BXP, Inc. (BXP) Q2 2020 Earnings Call Transcript

Good morning, and welcome to Boston Properties Second Quarter Earnings Call. This call is being recorded. Operator provided instructions to participants on how to ask questions. At this time, I'd like to turn the conference over to Ms. Sara Buda, Vice President of Investor Relations for Boston Properties. Please go ahead.

Great. Thank you, and welcome, everybody, to the Boston Properties Second Quarter 2020 Earnings Conference Call. The press release and supplemental package were distributed last night and furnished on Form 8-K. In the supplemental package, the company has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Regulation G. If you did not receive a copy, these documents are available in the Investor Relations section of our website at investors.bxp.com. A webcast of this conference call will be made available for 12 months. At this time, we'd 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. These statements involve known and unknown risks and uncertainties, and although Boston Properties believes the expectations reflected in the forward-looking statements are based on reasonable assumptions, we cannot assure you that the expectations will be attained. Risks and uncertainties 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 the company's filings with the SEC. In particular, there are significant risks and uncertainties related to the scope, severity and duration of the COVID-19 pandemic, the actions taken to contain the pandemic or mitigate its impact and the direct and indirect economic effects of the pandemic and containment measures on Boston Properties and our tenants. Boston Properties does not undertake a duty to update any forward-looking statements. I would like to welcome Owen Thomas, 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'd now like to turn the call over to Owen Thomas for his formal remarks.

Thank you, Sara, and good morning, everyone. I'm joining you today from Boston Properties' office in New York, where I've been working for almost a month, and it's great to be back. Our offices in Boston; Washington, D.C.; and obviously, New York City are open. Many of our employees have elected to join their property management colleagues and return to the office. Our buildings remain under 10% physically occupied at this time, but we anticipate some increase after Labor Day, as we and our customers are anxious to safely return to work in the months ahead. Despite a challenging environment, Boston Properties continued to perform in the second quarter and beat consensus earnings by $0.02, excluding charges. We also collected 98% of our office rents, 94% of our rents overall and completed 942,000 square feet of new leases and renewals, including a 400,000 square foot new lease with Microsoft at Reston Town Center. These achievements demonstrate the resilience of our business model in a difficult operating environment. I'm particularly proud of our team's commitment to serving our customers with the highest level of professionalism that is our standard at Boston Properties. This morning, I will focus my comments in three areas: the status and timing of the U.S. economic recovery, the future of office demand and Boston Properties' pivot to offense. The recovery of the U.S. and global economies is directly tied to the course of the pandemic. COVID-19 infection rates remain at elevated levels in the U.S. as many Americans appear to be less willing to follow the health safety protocols mandated by the CDC and local governments. As a result, COVID-19 will likely linger in the U.S. and around certain regions of the world for some time. Though a second federal CARES Act would help, the U.S. economic recovery has been extended out further and will likely not be able to return to a full new normal until therapeutics or a vaccine are developed. To date, there have been significant strides made toward the development of a vaccine with multiple biopharma companies currently in Phase III trials ending in late fall. The federal Operation Warp Speed has invested over $6 billion in the manufacturing of vaccine doses in advance of full approvals. A successful vaccine is not expected to be broadly available until year-end 2020 at the earliest and more likely well into 2021. Moving to the future of the office. Much has been written and speculated about the pandemic's effect on office use, which is understandable given the high percentage of employees still working from home and the resultant low physical occupancies of office buildings. To fully evaluate what has and could transpire, you have to consider the four key drivers of office demand: employment, location, density and occupancy driven by work from home, and look at each of these factors during and after the pandemic. So starting with employment. The pandemic has created significant job losses and other recessionary effects that are a headwind for office demand in many industry sectors. Many companies are looking to cut costs, CEOs are hesitant to invest capital in new space and leasing volumes have slowed considerably. However, employment loss for office workers is 6%, which is well below the national average of 16% overall as many of the job losses were in the service and hospitality sectors. Further, economic recovery, though recently stalled, has begun with recent jobs data showing employers have reinstated in May and June over one-third of the jobs lost over the prior two months. All recessions eventually come to an end, and we are confident that new space demand will return as the economy recovers. Further, several industries, particularly technology and life sciences, are performing well through the pandemic. Boston Properties' existing assets and developments are intentionally well positioned for this customer base. Location preference is another driver of office demand, and there has been speculation about companies moving out of major urban environments to smaller, less expensive cities. To date, we have not seen evidence of this behavior among our customer base and remain confident our cities will continue to be a location of choice for talented knowledge workers and the companies that employ them. I acknowledge the challenging budget deficits large cities face as a result of the crisis are an obstacle urbanization will need to overcome once again. There's also been speculation about corporate movement from city to suburban locations. This does not appear to be true for office demand; it does appear to be true for residential demand, as housing market conditions are strengthening for commutable suburban locations. But we have yet to see evidence of companies looking to move their offices to suburban locations as a result of the pandemic. Moving to densification. This is clearly a trend that is completely reversed during the pandemic period as companies are limiting workstation occupancy and actively spreading out employees for health security purposes. Though the urgency and magnitude of physical spacing may diminish after the pandemic, we do believe a reversal of densification trends will be a tailwind for office demand longer term. Finally, work from home, a key driver of office occupancy, has been a surprisingly serviceable way to conduct business during the pandemic. But many of our tenants and other large corporates believe it is not a long-term sustainable substitute for in-person work. As time wears on, it is increasingly clear to business leaders there are widening gaps for their companies in activities such as collaboration, creativity, training, mentoring and the building of company culture, when all employee communication and connection is virtual. We have heard from countless customers and business leaders about these shortcomings and their desire to return to in-person work. Though company and business function specific, I do believe there will be greater acceptance and adoption of part-time work from home for a larger segment of the workforce as an additive tool. It may act as a headwind to office demand growth, but will not be a full replacement of the office environment. Overall, though the pandemic and associated recession are challenging office demand in the short term, we are confident office markets in gateway cities will recover their vibrancy over time. Now moving to Boston Properties' activities. Over the past several months, we have been aggressively responding to the challenges of the pandemic, including collecting rent, restructuring leases with customers in need, ensuring the health security of our employees and customers and raising capital. These activities continue, but we are also selectively and proactively investing in our future growth. We continue to invest in our development pipeline, which currently stands at 10 development and redevelopment projects comprising five million aggregate square feet and $2.8 billion in total investment. The commercial component of this portfolio is 74% preleased with aggregate projected cash yields at stabilization of approximately 7%. In June, we completed the acquisition of the site at Fourth and Harrison in San Francisco for $140 million, or $174 per developable square foot. The 500,000 square foot first phase of this project has fully completed entitlements and plans, though we are not planning speculative construction in the current environment. Last week, we entered into a joint venture with Continental Development Corporation to acquire a 50% interest in their Beach Cities Media Campus development on Rosecrans Avenue in El Segundo, California for $21 million. The site has the potential for a 275,000 square foot development, which will not commence until the project is fully designed and market conditions justify commencement of construction. This investment is the next, albeit modest, step in the growth of our Los Angeles region and shifts our attention to our core competency of office development. Given adjacencies to the very attractive Beach Cities residential areas and LAX, we believe in the strength of the El Segundo market, particularly along Rosecrans Avenue, its most vibrant district. We are excited and honored to form this first partnership with Continental, the leading property company in the local market. Both parties, who share core values, anticipate the relationship will grow over time. We also continue to monitor our five core markets and Seattle for value-added investment opportunities where we can utilize our real estate operating platform to create value. These investments are primarily being pursued with private equity partners. So far, during this recession, there have been fairly limited opportunities. I would describe the market as "in discovery mode," as transaction volumes for office assets are down 66% from the first quarter. Sellers are holding out for pre-pandemic pricing given lower interest rates and the financing market is reasonably healthy, allowing many owners to refinance. There were a small number of transactions that closed in our markets over the last quarter, providing evidence of continued liquidity and perhaps marginally higher cap rates. In Boston, a leasehold interest in 27 Drydock Avenue in the Seaport District sold for $270 million, which was $932 a square foot and a mid-5% cap rate. This 289,000 square-foot building is 97% leased and sold to a domestic pension fund and its manager. In San Francisco, the Townsend Building, which is a renovated early 1900s asset in the SOMA District, recently sold for $138 million, a little over $1,000 a square foot and a low-5% cap rate. This 137,000 square-foot building was under contract to sell earlier in the year for approximately 9% more, but the original buyer defaulted forfeiting a deposit. The building is fully leased and sold to an investment manager. And lastly, in the San Jose CBD, 160 West Santa Clara sold for $138 million or a little over $1,000 a square foot and a 5.2% cap rate. This 212,000 square-foot building was sold to a private investor through a like-kind exchange. We are increasingly focusing on the life science sector, given the strong and resilient growth in user demand. Boston Properties is already well positioned for this industry with over 3.2 million square feet of office space leased to life science tenants and over five million square feet of new development and redevelopment opportunities in Boston and San Francisco. These two markets, where we have leading office market positions, are the top two life science clusters in the country due to their proximity to important academic institutions and research hospitals and dominant market share of venture capital and NIH funding for life sciences. Finally, despite the pandemic, we continue to raise capital and upgrade our portfolio through the sale of noncore assets. This quarter, we completed the sale of a 455,000 square foot divided interest in Capital Gallery in the Southwest Washington, D.C. CBD to the Smithsonian Institution for $254 million. Boston Properties retained 176,000 square feet in the East Tower of the complex consisting of office and retail space, a parking garage and development capacity. Boston Properties will continue to provide property management services to Smithsonian, which retains various leasing and purchase rights for the portion of the East Tower not conveyed. We also completed the sale of our 50% interest in Annapolis Junction Eight, a 126,000 square foot vacant office building and two land parcels at the Annapolis Junction Office Park in suburban Maryland to a user for a gross sale price of $47 million. To conclude, 2020 has clearly been a trying period for many types of real estate due to both the recession and physical distancing requirements of the pandemic. Fortunately for Boston Properties, we have long lease terms, minimal lease rollover the next few years and strong liquidity to invest opportunistically. All recessions and pandemics eventually end, and we are confident longer term in the U.S. economy, in major cities and the importance of the in-person workplace. Boston Properties has the franchise, capital and business strategy to emerge from the pandemic with strength and momentum. So let me turn the call over to Doug in Boston. Thank you.

Good morning, everybody. So Mike LaBelle, Sara Buda and I are all sitting together more than six feet apart at our corporate office at the Prudential Center. We've been here since June 1. So we're on, I guess, our ninth week. It certainly feels a lot longer than 90 days since we had our last conference call. Sara has organized calls or group meetings with more than 200 investors and analysts since late April, and she's also put out updates on a monthly basis. As Owen discussed in his remarks, the business environment that has arisen because of COVID-19's induced economic shutdown is the thing that we are most focused on, on a day-to-day basis in our business. While we are encouraged by the government's and the life science industry's determination to test, manufacture and mass distribute a vaccine, we still have to manage the realities of the gradual ramp-up of daily activities: schools, day care, commuting, shopping, dining, leisure activities and business; the immediate damage that has been inflicted on the economy and how it's going to impact the utilization of space. The health and safety of our employees, our tenants, our service providers and our visitors continues to be first and foremost on our minds. Almost 90 days ago, we published our Health Security Plan and our assets are all positioned to provide a safe environment for workers based on CDC and local government regulations. We have had hundreds of group and one-on-one conversations with our tenants regarding their plans to bring their workforces back to the office. Our first market to remove shelter-in-place requirements was Massachusetts in late May, and in early June, the city of Boston, and we are now in Phase III in Massachusetts. However, governmental leaders continue to encourage businesses to work from home and the census in our buildings, both suburban and urban, continues to be very light. Our suburban Boston portfolio includes over five million square feet in 33 single- to six-story buildings. Virtually every tenant employee drives a single-occupant vehicle and the elevators get infrequent use. The census there is under 8%. At the moment, the return to work is not about transportation and it's not about elevators. We are seeing similar census levels in the greater D.C. and New York City markets, which have also lifted their shelter-in-place orders. While a number of our retail tenants have reopened with volume restrictions, traffic is subdued and some of the food service and other amenities remain closed. Parking utilization is up sequentially in May and June, but it is still a fraction of its pre-COVID levels, and our Cambridge Hotel remains closed. Last quarter, I described our revenue components and my remarks this morning are organized around those themes. This is our first full COVID quarter. Our office revenue continued to perform as we expected. The portfolio ended the second quarter of 2020 at 92% occupied as compared to 92.9% in the first quarter. As Owen said, collections were really good at 98%, and they were the same in April, May, June and in July. These statistics include the nonpayment of Ascena Ann Taylor's parent company during this entire period in the second quarter. Mike is going to talk about our accrued rent and our A/R charges in his remarks. I want to make one note about our reported statistics. We have a few large retail tenants in addition to Ascena that have not paid rent that were put into default and when they didn't cure their defaults, we terminated their leases. This totals over 700,000 square feet. As long as these tenants refuse to relinquish possession, we have no ability to relet their space, and we are showing it as occupied and expiring in the subsequent quarter, but we are not recording any income and footnoting these spaces as tenants in sufferance. During our last call and in the updates that we provided during the quarter, we discussed the completion of some of our large leases that got signed in Reston, 535,000 square feet; suburban Boston, a 123,000 square feet; and New York City, 35,000 square feet; they all started pre-COVID. The remainder of the activity was small leases under 10,000 square feet for the quarter. Don't lose sight that our business also includes our operating assets and our development projects. We continue to negotiate a 250,000 square foot lease for the majority of the remaining space at Reston Town Center. We've made four distinct life science and office proposals in excess of 200,000 square feet each on our portfolio of potential new development sites in Waltham in the last couple of months. Earlier this month, we made a proposal and did a virtual presentation to a one-million square foot user with a mid-2020s delivery time frame for Three Hudson Boulevard. Some long-range planning activities continue despite the current health and economic uncertainty. However, our customers are focused primarily on their employees' safety and on the uncertainty of the impact of the economic shutdown on their businesses. Facilities professionals and their brokerage advisors are showing limited interest right now and actively pursuing transactions that don't revolve around an immediate expiration since their business unit leaders have very little forecasting conviction. There are very few post-COVID new transactions that have occurred in any of our markets. Where action is necessary, many tenants are executing short-term extensions. On July 1, as an example, we completed a 110,000 square foot 15-month extension with a tenant at the General Motors Building that had an early 2022 expiration. That tenant was negotiating for a relocation and COVID-19 resulted in a reevaluation of that decision. Last week, we completed a one-year extension for a 70,000 square foot tenant at 510 Madison Avenue, extending that expiration to early 2023. Anyone that tells you they know that rents have moved X percent or that concessions are up Y dollars has no transaction volume to back up their views. It's simply a prediction. It's absolutely true that there is more sublet space on the market in all of our regions and in most submarkets; conditions are going to be weaker. There are a number of technology companies located in San Francisco and Boston that primarily serve the travel and transportation, hospitality, retail and food service industries that have seen a dramatic impact on their revenues due to the shutdown and those have resulted in large headcount reductions; again, getting back to the pandemic impacting the economy. Many of the large block additions in the inventory come directly from these companies. Some examples are Airbnb and Uber in San Francisco and TripAdvisor and Toast in Boston. However, the majority of the sublet space is in small units with short-term expirations, but it's going to impact the market. To date, San Francisco has had the largest relative increase in sublet space, while New York City has had limited space added to its availability. I want to repeat that the foundation of Boston Properties' ongoing revenues and cash flow is our contractual office lease book of business with an average lease length that still is over eight years at 8.1 years. Our baseline office revenue for the second quarter before write-offs was $600 million. The remainder of 2020 assumes virtually no additional leasing other than renewals, similar to the transactions I described earlier, a minimal contribution from the 529,000 square feet of space that we've already delivered, but where the tenant is controlling the timing of occupancy and GAAP revenue recognition. We have expected move-outs of about one million square feet with an average rent of $54 a square foot with about three months on average left. Finally, the second half of 2020 revenue figures include the six months of contribution from 17Fifty Market Street in Reston versus three months in the first half. This is the only 2020 office development that was not in 2019. So if you put all this together, we have consolidated office rental revenue contribution, including our share of unconsolidated joint ventures for the second half of 2020 of about $1.2 billion. This would translate to 2020 full year baseline revenue about 1% higher than 2019. The reopening of urban consumer brick-and-mortar retail, including fast casual and sit-down dining is going to be slow. After breaking out our financial institutions, our technology, our telecom tenants with retail operations, our remaining brick-and-mortar retail cash revenue was about $12.5 million per month pre-COVID, so about 5% of total revenue. This is made up of 275 tenants with more than 40% in the fast casual and sit-down restaurant sectors, the rest being soft goods and other amenities. During the month of July, we collected about 50% of our brick-and-mortar retail cash rents relative to their pre-COVID basis. We continue to work with our food service and our other service amenities on ways to assist them in their reopening and in many cases, we are moving to an interim percentage rent arrangement as well as cash accounting, as Mike will discuss. Retail sales are not going to get back to their 2019 levels in 2020, and we know that our retail revenue is going to be impacted into 2021. With under 10% of our tenants' employees using their space and limited retail traffic, our share of parking revenue in the second quarter was $14.2 million compared to $28 million in the comparative period in 2019. Total parking was $113 million for 2019 and $56 million for the back half of 2019. While we've seen some large sequential increases in parking in May and June, over 100% in some garages, the April base was very low and actually, LA dropped in June, given the increase in cases of COVID-19 in that market. We have not recovered many monthly parkers yet, and we don't expect to get back to 2019 monthly levels in 2020. As the population in our buildings picks up, we do expect a significant ramp up in parking as more occupants will choose to drive into Boston and Cambridge, where the bulk of our parking revenue is generated. Our apartment portfolio contributed $33 million in consolidated revenue in 2019; that's about 1.2% of total lease revenue. In-person leasing has begun in the D.C. and Boston regions, but we lost momentum in Boston as the college repopulation uncertainty has dampened demand in the market, and we have postponed the leasing at Skyline in Oakland due to the shelter-in-place orders. We're projecting only $40 million of consolidated revenue for the apartment portfolio for 2020 with an extended lease-up at the Hub50 project in Boston and Skyline projects in Oakland. All of our base building new developments have resumed, and we have been pleasantly surprised to see no productivity losses due to COVID-19 safety procedures. All the projects are on schedule for completion within our contractual obligations consistent with their pre-COVID schedules. Tenant construction is also under way across the portfolio, and we have worked through most of the potential delay issues. Here, the lack of traffic on the ground and the minimal occupancy in the buildings has actually allowed for enhanced productivity by the construction trades. We still have no clarity on the timing of the Cambridge Marriott opening. Until Marriott Corporation has visibility on a level of occupancy that can sustain variable operating costs, we're unlikely to reopen the hotel. This is a business hotel that generates the bulk of its room nights from the Kendall Square businesses and at certain times of the year from MIT-related events. The hotel will reopen and it will once again have strong performance, but it's not going to be in the next quarter. This concludes my remarks, and let me turn it over to Mike.

Great. Thank you, Doug. Good morning. I'm going to cover three things this morning: our second quarter performance, the credit write-offs that we recorded and some high-level perspective for the rest of 2020. Despite the pandemic, our core office portfolio that comprises 92% of our total second quarter revenue continues to perform well. As we expected and described on our last call, the weakness primarily showed up in our retail, parking and hotel performance. Our tenants in the retail industry continue to struggle with closed stores and reduced revenues. Many did not pay rent in the second quarter, though collections have improved, as Doug described in July, as stores have begun to reopen. We evaluate our tenants consistently. This quarter, we recorded write-offs totaling $41 million at our share. This consisted of $15 million of accounts receivable and $26 million of noncash accrued rent. The vast majority of this relates to tenants in the soft goods retail and restaurant categories as well as entertainment industries that have been hit hard by the impacts of the pandemic. Going forward, we will record income from these tenants on a cash basis. The largest write-off is $14.3 million for Ann Taylor, who leases 336,000 square feet of office space for their headquarters in Times Square Tower in New York City. Times Square Tower is a building we hold in a joint venture, and our ownership interest is 55%. Ann Taylor also leases four retail stores, one in Times Square, one in Embarcadero Center and two at the Prudential Center. Ann's parent company, Ascena, filed for bankruptcy last week. They've indicated a reorganization plan, primarily around the Ann Taylor and Lane Bryant brands. But it's not clear what their plans are for our stores or their headquarters space. They are currently obligated to pay us $15 million in annual rent at our share. The remaining $26.7 million of write-offs are comprised primarily of local retail, entertainment and restaurant concepts, which by definition, have more limited financial backing and where it is unclear we will collect unpaid and accrued rent. As Doug described, we are temporarily converting some of our restaurants to a percentage rent structure and recording rent on a cash basis as most appropriate. Just $2.3 million of this remaining write-off is related to office tenants. Our second quarter FFO results of $1.52 per share reflect these charges. Excluding the write-offs, our second quarter FFO would have been $1.76 per share, which is $0.02 per share above analyst consensus for the quarter. The results came in closely aligned with the framework that we provided on last quarter's call. We expected our occupancy to come down to 92% due to expiring leases in Reston and at the GM Building as well as the termination of a 125,000 square foot space in suburban Boston, where we have a replacement tenant coming in early next year. We executed our 400,000 square foot lease with Microsoft in Reston. They took possession of a portion of this space immediately, but 220,000 square feet will not be delivered until 2021. We completed over 200 lease modifications, primarily with retail tenants, that resulted in abating or deferring $17 million of cash rents in the second quarter. The majority of this is recognized as straight-line rent, but the expense recovery piece can't be straight-lined and results in lower income this quarter and higher income later. Our parking revenues came in at $14 million for the quarter; that represents a decline of $11 million from the last quarter due to the loss of nearly all transient parking. Doug described this and improvement in parking is going to be dependent on increases in our building population. Our hotel, which is closed, operated at a loss of $2 million, and we have no immediate plans to reopen it. As you would expect, several of our operating statistics were meaningfully impacted this quarter in concert with our COVID-19 revenue impacts. Both our same-property results and our FAD were adversely impacted from the deferral of cash rents into later periods, the accounts receivable write-offs and the loss of parking and hotel revenues. Excluding these primarily COVID-related items, our same-property cash NOI would have grown by 3% over the second quarter 2019 and additionally, our FAD ratio would have been 83%. We have included a summary of these items in our supplemental report under a new page entitled COVID-19 Impacts. Turning to the rest of 2020. We are not providing formal guidance due to the continued uncertain environment. However, I would like to provide some high-level perspectives for the remainder of the year. For office revenues, we anticipate second half 2020 revenues to be $10 million to $15 million lower than the second quarter run rate due to the lease expirations that Doug described. We wrote off $15 million of accounts receivable this quarter, primarily for tenants in the retail sector. Most of these tenants continue to be delinquent. We're completing workouts with some and others have refused to engage with us, though they remain in occupancy. We'll be recognizing revenue on a cash basis for these tenants, and we expect the second quarter run rate to continue until the retail environment improves. For our parking and hotel revenue, we expect our second quarter run rate will be a good proxy for their contribution in the third quarter. For interest expense, we expect our quarterly run rate will be approximately $4 million higher than the second quarter due to having a full quarter of our recent $1.25 billion 10-year bond issuance. And finally, at the end of June, we sold 455,000 square feet of Capital Gallery in Washington, D.C. for $254 million. The lost FFO from the sale is approximately $4 million per quarter. As you think about our earnings outlook, it's important to remember that most of our revenues are subject to long-term lease contracts with primarily large creditworthy corporations that do not expire for many years. Our share of annualized office lease revenue, excluding the second quarter accrued rent write-off, is $2.4 billion. For the remainder of 2020, only 3% of these annualized lease revenues expire and in all of 2021, just 5.8% expire. In 2021, we will get a higher contribution from the lease-up of our residential developments and contractual rent from our 100 Causeway Street development in the latter half of the year. This provides a strong base of contractual revenue during a period of likely challenging economic conditions. Our hotel operations, our parking operations and our retail portfolio are at their nadir, and we have experienced a meaningful decline in 2020. If we are not at the bottom, we're certainly close. These business units will be coming back and when they do, the revenue will flow directly to the bottom line. We're also in a strong capital position. We have $3.4 billion of liquidity that includes $1.9 billion of cash and our full $1.5 billion line of credit available. Our cash balances are sufficient to redeem our consolidated debt maturities through early 2022 and fund our entire $1.1 billion of remaining development costs in our pipeline. Our development pipeline is 74% preleased, and it's expected to contribute significant earnings growth over the next several years. That completes our remarks. Operator, if you can open the line up for questions?

Operator provided instructions on how to ask questions and opened the line for the Q&A portion.

Good morning. So I guess, Mike, just the first question is, with regards to the write-offs that you guys took and the tenants that you mentioned, how should we think about the write-offs versus tenants that are closed and bankrupt where you have to go and backfill the space? So you talked about Ann Taylor, you talked about this very small part of office and then you mentioned some tenants that refuse to leave their space. As we think about you guys collecting cash rents or percent rents from tenants, the retail and restaurants, how many of that write-off bucket are still open and you expect them to slowly come back to business versus the space that's actually closed and now you guys have to eventually recapture it and relet that?

Alex, almost all of it is open, and those tenants are just not paying. As you're probably aware, we don't have much that we can do other than start the legal process with regards to that. But our numbers and everything that Mike and I just talked about assumes no revenue from any of those tenants in 2020. So as we relet it or as they come to the table and start to pay, there's upside. But we have no sense of how long it's going to take us to move through the process.

And Alex, there's only two tenants that are bankrupt: Ann Taylor, which I spoke of, and there's also 24 Hour Fitness. We have a 24 Hour Fitness at 601 Lexington in New York City, and that's part of the write-off. It's a couple million dollars. They are going to vacate that space. We also have a unit in Santa Monica, and we're not clear what they're going to do with that space.

Okay. And then the Under Armour space, that is still money good?

Under Armour is a tenant that's paying their current rent, and they're a company that raised a significant amount of capital in the last quarter. They have a pretty significant revenue base. We believe Under Armour is a viable, strong tenant.

Okay. And then the second question is on the investment side. You guys closed on Fourth and Harrison, you announced the El Segundo JV, and you did this amid COVID. Maybe you could walk us through how your underwriting of those two projects may have changed given that you entered them versus what you previously would have considered given everything that's going on? And Doug, your comments on the pace of the office markets and sublease that's coming on?

Let me break those two apart, Alex. Fourth and Harrison is a project we've been working on for many years. We have full entitlements for the first phase, which is 0.5 million feet. It's designed and before the pandemic occurred, we were going to proceed. With the pandemic, we've put the project on pause to wait to see what market conditions are going to be. We had an option on the site. We think the value that we acquired the site for is attractive, whether it be a pandemic world or a non-pandemic world. On our additional investment in L.A., as you know, we've been talking a lot about trying to grow in LA; we've talked a lot about our perimeter, which included El Segundo. We have been looking at lots of deals there, and we've also had, frankly, a long-term conversation with Continental Development Corporation, who's our partner and the leading property company in the local market. We were in discussions on this joint venture before the pandemic. Given our interest in going to El Segundo, our relationship with Continental and our confidence— as I described in my remarks — in the return to the office business, we elected to proceed with that modest investment in the site on Rosecrans Avenue in El Segundo.

Fourth and Harrison is a project we've been working on for many years. We have full entitlements for the first phase, which is 0.5 million feet. It's designed and before the pandemic occurred, we were going to proceed. With the pandemic, we've put the project on pause to wait to see what market conditions are going to be. We had an option on the site. We think the value that we acquired the site for is attractive, whether it be a pandemic world or a non-pandemic world. On our additional investment in L.A., as you know, we've been talking a lot about trying to grow in LA; we've talked a lot about our perimeter, which included El Segundo. We have been looking at lots of deals there, and we've also had, frankly, a long-term conversation with Continental Development Corporation, who's our partner and the leading property company in the local market. We were in discussions on this joint venture before the pandemic. Given our interest in going to El Segundo, our relationship with Continental and our confidence, as I described in my remarks, in the return to the office business, we elected to proceed with that modest investment in the site on Rosecrans Avenue in El Segundo.

Your next question comes from the line of Steve Sakwa with Evercore ISI.

Thanks, good morning. I realize this is a tough question for Mike or Doug. But as you sort of took a lot of pain here in the second quarter, how should we think about what else might be out there as you move forward? I know you laid out a lot of things about hotel and parking. But are there things within the office? I know retail is smaller, but are there other leases that maybe paid but you're worried about, they paid in Q2, but they're on the fence? How do we think about other bad things that may occur, realizing it's still pretty dicey out there? How much got flushed through this quarter?

Steve, I think our office portfolio is in great shape. It's well occupied, paying and full of strong companies. The vast majority of those tenants' revenues have not been significantly impacted like the retail companies are. The vast majority of this weakness is retail. We completed a full scrub of our tenants and were very thoughtful about recording charges where appropriate based upon the credit nature of the tenants and their payment history in the last four months. That included both office tenants and retail tenants. Some tenants entered into rent deferral deals where we think it's creditworthy, so we're straight-lining that rent deferral and we expect to get that rent. We've reviewed those credits and felt confident. There are others where we said we're not so confident, so we're going to record on a cash basis. I can't tell you if there will be additional future charges or not; we don't expect there to be future charges based upon our analysis and our view. But it's not possible to fully predict the length of this pandemic or its economic impact, and that may result in additional challenges for some tenants. At this point, we feel we've done a really strong job of looking at our whole tenant base and being thoughtful about what we took.

Okay. As a quick follow-up, the $17 million you said was abated in Q2 that you believe is money good — what is the rough timetable to get that $17 million payback?

It varies by tenant. The vast majority we're getting back within the next 24 months — so it's 2021 and 2022 payback. Additionally, we extended many of these tenants' leases, and we're likely to get more because we extended leases by three months, six months, sometimes a year. We tried to improve the overall lease terms when helping out clients that had cash flow difficulties.

I realize you had about $300 million of cash sitting in escrow based on sales in Q1 and Q2. What are your thoughts on successfully 1031-ing that money in the required time frame? Or might that require a special dividend of that money?

I do not believe it will require a special dividend. Our cash flows are lower because of the loss of revenues from hotel, retail and parking, which creates room in our current dividend. Regarding reinvestment of the Capital Gallery money — about $250 million of the $300 million — we have to identify something in the next roughly 20 days for a 1031, and there's nothing we are focused on right now. So it's relatively low likelihood we'll find something for that at this point; it would add to our liquidity. The rest of the restricted cash is security deposits and similar items. The 1031 money from Q1 deals has already been invested in Fourth and Harrison. There's nothing left in restricted cash for that.

Your next question comes from the line of Vikram Malhotra with Morgan Stanley.

Thanks for taking the questions. Maybe first your comments broadly on WeWork and coworking and specifically your exposure. How do you view it today? Is there a need for any potential reserves or writedowns?

I'll talk about the industry. Given the recession and the pandemic forcing spacing, the coworking model, which is generally based on selling by the seat rather than by square foot, faces short-term challenges. Long term, we believe in the product because customers will want flexibility. We see interest in our own FLEX by BXP offering from individuals and small customers who want space quickly. Increasingly, we also see interest from enterprise customers who want flexibility for a portion of their footprint. The question is who will provide that product and who will get through this period. WeWork has a large market share, significant capital backing from SoftBank, new leadership and a chance to be successful if they manage through the pandemic.

We spoke on the first quarter call about our coworking exposure. There was an accrued rent balance associated with coworking tenants of roughly $30 million. We did a full analysis of WeWork and are comfortable with their credit based on that analysis and the liquidity and support they have.

As an industry, we have five or six different operators. We're current on almost every one of them, which is good news. We reviewed financial statements for all these operators. While short-term revenue prospects are unclear, we're reasonably comfortable we'll continue to get paid.

Okay, great. Secondly, you talked about impact from known move-outs in the back half of this year. Could you give color about move-outs over the next 12 to 18 months? Any larger spaces you're focused on needing to release? And could you clarify why Starr Indemnity fell off the top 20 list?

About 5.5% of our tenant square footage rolls over in 2021, and there are no significant tenants rolling out at that point. The largest near-term move-out is AECOM moving out of about 250,000 square feet in Princeton, New Jersey, and we do not have a backfill for that. We also have some 50,000 to 60,000 square foot tenants with expirations in Boston and San Francisco; many will likely renew, some will grow, some will shrink and some will not stay. Our ability to retain tenants often improves in economic slowdowns because companies hesitate to relocate and spend capital. That typically benefits landlords over time.

With respect to Starr Indemnity (C.V. Starr), they continue to be a tenant at 399 Park. The only reason they moved off the top list is other tenants moved up, primarily Microsoft, because Microsoft took on part of the space we leased in Reston and they moved up the list.

Your next question comes from the line of Jamie Feldman with Bank of America.

Great, thank you. Owen, you mentioned interest in Seattle and working with private equity partners on the investment front. Can you talk about both of those comments?

We have mentioned for a while that Seattle would be a market we'd like to enter if we could find the right opportunity. Similar to how we approached Los Angeles before Colorado Center, we've been speaking to the market and waiting for the right deal. We are actively looking in Seattle but have chosen so far not to act. On working with private equity, we have done this in the past with partners like Norges and CPP. The private equity market is larger than the public equity market for real estate. We're working with these partners to pursue acquisitions and extend our capital further without issuing equity. These joint ventures allow us to maintain leverage levels and can add additional yield to our capital given fees and structure. As we pivot to offense and look at value-added opportunities during the pandemic, it's likely we'll do those with private equity partners.

In Seattle, would that be life science or office that you'd be looking at?

Both.

You mentioned tenants may redesign spaces and the potential reversal of densification. Has there been talk around how they would redesign spaces? Would people still have dedicated offices or would there be more sharing?

Right now, customers are dealing with the pandemic within their existing footprints and are not spending significant dollars rebuilding. They're looking at occupancy and spacing: some of that is dictated by regulation. In open areas they're taking out workstations, adding partitions, considering hands-free doors and changing flow. We haven't seen widespread full rebuilds in a post-COVID environment yet. I do think health security will remain on workers' minds and densities will decrease in tenant build-outs going forward.

To date, we've seen nobody pulling a building permit to do anything in their offices. Tenants are evaluating expectations about how long distancing measures will last and patterns of workers. The base building infrastructure and general layout of floors are not going to be significantly impacted in most cases; furniture is often going to be the tool they use to reconfigure quickly. Many of our technology company tenants generally don't have many perimeter offices now; they have collaborative areas and conference rooms that can be reconfigured with furniture.

Has the attitude changed on sharing space with COVID? Is there a movement toward less dedicated space per person or more dedicated space per person?

Right now, employees back at work do not want to work close to one another. In open spaces especially, we've seen spacing increased to maintain at least six feet. Even in a world where COVID-19 is less prevalent, health security will be increasingly important and dense layouts are likely to be less well received for health-safety reasons.

Quick follow-up for Mike: how much did you actually impair this quarter as a percentage of total NOI? And how do you feel about dividend coverage going forward based on this lower level?

The biggest thing that affected NOI was the $15 million of accounts receivable charge-off from retail tenants, since that was expected to be paid. The accrued rent will leak in over the life of leases. So the $15 million is the primary near-term impact. Regarding the dividend, this provides an opportunity to sell some assets and realize gains which would supplement lower cash income and help maintain the dividend. We have no plans to change the dividend at this point; it's a board decision made quarterly based on outlook. We expect some significant gains this year to help support it.

Your next question comes from the line of Manny Korchman with Citi; Michael Bilerman is on the line for Manny.

Owen, at the front of the call you talked about the four independent factors driving effective office demand and rental rates. I wanted to dig in on two of them. First, part-time work from home versus declarations of full remote: even part-time, wouldn't there be some headwind from lower square footage needs? As you're making investments, what are you baking in from that headwind? How does that compare to the densification trend over the last decade? Have you put numbers around it to frame what a 2- or 3- or 4-day work week may mean for a large tenant's requirements?

Michael, regarding part-time work from home's impact, savings require employees to schedule time away and accept flexible workspaces. If employees expect a dedicated workstation when they return, there are no space savings. Many of our customers expect to have a workstation when they come in, so that reduces potential savings. Quantifying these effects is difficult, which is why I emphasized the four factors. In the short term, the recession is the dominant driver of current office market weakness. Any acquisitions we pursue will be conservatively underwritten with careful views on market rents and growth prospects, considering both the work-from-home/density balance and the recessionary environment.

Second, on location: there's been strong suburban home buying. Why shouldn't the market be more concerned with wealthy people moving out of New York to Florida or a younger generation fleeing urban markets to suburbs? Won't businesses chase employees and move to where decision-makers live?

Every business is different, but we look at the evidence. In the New York area, commutable residential locations are strong because individuals and families are considering leaving but many want commutable locations. We have not seen companies broadly relocate headquarters to suburbs; rather, employees are moving to commutable suburbs while companies continue to value urban agglomeration effects.

Your next question comes from the line of Derek Johnston with Deutsche Bank.

How is the glut of sublease space being offered in San Francisco currently affecting market dynamics from your on-the-ground vantage? Also, is San Francisco still the strongest market nationally?

It's not affecting the market yet because there are few active occupiers looking for space. It will affect the market and rents will be lower over time. San Francisco is not the strongest market in our portfolio right now; greater Boston is a relatively stronger market given what has happened to employment in San Francisco versus Massachusetts, especially because of the extensive life science community and its stability.

What regions are being considered for expansion? When you go on offense, you mentioned LA and Seattle. Are there other metros you find interesting several quarters down the road?

Our footprint today is significantly sized in four major urban areas, with a growing deployment in LA and interest in Seattle. We are actively looking in Seattle but have not acted. We're not pursuing other new cities right now. We expect opportunities in the four major markets where we already operate and in LA and Seattle as we pursue value-added investments and deploy our land portfolio and entitlements that we control.

Your next question comes from the line of Nick Yulico.

Thanks. I wanted to ask about the rent abatements and deferrals. You broke out that number which was helpful — about $17 million impact in the quarter. How much of that was related to retail versus office? And can you give more color on the deferral piece? Also, why did you include that deferral as a negative to your same-store, which seems conservative versus how other companies reported it, since you do expect to get some of that money back?

The accounting judgment: NAREIT worked with FASB to allow companies to put deferrals on accounts receivable instead of straight-lining when the deferral doesn't result in a material change in the total rent. We elected to treat our lease modifications as lease modifications — we straight-lined them — because many included extensions we wanted. We reduced cash same-store for the deferral period and will have higher cash same-store later. The vast majority of the number related to retail tenants. Most of it was deferral; only about 20% to 25% was an abatement. There may be additional deferral later in the year for some longer-term arrangements. We expect most of this to be paid back over the next couple of years and we extended many of these leases, so overall rent over the terms of the modified leases is significantly higher than just the deferral.

Second question: on the current stalemate in the office rental market with low transaction volume, when does that end? Are you or competitors adjusting asking rents or concessions yet? When will new leasing return — fall when more employees are back or 2021?

The health solution for the virus is the most critical component to when transactional activity resumes. Until people are confident about health safety, they won't be in a position to make big leasing commitments. I don't see the third quarter being terribly active from a transactional perspective. Transactions take time to germinate and consummate. New development economics may see more transactions since those are longer lead items and involve capital planning over years rather than immediate relocations.

Your next question comes from the line of Frank Lee with BMO.

Hi, Owen. You mentioned census is at 8% in your office buildings. I want to clarify if that was just suburban assets or across your portfolio? And where do you think this could go in September and heading into 2021?

We have good data for all of our CBD buildings in Boston, all of our CBD buildings in New York City and a portion of our CBD buildings in San Francisco. On any given day those buildings are running under 10%, and many days they're 6% to 8%. We see similar low census in our suburban portfolios in those areas as well. As long as governmental authorities encourage work from home, that will continue. Looking into the fall, I don't think September will bring meaningful change; maybe a modest increase from 8% to 10% or 10% to 15%, but not back to normal until the virus is more under control.

Also be aware of regulatory caps: Boston and New York are at 50% capacity rules; D.C. area is at 25%, and California and New Jersey have had different restrictions. I do hear we may see a tick up after Labor Day, but I agree with Doug that it won't be close to normal until health conditions improve substantially.

Going back to the one million square feet of expected known move-outs, do you have a sense how this figure has changed over the past couple of months?

The number was 1.5 million square feet and there's about 500,000 square feet that we believe is going to stay. So the number has declined and the leases that are known have been known for a number of months, if not years.

Your next question comes from the line of Daniel Ismail with Green Street Advisors.

Owen, you referenced this briefly, but given where the cost of debt is and with hedging costs moving lower, could we see cap rates for stabilized CBD office properties move lower once transactions resume?

If you're asking whether cap rates could move back to pre-pandemic levels, it depends on the characteristics of the building. Buildings in innovation markets with little lease rollover and strong credit tenants may hold or see lower cap rates. Buildings with more rollover and uncertain re-leasing expectations will likely see cap rate increases. So it depends on asset quality, location, lease rollover and market rent uncertainty.

As you expand more into life sciences, do you have any targets for what that could reach as a proportion of your total portfolio? What are the pros and cons of expanding more into life science versus traditional office?

Our strategy is to be in the best cities, best locations and properties that serve the most active customers. Life science and tech have strong demand for space today, and we already have a foothold with over 3.2 million square feet leased to life science tenants and over five million square feet of potential development and redevelopment opportunities across Boston and San Francisco. The company is over 50 million square feet in total, which gives scale to the potential life science allocation, but we are not providing a numeric target today. We will pursue opportunities that fit our locations and capabilities.

Finally, a housekeeping question: I noticed Leidos fell off the top 20 tenants. Is there anything happening with abatements or deferrals impacting that?

No. Leidos was in two buildings at once because they moved into their new building right at the end of the quarter while still in their old building. Now they're only in the new building in Reston Town Center. It's just a transition issue, not a change in lease terms.

Your next question comes from the line of Blaine Heck with Wells Fargo.

Thanks. On Fourth and Harrison, you said the project is on pause. What metrics, signals or hurdles are you looking for to get more confident to start that project and achieve acceptable returns?

The key will be tenant activity and preleasing. We're actively speaking with customers to prelease all or parts of that building now. The decision will be driven by observed demand in the marketplace. Construction cost dynamics will also matter and could benefit economics if costs decline.

We haven't bid a large base building project in the last three months. On larger capex projects we're seeing reductions of a minimum of 5% and sometimes more. As the construction pipeline thins, contractors and subcontractors may lower margins to win work, reducing escalation rates. We won't know for sure until we bid significant projects.

Your next question comes from the line of Tayo Okusanya with Mizuho.

Good morning. Was there any additional comment on coworking in general and WeWork in particular?

We addressed this earlier. The current environment is a challenge for coworking given spacing and recessionary pressures, but we have confidence in the coworking model long term. Coworking will remain attractive to individuals, small businesses and enterprise customers. Existing operators face a challenging period, but WeWork in particular has large market share, several billion dollars of backing, new leadership and SoftBank's support. We have a strong relationship with them and believe they have a good chance of success over the long term.

At this point, are they giving back space or doing anything of that nature?

No.

There are no further questions at this time. I will now turn the call back to the speakers for final remarks.

I think that concludes all of our remarks. I'd like to thank everyone for their attention this afternoon. Thank you.

This concludes today's conference call. You may now disconnect.