BXP's performance in the first quarter continued to defy the negative market sentiment in the commercial office sector. Our FFO per share was consistent with our forecast and market expectations for the first quarter. We completed nearly 900,000 square feet of leasing, which is 35% higher than the first quarter of 2023 when we leased 660,000 square feet. This comparison is more relevant than that of the fourth quarter of 2023, given the increased leasing activity at the year's end. Our average lease term for leases signed last quarter was significant at 11.6 years, compared to 8.2 years in 2023. Our occupancy remains stable. We finalized the previously announced joint venture with Norges at 290 Binney Street, our lab development in Cambridge fully leased to AstraZeneca. This transaction alleviates $534 million of development funding for BXP by generating property-level equity for the company on favorable terms. Now, regarding macro market conditions, the two primary external factors impacting BXP's performance are long-term interest rates and corporate earnings growth. Lower interest rates would lower our cost of capital, encourage more transactions and investment opportunities in our sector, reduce new development costs, and benefit our clients' earnings growth. Much speculation surrounds the future trajectory of interest rates, which we expect to decline over time, but we cannot predict the exact timing. Companies typically do not hire new employees or expand their office space unless their earnings are increasing. Historically, S&P 500 earnings grow about 10% annually. However, in 2023, that growth was 0%, and in 2022, it was 5%. While the U.S. economy is expanding and unemployment is low, only about 7% of new jobs are in office-using categories, compared to a long-term average exceeding 25%. Forecasts suggest S&P 500 earnings will grow 11% to 13% per year over the next two years, which should positively influence BXP's leasing activity. Many technology clients, crucial for space demand since the global financial crisis, overcommitted to space during the pandemic and are currently adjusting, leading to a reduction in demand. There are exceptions, such as increased demand for space from the AI sector in San Francisco. In the long run, we anticipate many tech firms will see significant earnings growth and will need more office space. Premier Workplace, defined as the top 6% of buildings representing 13% of total space in our five central business district markets, continues to significantly outperform the broader market. Direct vacancy for Premier Workplaces stands at 11.2% compared to 17.9% for the overall market. Additionally, net absorption for Premier Workplaces has reached a positive 7 million square feet over the past 13 quarters, while the broader market saw a negative 30 million square feet. Asking rents for Premier Workplaces are now 50% higher than the general market, a growing disparity from previous quarters. This trend is evident in BXP's portfolio, where 89% of our NOI is derived from assets in CBDs that are primarily premier workplaces. These CBD assets are 91% occupied and 93% leased as of the end of the first quarter. In terms of the real estate private equity capital markets, office sales volume in the first quarter was $8.7 billion, down 3% from the previous quarter but up 32% from a low base one year ago. Office sales as a percentage of total commercial real estate transactions have risen to over 20%. Transaction activity for premier workplaces has been quite limited. BXP's main goal is to leverage our competitive advantages to maintain and grow FFO per share over time. Our key advantages include our commitment to the office sector and our clients at a time when many competitors are exiting the market, a strong balance sheet with access to both secured and unsecured debt and private equity markets, and a high-quality portfolio of premier workplaces built over decades of intentional development, acquisitions, and dispositions. Today, clients and their advisers are more focused on building quality alongside the financial stability and long-term commitment of their building owners, which are significant competitive advantages for BXP. Last quarter, I discussed three priorities for BXP in 2024: leasing space, new investments, and development. Doug will now provide additional details on leasing. We have made a strong start in the first quarter and anticipate a growing pipeline of opportunities for the remainder of this year and into 2025. Regarding new investment activity, we shifted to a proactive approach late last year and early this year by acquiring joint venture interests in three substantial in-service assets at attractive prices. We are actively seeking opportunities in our core markets and asset types, primarily focusing on two types of counterparties: lenders to highly leveraged assets in need of recapitalization and institutional owners looking to diversify away from office assets. To date, market transaction activity for high-quality office assets has been limited. With lenders, there are few premier workplaces facing leverage issues. In the rare cases involving such assets, lenders generally prefer borrowers who agree to make additional investments in their properties. Institutional owners show less interest in selling their highest-quality assets, and there remains a significant bid-ask spread as many assets have not been sufficiently marked down to market-clearing levels. Despite these challenges, we believe transaction activity and our investment efforts will increase in the upcoming quarters due to maturing financings, ongoing markdowns in institutional portfolios, and a prolonged period of higher interest rates. We have also received interest from institutional investors looking to partner with us on select opportunities. On the development front, we launched our 121 Broadway residential tower in Kendall Center as part of the 1 million square feet of commercial entitlements awarded by the city of Cambridge to construct 290 Binney Street and a future commercial building to be determined. The 37-story, 439-unit 121 Broadway will be the tallest building in Cambridge, featuring cutting-edge design and amenities that will set a new standard for residential offerings in the Kendall Square area. Earlier this month, during Boston Marathon weekend, we celebrated the grand opening of the 118,000 square foot Dick's House of Sports store on Boylston Street at Prudential Center. We continue to advance various residential projects that we are entitling and designing, with plans to raise joint venture equity capital in the latter half of the year. On office development, we have had multiple inquiries from clients across our core markets interested in occupying new spaces and anchoring development projects. Due to escalating costs for materials and labor, anchor clients must offer rents exceeding market levels today to justify initiating new projects, a dynamic made more difficult by the previously mentioned earnings growth concerns. While BXP has seen a slowdown in new office development activity, we expect that there will be limited new office development in the near future within our core markets, which is beneficial for our existing portfolio. As vacancies for premier workplaces continue to diminish, rents should increase, ultimately closing the economic gap needed to justify new developments. Although we believe acquiring assets offers better opportunities than selling in the current market, we are open to raising capital through asset sales if attractive prospects arise. We are currently exploring a few small dispositions defined as under $30 million. BXP is actively progressing on a significant development pipeline, with 11 office, lab, retail, and residential projects underway as of the end of the first quarter. These projects total approximately 3.2 million square feet and represent a $2.4 billion investment from BXP, with $1.3 billion left to be funded and projected to yield attractive returns upon completion. In summary, despite pervasive negative market sentiment, BXP continues to demonstrate resilience and stability in occupancy, FFO, and dividend levels. BXP is well positioned to gain market share in both assets and clients during this period of market dislocation. The potential for lower interest rates and stronger corporate earnings also provides a favorable backdrop for renewed growth.

Thanks, Owen. Good morning, everybody. I hope what you're going to hear today from me is you'll be presented with a relatively constructive perspective on what's going on in our markets and our revenue picture, as well as our leasing picture. As we sit here at the end of the first quarter, in spite of the absence of a broad pickup in office-using jobs, BXP continues to lease space. We are leasing space. There's momentum in the economy despite persistent high interest rates. Overall earnings growth for our clients and potential clients appears to be improving, and we're pretty optimistic it’s going to lead to employment and space additions. While we are not going to see broad reports of shrinking availability across any market, until there is a pickup in white-collar job formation, there are pockets of supply constrained in select submarkets where we are seeing competition for space and improving economics. As reported in our supplemental, the mark-to-market of the leases that commenced this quarter was up 7% and the transaction costs averaged $8.60 per year, which is lower than it's been in the last few quarters. The overall mark-to-market of the starting cash rents on leases executed this quarter relative to the previous in-place cash rent was up about 2%. The starting cash rents on leases we signed this quarter on second-generation space were up about 22% in Boston, down 6.5% in Manhattan, down 3% in D.C., and up 8% on the West Coast with San Francisco CBD up 12%. Boston's increase is largely due to the replacement of a tenant that was in default and had stopped paying. Adjusting for the transaction, the Boston numbers would have been up about 6%. As Owen stated, the seasonal trend line of BXP's leasing activity in the first quarter of '24 picked up relative to what we experienced in the first quarter of '23. This quarter, we completed 61 transactions, 32 new leases for 494,000 square feet, and 29 renewals encompassing 399,000 square feet. We had three expansions totaling 18,000 square feet and four contractions totaling 44,000 square feet. As a point of comparison, in the first quarter of '23, there were 57 leases, 29 leases were with new clients for 410,000 and 28 renewals for 250,000. There were 10 expansions and three contractions. Last quarter, Fourth quarter of '23, we signed 37 lease renewals and 37 leases with new clients, and there were eight contractions and nine expansions among our existing clients. This quarter, new leases encompass 55% of the volume. Activity was across the entire portfolio with 178,000 square feet in Boston, 225,000 square feet in the New York region, 154,000 square feet from the West Coast, and D.C. led with 336,000 square feet. To give you some additional color on this activity, there was only one transaction greater than 60,000 square feet due to the 215,000 square feet long-term law firm extension, which included a 25,000 square foot contraction in D.C., although that same law firm took an additional 7,600 square feet in our Reston portfolio. Princeton made up 38% of the New York activity this quarter, almost all new clients. New clients made up 90% of the leasing volume in Boston and in New York, while renewals captured 73% of the West Coast and D.C. market. Equally important is our pipeline. Post March 31, we have over 875,000 square feet of active leases under negotiation, which we define as a transaction that is being documented by our legal teams. Some of these transactions have been completed. This is consistent with the level of in-process leases we've made for the last few quarters. These transactions include a multifloor expansion of an asset manager in our Midtown portfolio in New York, a full-floor expansion by a law firm in Midtown, an asset manager taking a full floor at 360 Park Avenue South, a consumer brand company relocating to a building in Waltham, a multi-floor renewal of a law firm in San Francisco with no change in the premises, and a downsizing along with an extension of a technology company in Reston, Virginia, and a similar transaction in Waltham. We have seen an uptick in the number of active deals. At the end of the quarter, we had signed leases that had yet to commence on the in-service vacancy, totaling approximately 817,000 square feet, which includes 624,000 square feet that is anticipated to commence in 2024. We also have signed leases with new clients for another 534,000 square feet of currently occupied states. These leases have yet to commence but they are reflected in the reduction of our rollover exposure shown in our supplemental. The strongest user demand continues to come from the asset managers, including private equity venture hedge funds, specialized fund managers, and their financial and legal advisers. These organizations are the heart and soul of our New York and our Back Bay activity and are an important driver of our San Francisco CBD demand. In some instances, these clients are growing their teams and capital under management. In all cases, they want to occupy premier workplaces. We continue to see significantly more client demand in our East Coast portfolio versus the West Coast due to the disproportionate concentration of technology and media content-related demand on the West Coast. However, there have been some subtle and encouraging trends across much of the portfolio. Our Back Bay Boston and Park Avenue Centric New York City portfolio continue to have outsized demand relative to our availability. While concessions are still at elevated levels, we've been able to increase our asking rents and actually have clients that we cannot accommodate due to a lack of available space in certain buildings. In the last 90 days, there's been a strong pickup of client activity in our Urban Edge Waltham portfolio. We have an 80,000 square foot tech client expiring in 2024 with a planned downsize to 16,000 square feet. This quarter, we completed a lease for 45,000 square feet and are in negotiations with two other clients, new ones for another 37,000 square feet of that expiration. The existing client will stay with us but relocate within the building. Additionally, in a different Urban Edge building, we're negotiating a 45,000 square foot lease with an existing subtenant to extend when their prime lease expires in '25. We're negotiating a 25,000 square foot lease with a lab user proportionate of our availability on Second Avenue and we're negotiating a 55,000 square foot lease with a non-tech company in a different building. None of these transactions, more than 220,000 square feet were in our pipeline on 12/31/2023. All of this occurred in the last 90 to 120 days. In the District of Columbia and Northern Virginia, we continue to see more buildings with over-leveraged capital structures unwilling to provide capital for new transactions, and therefore, they have very little client interest. At the other end of the spectrum, when the market got wind of our lease extension at 901 New York Avenue and the anticipated enhancements that we are planning, the interest in the available space at 901 New York accelerated dramatically. Reston continues to house the largest concentration of our Washington regional portfolio. It's the headquarters for numerous major corporations and also the home to a number of large technology companies like Microsoft. Because of the environment of the Town Center with 7 days a week food, beverage and shopping, it is also a natural location for small businesses in the financial services and legal industries. This quarter, we completed a 58,000 square foot lease with a new technology client at Reston Next that's moving from a toll road building, an expansion for a law firm, and we are seeing a pickup in small tenant activity related to 2023 and as well as large users looking to upgrade their premises. The AI organizations in the city of San Francisco continue to look for additional space, which will continue the positive absorption story. They continue to focus, however, on build and expensive space. While there is an abundance of available space in the city, there continues to be outsized demand for view-space north of market relative to the available supply. We completed a 35,000 square foot lease with a boutique financial adviser at Embarcadero Center this quarter that was only interested in view-spaced north of market. We're negotiating six transactions with new clients totaling 40,000 square feet, as well as an 80,000 square foot renewal with a law firm that's retaining their existing space. Today, the Seattle CBD is almost exclusively a lease expiration-driven market, and there has been a material pickup in the level of activity. The number of tenant tours that we have conducted has picked up in the last two quarters. We completed a lease with a new client on a 10,000 square-foot prebuilt suite and are in negotiations with a law firm for a parcel floor and discussions with a technology company for a full floor. West L.A., however, continues to be the market where activity remains light. While Century City is seeing great demand and strong rents as financial and professional services firms head west from the downtown market, those clients are not yet prepared to take space in low-rise buildings in Santa Monica. There continues to be pressure from streaming profitability, industry consolidation, and job reduction in the gaming and media space that is impacting overall demand growth in the West L.A. area. As we forecasted during our last call, our occupancies declined slightly from 88.4% to 88.2% during the quarter, with a known expiration of 230,000 square feet in Princeton, where, as I mentioned, we have signed 80,000 square feet of new client deals this quarter that will commence this year. We have two additional large lease expirations across the portfolio in 2024 that will occur during the second quarter, 200,000 square feet at 680 Folsom in San Francisco and 230,000 square feet at Times Square, where we own 55%. Occupancy will drop in the second quarter and recover as we move into the fourth quarter. Mike is going to spend some time discussing changes to our interest expense outlook in his remarks. The issue of the day is the level of inflation, and I thought I'd make a few brief comments on how inflation is impacting our business. We are not seeing any deflation in our base building costs as we build, as we bid potential stick-frame residential projects that Owen was describing earlier, but escalation assumptions are now normalized, no more 8% to 9%. The changes to the building and energy codes, along with the elevated level of interest expense associated with any construction financing, continue to pressure project costs and make new starts very challenging. However, we are seeing costs come down on tenant improvement jobs, which is a reflection of reduced demand on the group of contractors and subcontractors that focus on interiors work who are looking to maintain a consistent book of business. New high-rise tower construction costs are unlikely to deflate. In the longer-term interest rate environment, the longer rates remain elevated, the longer it's going to be before we see market rents approach the levels necessary to rationalize new office building leasing economics and corresponding new development. We are experiencing an operating environment where leasing available space is primarily driven by gaining market share. That's with the world that we are living in, and we're winning. As clients choose premier properties in sound financial condition, operated by the best property management teams, BXP will continue to be successful in doing just that. I'll stop there and turn it over to Mike.

Great, thank you, Doug. I appreciate it. Good morning, everybody. This morning, I plan to cover the details of our first quarter performance and also the updates to our 2024 full-year guidance. We've also been active in the debt markets this quarter, so I'm going to start with a summary of some of the changes in our debt structure. In early February, we paid off $700 million of unsecured notes with available cash that was in line with our plan. We also entered into a $500 million unsecured commercial paper program. This program offers an additional market for us to tap beyond the bank market mortgage and unsecured bond markets that we currently actively utilize. We started issuing under the program last week, and we've raised the full $500 million for terms ranging from overnight to one month at a weighted average rate of SOFR plus 25 basis points. The all-in rate, including fees, is approximately 5.75%. We've used the proceeds to pay down our term loan from $1.2 billion to $700 million, which will reduce our borrowing cost on $500 million by 75 basis points or about $0.01 per share in 2024. In addition, we increased our corporate line of credit by $185 million to $2 billion. Our banks continue to be strong supporters of BXP even as they evaluate their global commercial real estate exposure and exit certain relationships. Now I'd like to turn to our first quarter earnings results. Despite the difficult real estate operating conditions and the stagnant office-using job growth statistics, our portfolio is demonstrating strength and stability. As Owen and Doug described, portfolio occupancy has been relatively steady for the past six quarters. Our revenues continue to grow with total top-line revenue up again this quarter by $10 million or 1.3%, and our share of portfolio NOI is also higher, up $6 million or 1.2% from last quarter. High interest rates are our biggest earnings challenge. This quarter, our interest expense increased by $7 million. It's important to point out that more than half of this increase was due to higher noncash fair value interest expense related to below-market debt on our recent acquisitions. We reported funds from operation of $1.73 per share for the quarter that was in line with our guidance for the first quarter, and it was equal to our first quarter FFO from one year ago, again demonstrating the stability of our income statement. Portfolio NOI exceeded our expectations by about $0.02 per share. The majority of this is from lower-than-anticipated net operating expenses that we expect will be deferred to later in 2024. This was offset by higher-than-projected net interest expense of $0.02 per share primarily from higher noncash fair value interest expense related to the acquisitions, and we also booked lower-than-projected interest income due to changes in the timing of closing our 290 Binney Street joint venture. So moving to the full year, since providing our initial 2024 guidance, we finalized the assumptions utilized in valuing the in-place debt and interest rate swaps for our 901 New York Avenue and Santa Monica Business Park acquisitions. For 901 New York Avenue, we increased our assumption for the interest rate on the debt by 70 basis points to 7.7%. And for the interest rate hedge at Santa Monica Business Park, we determined that the change in market value will be amortized through our interest expense for the remaining term of the loan that expires in 2025. These adjustments result in an additional $0.05 per share of noncash fair value interest expense in 2024 relative to the estimate we used when we provided our guidance last quarter. This noncash adjustment impacts our full-year guidance and is the primary reason we have reduced our FFO guidance for 2024. Other interest expense assumptions have also been impacted by the changing expectations for rate cuts in 2024. Last quarter, we forecasted four rate cuts commencing in the second quarter which was actually conservative to market expectations at the time. We've now pushed out any rate cuts to late in 2024. The impact on our floating rate debt is partially offset by the lower cost of our commercial paper program, but overall, we expect $0.02 of dilution from higher short-term interest rates compared to our prior guidance. The operating assumptions for the portfolio occupancy and same-store NOI remain relatively unchanged from our prior forecast. As Doug described, we do expect occupancy to decline slightly this quarter; we did expect occupancy to decline slightly this quarter and in the second quarter before improving in the back half of the year. Our assumption for same-property NOI growth of negative 1% to 3% is unchanged. Other modifications to our guidance include reducing our assumption for 2024 G&A expense by $0.01 per share and a modest reduction in our fee income projection. So in summary, we are reducing and narrowing our 2024 full-year guidance for FFO to $6.98 to $7.10 per share. This represents a reduction of $0.06 per share at the midpoint from our prior guidance. The primary reasons for the reductions are $0.05 of higher noncash fair value interest expense and $0.02 of higher interest expense from higher short-term interest rates, offset by $0.01 of lower G&A expense. The last item I would like to mention is that we published our 2023 sustainability and impact report, and it can be found on our website. The report contains a wealth of information on our sustainability efforts and the progress towards achieving our critical goals of reducing our energy use intensity, carbon emissions and achieving net zero carbon operations for Scope 1 and 2 greenhouse gas emissions by 2025. We invite you to join us for our sustainability and impact webcast on May 15. If you have not received an invitation, please reach out to Helen and our Investor Relations team. That completes our formal remarks. Operator, can you open up the line for questions?

I have a broader question for Owen regarding the various opportunities available. You mentioned potential acquisition prospects, and you just launched 121 Broadway, which requires a significant capital investment. Given the current stock price, which I assume you're not completely satisfied with, I'm trying to understand the company’s current investment strategy. How do you plan to finance this? Are you considering issuing equity or buying back stock? Any insights on this would be appreciated.

Yes. So Nick, I would like to mention a few things. First, regarding 121 Broadway, it is an excellent new residential building we are developing in Cambridge, which is also crucial for achieving 1 million square feet of commercial entitlements in the area. These entitlements allowed us to start the 290 Binney Street development, and we still have some space available for one or two more commercial buildings. It's important to consider that this development is linked to the 290 project we began last year. As for new investment opportunities, as I mentioned earlier, there is significant dislocation in the office sector. Many assets are over-leveraged, and several institutional owners are looking to reduce their exposure to office properties. This situation will create opportunities for us. Historically, during down cycles in real estate, BXP has strengthened its portfolio with acquisitions like 200 Clarendon Street and the GM building. We believe this pattern will occur again in this cycle, and we want to be involved. As we pursue these opportunities, we will be carefully monitoring our earnings growth and leverage. Each transaction will need to be evaluated individually regarding how we will finance it.

Doug, I guess I wanted to just maybe follow up on your positive commentary on leasing and just maybe get a sense for how much of this is for the existing portfolio? How much of this is for the development pipeline? And I realize we're getting sort of close to the middle of the year. So any of the leases being signed are probably really more of a '25 beneficiary than they are going to be at '24. But just how do you think about building up the occupancy on the existing portfolio and as importantly, filling up the vacancy within the development pipeline?

Thank you, Steve. In our current pipeline, we have 875,000 square feet, of which about 20,000 square feet is dedicated to development. The remaining 855,000 square feet consists of existing portfolio deals, primarily in available space. To clarify, we have the leases we signed this quarter and our ongoing pipeline. Currently, I am tracking an additional 1.7 million square feet of active deals that our teams are working on across various regions. These involve actual negotiations rather than casual inquiries from potential tenants. Most of this activity is focused on our in-service portfolio. Regarding our development pipeline, it includes 360 Park Avenue South, and Hilary can provide updates on that, as well as our life science buildings in Waltham, which currently have no active discussions, and the property in our joint venture in South San Francisco, where there’s also no significant activity. Thus, our primary focus is to maintain and gradually increase occupancy within our existing in-service BXP core portfolio.

Sure. Thanks, Doug. Steve, in terms of the leasing activity in Midtown South, I think we saw a slowdown in the first part of this year. I will say that we are starting to see more activity as 360 Park Avenue South has come online and clients can actually see the very high quality of the finishes and the lobbies and the common areas and the amenities that we've put in place. And so we are starting to see a pickup in our activity there. It remains the case that the businesses that are interested in locating at 360 Park Avenue span across industry sectors. And so while Midtown South in general has historically been home to tech and media tenancies, we're seeing everything from corporate to financial services and, as Doug mentioned, an asset management firm come into that building and show interest in occupying that building. I think, anecdotally, while the leasing activity is picking up a bit, it remains to be seen where that will settle out in terms of executed leases in the coming quarters, but we feel encouraged by the fact that the volume of interest in the building has stepped up meaningfully since we completed it and opened it.

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

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

Yes. Thanks, Doug. So yes, last year, of course, was a big year for AI in San Francisco. There were two very large leases that were completed. I believe that made up about 27% of the overall leasing activity for the year, which was pretty substantial. So coming into '24, there's still been activity on the AI front. One of those larger tenants that did the deal last year is also in the market again for more space. So we're watching that closely to see where that goes. I think it's definitely a bright spot. These different companies often define themselves as AI, but it's broad across the spectrum of that technology. As you see that down in Silicon Valley, in fact, there are some AI companies, many of them which are tied into the automotive industry. We have a couple of them in our own portfolio, and some of those are in the market as well. So definitely a consistent point of additional optimism and demand for the Bay Area.

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

So this is Doug, and I'll let someone else make a comment as well. We are committed to the locations where we currently have occupancy and vacancy. The majority of our available properties are in suburban areas, partly due to our own decisions during 2020 to 2022 when we evaluated the highest and best use for some of our assets in Waltham and Lexington. We concluded that over the long term, these assets would be more valuable as life science facilities rather than traditional office spaces. As a result, we cleared out some buildings, like 1050 Winter Street and Reservoir Place, for this purpose. Unfortunately, the current market conditions have not favored us, and we are managing the available space. Despite having opportunities to lease some of it to office companies, we decided to hold off on one building, planning to convert it to a life science facility when the right economic model aligns, meaning when a tenant is willing to pay the right rent for it. Our other significant available space is in Princeton, which is a premier property compared to other assets in the greater area. Currently, we have more activity in Princeton than anywhere else in our New York portfolio on a relative basis. I can't explain why we've seen increased activity in the first and second quarters of 2024, but it's mainly linked to the pharmaceutical and life science sectors, particularly companies in that field with SG&A functions. Hilary, you can provide insights on the Princeton market, and I'll let Bryan share thoughts on the Waltham market.

Sure. Thanks, Doug. As Doug said, we've seen an incredible pickup in leasing activity in the Princeton market in the first and second quarters and that includes signed leases, but also leasing activity that continues now and we expect to be executed in the second and third quarters. A lot of it, as referenced, is new activities. Some of it includes clients that exist in the portfolio of Carnegie Center today and who have expressed needs to expand both from consolidation of business units or expansion of lines of business and from an increased experience of return to office, and so it's a pretty diverse set of reasons that people are expanding. But to Doug's point, the campus is pretty highly concentrated with pharmaceuticals and, in particular, foreign pharmaceuticals, and that is where the bulk of the demand is coming from. And so we're incredibly encouraged by the amount of leasing activity, and we expect to see additional signed leases coming out of it in the coming quarters.

This is Bryan Koop from Waltham. I'll echo what Doug mentioned, referring to it as an Urban Edge market because it's less than 10 miles from downtown Boston, which is significant regarding commuting and the population density in the Waltham area. To add to Doug's points, we're observing differences on the east side of I-95, which displays all the characteristics of an urban development similar to Reston, featuring taller buildings and more amenities. We're also seeing improvements in access to the highway, including a new ramp we installed last year with plans for further upgrades. However, we are noticing some challenges with assets like Bay Colony, which resemble typical suburban office buildings and feel more rural despite their close location. Nevertheless, we firmly believe that Waltham qualifies as an urban edge market, distinct from the usual suburban developments described by most in real estate.

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

So when you use the term lease rate, you're talking about occupancy rate, right, not economic rent rate, I'm assuming. So again, I think that it's going to be slow and steady. So our projections when we gave our guidance during the call in the first quarter was that we were going to hopefully be flat to where we ended 2023 at the end of 2024 and then we'll continue to make additional progress. If you look at our exploration schedules, they're pretty manageable, right? I mean we have 5% to 6% expiring every year for the next 4 or 5 or 6 years. We need to lease space. We need to gain market share, which is, again, my sort of point. We are gaining market share in our markets, but when we do have technology companies expiring, we have to fight that water coming at us. And so it's a challenge to dramatically increase occupancy in the short term. But we are getting to the point where we believe occupancy will continue to moderate upwards.

What are the economics of the new multifamily development? And how do you think about your cost of capital? And then along the same lines, what is the thought process on the new commercial paper program and what upsize options do you have?

Well, let's let Mike answer the commercial paper question, and then I want to answer the question on our return expectations for multifamily.

So we decided to enter in this commercial paper program because we're always looking for additional markets to access, especially in this environment. It's the cheapest form of floating rate paper that we can issue. Historically, we've been primarily fixed rate. We're going to continue to be primarily fixed rate, but I think we will have a moderate amount of floating rate debt on a consistent basis over the foreseeable future. Right now, we have about $1.2 billion of unsecured floating rate debt, and we have about $700 million of joint venture unsecured debt. I think it will go down from there going forward. But we view using this commercial paper program as a consistent piece of our debt structure over the next several years. Because we can save 75 basis points by using it, it's a very liquid marketplace, we've got high credit ratings. So our access has been good, and now we've experienced it for the first couple of weeks, which has been very, very positive. So we're building an investor base in it. We just felt like additional arrow in our quiver from a capital perspective and lower cost of capital both drove that decision.

Yes. It's Owen, let me address the 121 Broadway development. As I described in my remarks, this is a notable building. It's the tallest building in Cambridge and it's also a very high-quality residential tower given the finishes and our design and planning. Due to coordination with the development of the vault for Eversource, the project is not expected to deliver its first units until late 2027 and is expected to stabilize not until the second quarter of 2029. So again, you have to think about this project as part of the overall East Cambridge development that we've been working on and talking to all of you about for the last two or three years. So the forecast returns on the 121 Broadway development alone are below our typical thresholds for development. However, if you look at the yields that we're receiving from the entire entitlement package, so that includes 121 Broadway, it includes 290 Binney Street, and it includes what we think we can get with the remaining commercial entitlements that we still have, those projected returns do meet our development hurdles. Then to the extent that we are looking at new stick build, our expectation is that those returns are going to be meaningfully higher than in urban development. So we're talking about yields well in excess of 6%. And that's what we need to consider starting a new residential development in 2024, 2025.

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

The answer to your first question is that the situation is quite detailed. We are experiencing occupancy increases in locations like the General Motors building, where we are actively negotiating with tenants to occupy space soon in 2024. In Princeton, we have a backlog of potential deals that we believe will be completed in 2024, as Hilary mentioned. In the greater Metropolitan Washington, D.C. area, particularly in Western Virginia, there are many smaller deals expected to close in 2024. The activity I mentioned in Waltham mostly involves expiring or vacant spaces, which will largely be settled in 2024. Overall, the activity is widespread, and I wouldn’t point to a single major deal that would significantly alter the landscape. Therefore, we anticipate returning to our previous occupancy level of about 88% by the end of 2024. I am hopeful for some positive surprises, such as tenants moving in sooner than expected. We believe lease agreements will be executed, but determining the exact timing for recognizing revenue is challenging. This depends on whether the space is being demolished or if we are managing a turnkey build-out, as we await our clients’ decisions regarding their needs. We aim to ensure the spaces are ready for occupancy in 2024, which would contribute to our occupancy statistics. Regarding life sciences, demand appears to be relatively slow, and I will let Bryan comment on the situation in the greater Boston area, while Rod will discuss what's happening in South San Francisco.

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

Yes. Just in South San Francisco, our one project is the 651 Gateway building, and that is basically a converted office building, 16 stories. That building is completed, and we've done three deals in there, three, four floor deals, and those tenants are in various stages of moving in. But in terms of new activity, it's been very slow. The few deals that are in the market tend to be smaller, call them, 10,000 to 20,000 feet, not the 200,000 foot deals that were in the market several years back. So that section has been quiet. But our building is actually very well positioned to attract that demand that is in the market. We have a space that is going to be built on a spec basis. We're going to do a full floor, which is going to be ready to accept that tenant when they're out there. So but the larger tenants are not there.

First, I want to acknowledge that if you were any other REIT, you would have adjusted for your $0.06 or a significant portion of it and likely be up today instead of down 3%. I appreciate your dedication to FFO, as defined by NAREIT; I believe that will be rewarded in the long run. Now, regarding my question about the Castle data, utilization in the office space is still below 60%. I'm not sure how that compares to your top-performing assets, but it's clear that utilization hasn’t returned to pre-pandemic levels. Do you see a scenario where the BXP story can remain viable in the long term if underutilization in offices becomes a permanent situation? Or do you believe you need to fully recover to build a sustainable long-term narrative? I'm interested in your thoughts on the long-term outlook for office utilization.

Yes. That was a lot to unpack, but I’ll give it a try. First, Castle data is widely used in the media and financial community, but it only provides a rough estimate of office demand. It somewhat reflects foot traffic in urban areas over time. However, many owners of prime office spaces do not use Castle systems in their buildings, so we don’t have a clear understanding of what buildings are being measured. Additionally, it doesn’t account for the current lower occupancy rates in the office market from a leasing perspective. The data covers the entire week, which is less relevant for office use, as it’s more important to focus on peak days. While many people rely on this data, it does not accurately represent our experience. We have turnstile data for about half of our 55 million square feet under management. We've analyzed same-store data for buildings that have maintained their leasing levels since March 2020. In New York, our buildings show similar turnstile swipes on Tuesdays and Thursdays as they did in March 2009, indicating that New York is essentially back to where it was. Notably, Fridays were slow even before the pandemic, and Mondays are just beginning to recover. Overall, I would say New York is almost back to its previous state, particularly three days a week. Boston is at about 75% on that measure. However, San Francisco is lagging, with about 45% to 50% occupancy on those peak days. Peak days are vital because if you use office space, you need to accommodate your staff when they come in. Again, we see improvements. As I’ve mentioned multiple times, we believe that the current slow leasing activity is not primarily due to remote work but rather the earnings growth of the businesses we serve. We offer services to businesses, not consumers. When those businesses are not seeing earnings growth, they aren’t hiring or expanding office space. As earnings begin to rise again, which we’re witnessing now in the first quarter, we expect our leasing to increase. Doug effectively highlighted some positive indicators that we anticipate will materialize later this year.

And Rich, just from a sort of macro thesis perspective, I think what is 100% clear is that new construction is not part of the vernacular in 2024, 2025, which means unlikely you're going to see buildings delivered that aren't already under construction. There is some stuff under construction, but you're not going to be seeing new buildings delivered in any of these metropolitan areas for the next five-plus years, right? That's how long it takes to build a building. Look at the time frames associated with these press releases about a potential new building in Midtown Manhattan. If our thesis continues to be accurate, and Owen has described the difference between the premier and sort of the other portions of the office inventory, there is going to become less and less premier space, and the premier space will continue to pick up its occupancy, its lease percentages, and we will see the fruits of that in the properties that we have in all of our marketplaces. And again, I harp back to sort of this dislocation that's occurring. What we are seeing in Washington, D.C. relative to the number of buildings that people would deem to be a to a minus buildings that are incapable at this point of making a leasing transaction because there is no capital available because the buildings are underwater to find out there's too much debt, and the equity holders are saying, we're not prepared to put capital in for the benefit of the lender. It's changing the characteristics of how these things occur.

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

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

Sure, Cait. I'll make a brief comment and let Rod describe it. So WeWork actually is in negotiation to remain in all the space that we have with them at that building. And we have an expiration with Zillow. It's truly a Flash Zillow, their fact consolidation which occurred earlier and that's where the majority of the availability is. Rod, you can describe sort of leasing prospects there and how things are looking in our portfolio in the South market?

The space you mentioned is in the low rise of that building and was previously occupied by Zillow/Trulia. We have seen some activity in that area, but we've had better interest in a couple of floors higher up. In fact, we just finished a full floor of spec suites on the 11th floor, which has received a great response from the market, and we anticipate leasing that up quickly. Regarding the SOMA portfolio, earlier we discussed the availability at 680 Folsom, which comprises 200,000 square feet. We just regained that space, and today marks the first day it’s officially vacant. However, we have been marketing it for a while and have had some interest. We are currently in discussions with various groups, and we are pursuing another potential tenant. There's been a noticeable increase in activity in the Northern market. Our Embarcadero Center property seems to be attracting more attention compared to some southern market spaces, likely due to traditional companies preferring Embarcadero Center while tech firms still focus more on the South market. Additionally, there is some sublease space at Salesforce Tower that they are marketing, which is also receiving good interest. I am quite confident that we will successfully lease up the available space.

I have two quick questions. First, Mike, I want to clarify regarding the guidance adjustment you mentioned. Are you referring to the overall shift in the curve, or are you incorporating some potential rate cuts in your guidance? Secondly, in relation to achieving the occupancy increase in the second half, do you expect the first quarter leasing run rate to increase as well, considering the upcoming expirations?

We have revised our expectations to include an additional rate cut later in the year. If that rate cut does not happen, it is unlikely to significantly affect our guidance, given its timing in the year. We will need to monitor the inflation data and the Federal Reserve's actions as we consider the future direction of rates for both this year and next. I don’t believe that a lack of cuts this year will materially impact our guidance. Regarding leasing, could you please repeat the question? For Q1, occupancy decreased slightly and is expected to decline a bit more in Q2 due to the expirations Doug mentioned, specifically at 680 Folsom and Times Square Tower. In the latter half of the year, we don't anticipate significant expirations of substantial size. This timeframe is when many of the leases we have already signed, totaling around 815,000 square feet, most of which will begin in 2024, along with the letters of intent we have, will start to take effect. This gives us confidence that occupancy will stabilize after Q2 and hopefully begin to increase thereafter. That is our expectation.

Yes. I just wanted to go back to the guidance for the year. So if we take the first quarter, and we take the midpoint of the second quarter, you're about at a 344 midpoint of guidance, the 704. We're talking about rates higher for longer, occupancy probably picking up in the fourth quarter or so of the year. So could you just help us walk us through the acceleration of earnings in the back half? What the drivers of that will be?

So Omotayo, there's really three, I think, impacts that are going to help us in the third and fourth quarters. The first is we expect NOI from the portfolio to be up, and we expect that to occur because of the occupancy improvement that we have talked about. So I would expect that both the third and fourth quarter will show higher portfolio NOI than what we have in the first and second quarters. The other is G&A. So G&A is seasonally high in the first and second quarter because of just the timing of the vesting schedules as well as taxes that are paid on payroll. So that's a pretty meaningful move between quarters; it could be between $0.05 and $0.07 lower in the third quarter and the fourth quarter from where it is today. And then the last piece is we do expect to have interest income be lower than it is today as we fund our development pipeline. That is offset a little bit by capitalized interest. But I see our interest expense as being slightly lower next quarter and then stable and our interest income will drop a little bit sequentially by quarter as we spend on our development pipeline. So those are really the three things that are driving the improvement in our FFO in the third and fourth quarter to achieve the midpoint of the guidance range.

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

So this is Mike. I'll respond to this, and the rest of the team can add on. Lenders in general are not getting payoffs. So typically, they have volume requirements that are pretty significant because they're constantly getting paid off, and they need to replace and hopefully grow that. In this environment, their borrowers are not necessarily paying them off. So they're not excited about increasing their exposure to commercial real estate and office properties right now. I think, as a whole, banks are not excited to provide lending; I think they would be more likely to lend on a stabilized piece of property at an appropriate debt yield than do a construction loan. I think there's very little in the way of construction financing available out there, particularly anything speculative. But if you came to a bank and you had a fully leased property, maybe you could get that done. But again, the pricing is going to be, I don't know, 300 to 400 over SOFR. So SOFR is at 5.3%. So you're talking about 8% to 9% money. So it's really, really hard to make sense of that when that is the case. So again, Doug talked about very little in the way of new construction going on. The bank financing market is another limiting factor to that picture.

Yes. To add to your question about development yields, let's differentiate between office and life science versus residential. For office and life science, our initial targets when rates were low were in the 6% to 7% range, but those have increased by at least 200 basis points. As Mike mentioned, obtaining financing is very challenging, and as I noted earlier, development costs have risen. This is partly due to the inflation Doug highlighted, but also because of the yield requirements with the higher rates. For residential, we have traditionally viewed it as 100 basis points over exit cap with no untrended rents. Currently, it's somewhat difficult to assess, but there's evidence of high-quality residential properties trading in the mid-5s range. In terms of development yields, we're likely looking at least at mid-6s for residential. To proceed with such projects, we need a joint venture partner, like we have at Skymark, our ongoing development in Reston.

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

The response to your first question is quite detailed. It involves occupancy increases in places like the General Motors building, where we are currently in discussions with tenants to secure some space in 2024. We also have activities occurring in Princeton, as previously mentioned, with several transactions expected to take place next year. In the greater Metropolitan Washington, D.C. area, especially in Western Virginia, we have a solid pipeline of smaller deals lined up for 2024. The situation in Waltham involves mainly expiring or vacant spaces, most of which will be accounted for in 2024. Overall, we see activity occurring across various locations, but there isn't a single major deal that would significantly alter our projections. We anticipate returning to around 88% occupancy by the end of 2024 and hope for some positive surprises with tenants potentially moving in sooner. While we are confident that leases will be signed, the timing for recognizing revenue will depend on factors like the demolition of spaces or our control over tenant build-outs, ensuring everything is ready for occupancy in 2024. Regarding life sciences, demand appears to be relatively slow. I will let Bryan talk about the life science demand in the greater Boston area, while Rod will address the situation in South San Francisco.

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

Yes. Just in South San Francisco, we have our project, the 651 Gateway building, completed, and we've done three deals in there, three, four-floor deals, and those tenants are in various stages of moving in. However, new activity has been quite slow. The few deals that are available tend to be smaller, around 10,000 to 20,000 feet, unlike the 200,000 foot deals that were available several years back. That area remains quite quiet. Nonetheless, our building is well-positioned to attract demand when it arises. We're planning to have a full floor built on a speculative basis, so we're ready to accept that tenant when they come to market. However, larger tenants are not yet present.