BXP, Inc. (BXP) Q1 2021 Earnings Call Transcript

Company Representatives: Owen Thomas - Chief Executive Officer; Doug Linde - President; Mike LaBelle - Chief Financial Officer; Ray Ritchey - Senior Executive Vice President; Bryan Koop - Executive Vice President, Boston Region; John Powers - Executive Vice President, New York Region; Ray Ritchey - Senior Executive Vice President; Sara Buda - VP of Investor Relations.

Good morning, and welcome to Boston Properties First Quarter 2021 Earnings Call. This call is being recorded. All audience lines are currently in a listen-only mode. Our speakers will address your questions at the end of the presentation during the question-and-answer session. At this time, I’d like to turn the conference over to Ms. Sara Buda, VP of Investor Relations for Boston Properties. Please go ahead.

Thank you. Good morning, and welcome to Boston Properties' first quarter 2021 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 Reg 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 call will be 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. Although Boston Properties believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be attained. Factors and risks that could cause actual results to differ materially from those expressed or implied by forward-looking statements were detailed in yesterday's press release and from time to time in the company's filings with the SEC. The company does not undertake a duty to update any forward-looking statement. I'd like to welcome Owen Thomas, Chief Executive Officer; Doug Linde, President; and Mike LaBelle, Chief Financial Officer. During the Q&A portion of our call, Ray Ritchey, Senior Executive Vice President, and our regional management teams will be available to address any questions. And now I’d like to turn the call over to Owen Thomas for his formal remarks.

Thank you, Sara, and good morning everyone. The BXP team is joining you today from our offices all over the country, where we are beginning to see renewed signs of life as our cities reopen with increasing activity on the street, in shops and restaurants, on public transportation and yes, even in office buildings where building census is picking up and tour activities have accelerated. U.S. GDP is growing at 4.3%. Over 1.6 million jobs were created in the first quarter. Weekly jobless claims are in decline and unemployment has dropped to 6%, only 2.5 percentage points above pre-pandemic levels of February last year. Professional service employment has remained healthy, which is important given our tenancy. U.S. retail sales surged 9.8% in March and air travel as measured by TSA checkpoint counts is up 10x over a year ago, though still only 50% of pre-pandemic level. The U.S. and global economic recoveries continue to follow the course of the virus and vaccination rollout. While new COVID-19 cases have remained sticky at around 60,000 per day since late February, all data, including three million daily vaccinations, 43% of Americans having received at least one shot and the Johnson & Johnson vaccine reinstatement, suggest the trajectory for a highly vaccinated population and fewer new infections remains positive. The U.S. economy will likely continue to surge given the financial health of most industry sectors, the significant federal fiscal stimulus provided to individuals and small business, accommodative monetary policy and pent-up consumption sparked by the pandemic reopening. This recovery is starting to bring positive momentum to the office market and BXP's result. For the buildings we can track, our census last week was, depending on the city, at or above the post-pandemic peak established last October. In the first quarter we completed 592,000 square feet of leasing, 84% of the leasing volume we achieved in the first quarter of last year and 46% of our longer-term first quarter average. These leases had a weighted average term of 7.6 years. Our leases that commenced this quarter demonstrated a 15% roll-up of net rent for second generation space. We exceeded our FFO per share forecast for the first quarter and the tenant charges we experienced in 2020 largely disappeared. More broadly, tenant requirements in our target markets in March based on data provided by VTS were up 33% versus the prior month and 51% versus the prior year; they were still down 40% from pre-pandemic levels. Office markets are lagging other asset classes because very few employers are currently mandating in-person work. That is now changing rapidly as many large employers such as Google, Goldman Sachs, JP Morgan, Ernst & Young, Facebook, Amazon, Apple and others have announced return-to-work plans for this summer. We continue to see Labor Day as a key tipping point for employees returning to the office, with forecasts of low COVID infection rates, high vaccination levels, the end of summer and schools reopening. We hear repeatedly from our clients, as well as in interviews we have completed with large occupiers, that the key to future success and competitiveness is to successfully reintroduce in-person work. Unlike most recessions, most of our clients are thriving and have not reduced headcount. In our leasing activity and renewal conversations with clients, we have not seen material reduction in space requirements. Now, moving to private equity market conditions — there were $15 billion of significant office asset sales in the first quarter, though volumes were down 37% from the first quarter of last year. Assets with limited lease rollover and anything life science-related currently receive the best pricing, often better than before the pandemic. There were again several deals of note completed in our markets, including in San Francisco, the Exchange on 16th located in the Mission Bay district sold for $1.1 billion or $1,440 per square foot, a record price per square foot in San Francisco and it represented a 4.9% cap rate. This 750,000 square foot recently developed building is 100% leased to a tenant trying to sublease the entire building. The asset was sold to a fund manager which may attempt a life science conversion. In Seattle, 300 Pine, the Macy's building, sold for $600 million or $779 per square foot at a 4.4% cap rate. The majority of the 770,000 square foot asset was recently converted to office space, which is 100% leased by Amazon, and the remainder is undergoing further renovation. The building was purchased by a joint venture between a fund manager and a real estate operator. And in midtown Washington, D.C., a 49% interest in Midtown Center was sold to an offshore buyer. The building comprises 870,000 square feet and is substantially leased to Fannie Mae as its headquarters. The gross sale price was $980 million, $1,129 a square foot and a 4.7% cap rate. Moving to BXP investment activities, let's start with our growing life science business. BXP currently has over 3 million square feet leased to life science clients, approximately 2 million square feet of current and future office-to-lab conversion projects and sites for approximately 4 million square feet of life-science ground-up development, primarily located in among the strongest life science markets in the U.S., namely Cambridge, Waltham, and South San Francisco. We recently received 1 million square feet of new entitlement at Kendall Center in Cambridge, and our joint venture at Gateway Commons is in discussions with local authorities in South San Francisco to increase entitlements by 1.5 million square feet. We had a very active first quarter launching three new lab development and redevelopment projects: 180 CityPoint, a 330,000 square foot ground-up development and part of our larger CityPoint campus in Waltham with strong visibility from I-95; 880 Winter Street, a 224,000 square foot Class A office asset we acquired in 2019 for $270 a square foot and will redevelop into a lab building; and 751 Gateway, a 229,000 square foot ground-up lab development as part of our Gateway Commons joint venture in which we own a 49% interest. Though all three projects are being commenced speculatively, we are seeing many new life science requirements in both the Waltham and South San Francisco markets and have made multiple lease proposals to potential tenants. A large portion of our active development pipeline is now lab and currently comprises 920,000 square feet and $560 million of projected investment for our share with projected cash yield at stabilization of approximately 8%. BXP has a rich history of success serving the life science industry. We have the land and building inventory in the strongest life science clusters in the U.S., as well as the execution skill and client relationships to make life sciences an even more meaningful component of our overall business. Moving to the balance of our development pipeline, we delivered into service this quarter 159 East 53rd Street with 195,000 square feet of office fully leased to NYU, as well as The Hue which will open after Labor Day and serve as the unique culinary amenity for our three-building 53rd and Lexington campus. We remain on track to deliver our 100 Causeway development in Boston later this year which is pre-leased to Verizon, and we have four additional significant projects later to deliver in 2022. This pipeline is 86% preleased with aggregate projected cash yield at stabilization projected to be approximately 7%. To maintain our external growth in addition to adding the three life science projects, we are also investing approximately $182 million into an observatory redevelopment project on the top of the Prudential Tower in Boston. When complete, the observatory will have three levels, comprise 59,000 square feet and will be a world-class attraction featuring both indoor and outdoor 360-degree viewing decks, as well as exhibit and amenity spaces. The project will be the only observatory in Boston and we expect it will generate strong returns to BXP after delivery in the spring of 2023. Net of all these movements, our active development pipeline currently stands at 10 development and redevelopment projects comprising 4.3 million aggregate square feet and $2.7 billion in total investment for our share. We expect these projects, along with the lease-up of two residential buildings delivered in 2020, as well as 159 East 53rd Street, to contribute 3.5% of annual external growth to our NOI over the next three years. We continue to actively pursue value-added acquisitions in our core markets and sovereign investors have continued to pursue partnerships. To enhance our financial resources, execution speed and return, we have reached an agreement with two large-scale sovereign investors to pursue select acquisitions together. The partners including BXP will commit up to $1 billion and will have the opportunity to invest one-third of the equity in each identified deal at their discretion. BXP will provide all real estate services and has agreed to commit its acquisition deal flow to the partnership subject to specific carve-outs. We believe this venture with approximately $2 billion of investment capacity provides us the financial resources and return enhancement to be an even more nimble and competitive participant in the acquisitions market. We will announce the completion of the partnership, including the participants, once documentation is complete, likely in the next month. Moving to dispositions, we recently completed the sale of our 50% interest in Annapolis Junction Buildings Six and Seven, our last two remaining properties in the Fort Meade, Maryland market. The buildings totaled approximately 247,000 square feet and sold for a gross price of $66 million, which is $267 a square foot. We have under contract three buildings in our VA-95 business park in Springfield, Virginia for a gross sale price of $70 million, and we also have under letter of intent the sale of several stabilized suburban buildings for approximately $190 million. Additional asset sales are being evaluated and we believe our gross disposition volume in 2021 will exceed $500 million. To conclude, BXP is emerging from the COVID-19 pandemic with strength and momentum. Leasing volumes and requirements are rising; office collections exceed 99%; our clients are healthy if not thriving; tenant credit charges have largely disappeared; our $30 million per quarter of lost variable revenue is poised to return with offices reopening. We've launched new life science development. Our active development pipeline is expected to deliver strong external growth and we've raised a war chest for new acquisitions to add even further growth. I remain confident in both our near-term and long-term growth prospects. I turn it over to Doug.

Thanks Owen. Good morning everybody. I'm going to try and give you my best shot at describing the operating environment that we are seeing in our portfolio as we sit here in late April. As Owen said, office tenants are deep into planning for their return to the physical in-person work environment as we approach the back half of 2021, and while there are lots of announcements as Owen said of relaunches and our building census is up, we are still at pretty low levels, and I think you can see that most clearly from a financial perspective when you look at our monthly or daily parking, which was basically flat in the first quarter compared to the fourth quarter of 2020. Although just yesterday, as an example, at our meeting for our California parking operations we had 67 requests for additional monthly spaces, 42 of which were hard commitments. To give you perspective, we actually locked more than half of our monthly parking — over 800 monthly spaces in the market area, so things are picking up. When we spoke to you late in January, we said that the first half of 2021 was going to have a low level of market leasing activity as defined by executed leases and that statement still holds. The reports that are published by the commercial brokerage organizations describing broad market conditions and all the calls that are sponsored by the analysts that follow our sector really didn't have any surprises in them. Leasing volumes are up at their historical pace, there was modestly more sublet space which was added to the market and that translated into some negative absorption and increased availability — no surprises, no shocks. Last quarter, I described the dynamics around sublet space, particularly opportunistic sublet space. This is when tenants are listing their entire premises, often expecting to decide what to do if they actually get an offer down the road. But the reality when push comes to shove is that tenants may reoccupy, they may relocate and transact, and then they find a way to sublet a portion of their space, but not the whole space. I'll give you a couple of examples. In Boston we had a 50,000 square foot tenant, two floors in our CBD portfolio, list their entire space. They successfully sublet one floor and then they pulled the second floor off and they are reoccupying in July. We completed a long-term, fully furnished sublet in Mountain View in Silicon Valley and the user began to negotiate on a sublease, but when the prime landlord refused to agree to recognize the sublease, the user quickly walked away and took direct space. So I'm not going to downplay the fact that there is a lot of sublet space on the market, but a large portion of it is not accessible because of short-term, unworkable existing conditions or quite frankly the user discomfort with the lessor's profile. And when you ask what percentage, I don't know, but it's meaningful and yesterday JLL came out with a report saying there was about 1.5 million square feet of New York City sublet space that was pulled from the market by those subtenants. Now the headwind from sublet space is going to exist, but it's going to dissipate as companies return to in-person work. Obviously we are also confronting the caution that some organizations are facing as they work through how they move beyond having their employees working from their homes and only interacting on video calls that are typically scheduled days in advance. This may delay decisions to increase space needs, even though companies have hired more staff as Owen said during this COVID shutdown and now as the economy is reopening. This backdrop is obviously going to add some more short-term pressure on lease economics in some markets. It's not going to affect all markets in the same way, and it's certainly not going to impact all the buildings in those markets in the same way either. The potential impact on pricing from sublet space and work-from-home makes a dramatic commentary, but it's not going to be driving Boston Properties' results. I hope the following analysis will illustrate that point. So the average gross rent on our expiring office space portfolio in 2021, 2022 and 2023 — so the next almost three years — totals about 5.8 million square feet, and the average expiring rent is about $65.50 per square foot. So if you believe that pre-pandemic market rents on that space were $70 per square foot, and I'm just using that as an example, and you wanted to measure the impact of some kind of decline — let's use 10% as an example — then you would get to about a 4% roll down in rent or $2.50 per square foot or approximately $4.8 million per year over three years. That's it; that's the impact of the decline in rents on our portfolio from weak conditions. And as a point of reference, the change in second generation gross lease rent this quarter was positive 9.5%. Now that's a deal that started and was signed prior to this quarter. As I go through my remarks, I'm going to talk about where rents are on spaces that we physically signed leases on this quarter, or that we are working on now, and how those rents compare to existing in-place rents. So that’s it for my remarks on the Boston Properties portfolio. I'm going to describe our level of activity and I think it's going to be counter to the weak macro market conditions that you're hearing about in macro reports. So let’s start with our occupancy. Our in-service portfolio occupancy which includes 100% of our JVs ended the quarter 140 basis points down or 640,000 square feet. Now 50% of that space that was added to our vacancy this quarter provided no revenue over the last 12 months; that is, it was space that we were trying to recapture from defaulting tenants. In other words, much of this drop in occupancy doesn't reflect any future revenue decline. This includes the Lord & Taylor box at the Prudential Center where we are in active discussions and expect a dramatic increase in the revenue from that space. The office space that was given back by Asana at Times Square Tower and their retail outlook is a branch of that. Next quarter we are going to have another one of these as we take back the ArcLight Cinema space since they officially ceased to operate. That’s a 66,000 square foot lease at The Hub on Causeway joint venture, and again, they never paid rent. Also this quarter, we took back 62,000 square feet in a recapture so we could expand a growing tenant that we are negotiating a lease extension on at Colorado Center, but that lease hasn't been executed yet so the space is in vacancy. We did have one disappointment, which was the 200,000 square foot departure at the Santa Monica Business Park. However, today as I sit here talking to you we have 640,000 square feet of signed leases that have yet to commence and they are not included in our occupied in-service portfolio. Unless we're actually booking revenue we don't consider it occupied. On a relative basis, my view of the leasing activity in our portfolio — active lease negotiations, tours, RFPs — is as follows from top to bottom: Boston (we don't really have any space in Cambridge so I don't include that), Midtown Manhattan is second, the San Francisco CBD is third, Northern Virginia is fourth, followed by the Silicon Valley peninsula, West Los Angeles, Princeton and the D.C. CBD. All the transactions I am going to describe to you are post-COVID negotiations having begun in the latter half of 2020 or in 2021. So let’s start in Boston, which by the way represents over a third of the company's total revenue. During the first quarter in the Boston CBD we did five leases totaling 37,000 square feet and in every case the starting rent represented a gross rent roll-up between 12% and 25%. We continue to have additional activity in the CBD portfolio, albeit with a preponderance of smaller tenants as we don’t have much in the way of lots available, and we are working on eight leases totaling over 60,000 square feet. Of the 30 leases we have done this quarter or in the works, none of those customers are contracting and five are expanding and more than doubling their footprint. In the suburban portfolio, we completed 124,000 square feet of new leasing. The cash rent of those leases was up by 50%. We continue to have additional activity in suburban Boston. In Waltham we are negotiating six more transactions totaling over 60,000 square feet. In the suburban portfolio, we have had some existing tenants expand and some contract, but we will be gaining occupancy with new tenants coming into the BXP portfolio like our new tenants at 20 CityPoint and 195 West Street in Waltham; again those leases haven't commenced yet. Life science demand in Waltham continues to accelerate. We announced our plans to reposition 880 Winter Street in early March and it has had significant tour activity and we have begun making proposals. This 224,000 square foot building will be available for tenant build-out in the second quarter of 2022. In New York, since the beginning of the year we've had more physical tours than we had in the comparable period in 2020 and in 2019. We completed three leases during the quarter totaling 38,000 square feet, including a full floor expansion by a tenant at 399 Park. In total, the gross rents on the space were about 5% higher than in-place rent. Now I said New York City is our second most active region, and we're negotiating 14 office leases totaling over 170,000 square feet, including a full-floor lease at Dock 72 in Brooklyn. We also have two other active proposals to Dock 72, each in excess of 100,000 square feet. The majority of these New York City leases will be full term in excess of five years and more than half of those tenants are new to the portfolio. We had one midtown tenant pull their space off the sublet market and another large tenant that still has its entire space listed has begun to repopulate. Five of the 14 active deals represent tenants that are negotiating expansions. Activity at the street level of our buildings is also picking up. When negotiating leases for food outlets at our 53rd Street properties we are eagerly anticipating the opening of The Hue Culinary Collective at 601 Lexington later this year, and we have a new lease negotiation for our vacancy on the street in Times Square Tower. In Princeton during the quarter, we completed four transactions and we executed a fifth at the beginning of April for a total of 28,000 square feet and we're negotiating leases for another 29,000 square feet, all with new tenants. Activity in the D.C. region was light during the quarter with only 50,000 square feet of office leasing. But as the calendar moved to April, we signed another 170,000 square feet; 210,000 square feet of total leasing was completed on currently vacant space and included two large leases at Metro Center in the district and an expanding tenant in Reston Town Center. We have another 68,000 square feet of leases in process in the D.C. region, including 25,000 square feet in Reston from another expanding tenant. Town Center rents are basically flat to slightly down 1% to 2% since the re-let rents have been adjusted by the fact that the current rents have been increasing contractually by 2.5% to 3% for the last five to ten years. I would also note that retail activity in Reston has picked up. We have now opened four new restaurants since November 2020. We are negotiating leases with new food outlets totaling 27,000 square feet; they are going to open in 2022. Pedestrian activity in Reston Town Center is active. California has finally begun to reopen and allow for higher levels of office occupancy, although it's still way behind the rest of our markets. During the quarter in Embarcadero Center, we settled rent arbitration on two multi-floor five-year extensions, and completed another 10-year full-floor renewal. The markup on these three deals totaling 125,000 square feet was 46%. Tour activity for small tenants under 10,000 square feet has picked up and grown about 40% sequentially month-to-month from January to April. I would characterize half of our San Francisco CBD activity as with expanding tenants and half with tenants that are contracting. The uncertain level and the lack of pedestrian activity at the street level, particularly in the CBD of San Francisco, has been more severe than anywhere else in our portfolio. This has affected tenants’ appetite for making any decisions. But large tenants have started to begin to look for space. There have been a number of tours on high-quality sublet offerings in the market. We see activity in the proposals on the available sublet space we have at 680 Folsom. In South San Francisco, we signed a lease of 61,000 square feet at 601 Gateway; that's going to absorb about 50% of the exploration that’s going to occur in the second quarter. We are underway at 751 Gateway, our first lab facility development in South San Francisco and have begun responding to proposals for this early 2023 delivery. 651 Gateway will be taken out of service in the second quarter of 2022 when the final tenant vacates and we will commence a lab conversion of that 293,000 square foot building. In Mountain View we continue to see a constant flow of medical device, alternate energy, battery storage, automotive and other R&D users looking for space. We are in renewal discussions with 24,000 square foot tenants and have commenced lease negotiation with a second tenant for 30,000 square feet on market-ready vacant space and we have a tenant ready to go on a remaining floor of 18,000 square feet at 244. There are some large tech tenants in the market in the valley today looking for expansion space and we are certainly chasing those tenants if the timing were to match for our potential delivery at Platform 16. In spite of the challenging COVID conditions in California, in Santa Monica we continue our renewal negotiations with the 260,000 square foot tenant at Colorado Center and as I said at the outset, we recaptured about 60,000 square feet that's going to roll into that tenant expansion. We’ve also signed a lease for 72,000 square feet at Colorado Center with Roku who's new to the portfolio. As you may recall, earlier late last year we did an expansion with a tenant at the Santa Monica Business Park. So to summarize, the takeaway from my comments: it's true that market fundamentals are weaker than they were a year ago, but what drives our same-store portfolio performance will be occupancy pick-up as well as the return of our parking income and the recovery of our retail activity and revenue. There are tenants in our portfolio that are expanding in every one of our markets. Conditions are going to vary dramatically by submarket. Rents may or may not decline depending upon the submarket, but we will still have embedded markups in our portfolio. There will be a flight to quality as better buildings see more tenant demand and tenants value paying less of a premium to be in the best assets, which should initially improve our occupancy. Let me turn to Mike.

Great, thanks Doug. Great summary. Good morning everybody. I'm going to start my comments this morning with a few pieces on our activity in the debt capital markets. We had a very busy quarter and it impacted our results. As we guided last quarter, we redeemed $850 million of our expiring unsecured bonds that had an above-market coupon using available cash. In addition to that, and not part of our prior guidance, we issued another $850 million of new 11-year unsecured green bonds at an attractive coupon of 2.55%. The proceeds were used to repay our $500 million unsecured term loan that was due to expire next year, and we redeemed at par an expensive $200 million 5.25% preferred equity security. We incurred non-cash charges during the quarter of approximately $7 million or $0.04 per share related to writing off unamortized financing costs. Our next bond expiration is not until early 2023 when we have $1 billion expiring at an above-market interest rate of 3.95%. In advance of that, in early 2022, we have a $626 million mortgage expiring on 601 Lexington Avenue in New York City. This loan also carries an above-market interest rate of 4.75%. So turning to our earnings results for the quarter, for the first quarter we reported FFO of $1.56 per share; that was $0.001 above the midpoint of our guidance range. The variances to our guidance were comprised of $0.04 per share of higher NOI from the portfolio and $0.001 per share of higher fee income, partially offset by the $0.04 per share non-cash charge related to our refinancing activity. The portfolio NOI outperformance included $0.02 per share of lower operating expenses during the quarter, much of which will be incurred later in the year. On the revenue side, we collected delinquent 2020 rent from several of our retail tenants, whose rents are being recognized on a cash basis. These collections drove a significant portion of our $0.02 revenue beat. As we described last quarter, we believe the vast majority of our tenant credit charges are behind us. Our net write-offs this quarter were immaterial and collections from our office clients continue to be consistent and very strong. We provided guidance for the second quarter of 2021 FFO in our earnings release of $1.59 to $1.61 per share. At the midpoint, this is $0.04 per share better sequentially from the first quarter. The expected improvement is from lower seasonal G&A expense and the cessation of preferred dividends from our redemption; also the first quarter financing charges are not expected to recur. Partially offsetting this, we project lower termination income in Q2 and as Doug explained, our occupancy declined by 140 basis points this quarter, which was expected but results in a sequential drop in portfolio NOI from the half that was paying rent before. We expect another drop in occupancy next quarter followed by a modest improvement in the back half of the year. Doug described 640,000 square feet of signed leases that have yet to commence occupancy. Four hundred sixty thousand square feet of this will take occupancy later this year, representing over 100 basis points of occupancy pick-up. While we're still not providing full-year specific guidance given the uncertainty and timing of our ancillary revenue streams, we did provide you with a framework for 2021 in our last call. As you revisit your models for the full year, there are three other changes to consider. First, our financing activities during the first quarter have a net impact of increasing interest expense, about $5 million for the year. Second, we have a loss of rental revenue from taking 880 Winter Street out of service for redevelopment into a life science facility, which has a negative impact of about $2 million. And lastly, the additional $260 million of dispositions that Owen described are expected to result in the loss of about $7 million of NOI. In aggregate these items are expected to reduce FFO for the rest of 2021 by approximately $14 million or $0.08 per share. Looking further ahead to 2022, we’ve made substantial investments in prelease developments that will drive earnings growth. We anticipate delivering 100 Causeway Street in Boston and 200 West Street in Waltham late in 2021, representing $315 million of investment at our share that is collectively 95% leased. The contribution from these two development deliveries will not be significant to 2021, but they will be at a full run rate in 2022. The bulk of the remaining pipeline is projected to deliver in 2022. This includes our building for Google in Cambridge, Reston Next for Fannie Mae and Volkswagen, and the Marriott headquarters at 2100 Pennsylvania Avenue. This represents delivery of $1.7 billion of investment in 2022 at our share, and 2.7 million square feet that is currently 85% preleased. This $2 billion of investment in conjunction with the recovery of our ancillary income sources and improved leasing activity post-pandemic sets us up for occupancy improvement in a period of solid future earnings growth. With that, I would like to turn the call back over to Owen.

Thanks Mike. Before we take questions, there are just a last couple of things I'd like to mention. Last week on Earth Day we published our 2020 ESG report, where we made several important commitments, and those include: we set a goal to achieve carbon neutral operations by 2025. In addition, BXP had previously set a carbon emissions reduction goal in line with the most ambitious designation available under the Science Based Targets initiative. In 2020 BXP was one of six North American real estate companies with this distinction and the only North American office company. We also established a new board-level sustainability committee to increase board oversight of and input for our sustainability issues. Lastly, we launched an internal diversity and inclusion committee last year with the mission of pursuing greater diversity among our workforce and vendors, as well as new programs supporting diversity and fairness in our community. BXP is proud of its consistent recognition as an industry leader in sustainability and ESG, an area increasingly important to our clients, our community, capital providers and employees. And then lastly there's one important milestone that I want to mention. This will be Peter Johnston’s last earnings call as he's retiring from Boston Properties next month after 33 years of service. Peter’s been an outstanding leader in our Washington, D.C. business and he will be greatly missed by all of us. Thank you very much Peter. Operator, we're ready for questions.

The operator provided instructions for participants on how to ask questions. Your first question comes from the line of Alexander Goldfarb with Piper Sandler.

Hey, good morning. Mike, I guess just going to the guidance question. In the last quarter you talked about sort of an unofficial $6.52 when you took the run rate and then made changes for the dispositions and the other items, and that would suggest then 2010’s pickup with the second half of this year, but you just outlined about $0.08 of negative that is incremental to that. So is that $6.52 sort of now $6.45-ish type number or is there some other things that may impact where we should be thinking about where this year will end up?

So that was the reason I described that $0.08 — because these are new things that happened this quarter that we didn't project in our prior guidance, which was not the payout of the larger bond that we have, but the new bond that we issued and then the sale of certain assets. So yes, I want to describe those FFO drops for later this year. Now, we’ve given some guidance for the second quarter and it does show that we will have pick-up later in the year. We expect to have a further drop in occupancy in Q2, and if you look at our rollover schedule, about 60% of the main rollover for the year is sitting in Q2. So Q3 and Q4 have very light rollover exposure, so we do expect to have some pick-up in occupancy and revenue in the back half of the year from that leasing activity, and we would expect occupancy by the end of the year to be somewhere between 88% and 89%. And then as I also said, we had 460,000 square feet signed that was going to occupy this year, so that’s part of that number. So the improvement in the back half of the year is coming from a combination of some occupancy improvement from Q2 through Q4, we also expect our parking to start to improve — as Doug mentioned, we're starting to see some green shoots with the parking — and then we have a couple of development deliveries that I talked about that will provide revenue later in the year. Those are the things that would pick up in the back half.

Okay. So with that Mike, the negative $0.08 that you mentioned right now, and that you're hoping for a positive recovery on the ancillary deposits, etc., it sounds like we’re still sort of probably in the upper $6.40s, maybe $6.50s. It's sort of mentally how the street could be thinking about it.

Yeah, I think the street should be thinking about it as, you know, we feel good about the ability to improve in the second half of the year, but there are already sales that we're going to have. So it's going to be down from what I told you last quarter.

Okay. The second question is — and you didn't mention the MTA site in your prepared remarks. Certainly there seems to be a lot more interest around Grand Central, especially with the coming of the East Side Access and the ease of commuting. You got the Hyatt project, whatever we know there as the 350 Park, then obviously your site numbers got to like probably one or two others that people try to cancel. Maybe if you could just give an update on how in your tenant discussions, how anchor tenants that you guys will be after are thinking about taking — potentially anchoring one of those projects.

John Powers, are you on the line?

I’m on the line, Owen. First, let me say we're very excited about the MTA site — it's a terrific site. It's a better site now than it was a couple of years ago and it'll be a better site in four or five years than it is now with JP Morgan finishing nearby. We're entering a new review loop, so we have to go through the process. We don't know how that will come out. We have to go through the whole community board process to find out how big the building will be. We’ve drawn it a certain way and we're very excited to present it. This is going to be quite a few years out from now, so we're not talking to any tenants yet.

Yeah, I didn't mention it Alex just because of the time frame, but we're very excited about this site and we think the Grand Central hearing environment is improving.

Okay, great, thank you.

Your next question comes from the line of Nick Yulico with Scotiabank.

Thanks. Good morning everyone. I appreciate all the commentary on the rents for the leases signed in the quarter. I wanted to see if you could give us a feel for what the blended gross rent number was — the increase for the quarter on the signed, not executed leases. And then also maybe if you could give us a feel for how that number would be different on a net effective basis, given we continue to see face rents are down less than net effective rents.

So Nick, I don't have that blended number at my disposal here. The numbers are obviously up. I described some that were up 5% and some that were up 50%. This quarter there happened to be a lot more leases that we executed that were up 50% than those at 5%, so the blended number will skew up. With regards to net effective, none of the transactions that we have been working on have had much in the way of significant changes in either free rent or TI allowances. I would say we've been building more space, but we were building more space pre-COVID, so there hasn't been a pickup in the cost of space, particularly on the TI side that we've seen yet, which is good. So I don't think that has really impacted where our results are showing on a relative basis from nine months ago to where we are today.

Okay, thanks. My second question is on the topic of unassigned seating plans. We have seen examples in your portfolio, but in the New York City market we’ve got some tenants moving increasingly to unassigned seating or space-per-desk changes — space per employee maybe going down because people won't have a fixed desk. I guess I'm wondering in your portfolio if you're seeing any examples of this, and what your thoughts are on this topic.

Let me give a quick comment. First of all, I have a whole host of expanding tenants in our portfolio and particularly on the smaller side; they are not making any changes to the way they are utilizing their space. Most of those smaller tenants are in the financial asset management and professional services sector and they are building perimeter offices and larger workstations. Everyone is getting workstations and nobody is sharing desks. So there's a significant component of the market in terms of transaction volume that is in that sector. The larger tenants have a whole spectrum of approaches. We had a tenant that took 75,000 square feet of space in Waltham and they basically said they're not putting a workstation in for every single person in their organization who lives in the Boston area; they expect some people will work from home. I have a daughter who is working for a tech company in New York City and their mandate was if you're not prepared to work X number of days per week, you're not getting a permanent workstation and you're going to have to use hoteling. Owen has had conversations with some of the larger technology companies across the country and they have a very different perspective.

A lot of employers are trying to accommodate workforce preferences and that includes flexibility, but if you look at several surveys, notably by some workplace research firms, a majority of respondents still want a fixed workstation. Also, many would not trade a fixed workstation for another benefit. And with COVID concerns, sharing desks is less attractive. So while some employers will adopt hoteling or desk sharing, I'm not sure it's going to be a big wave right away.

I've heard a lot about this in discussions, but I can tell you in our portfolio in New York, not a single tenant has pulled a building permit to make any changes to their space related to COVID. We have almost 1 million square feet under construction during COVID and there was not one change order made by any of those tenants to adjust plans pre-COVID while under construction. So I think this is a lot of wait and see. It takes a lot of capital to make the adjustments that people are talking about.

Thank you.

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

Thanks, good morning. Mike, I wanted to try and piece together a couple of things you talked about when you're going through guidance and through the bridge from 1Q to 2Q. You guys talked about occupancy being down, but not all of that was cash-paying occupancy. So I wanted to figure out what the lost revenue moving into Q2 is, and you talked about rents being collected related to 2020 rent. It sounds like that might have been a one-time pick-up. I'm trying to think about those two as we move into the next quarter.

I agree with you Steve that some of the retail rent collections in the first quarter were more one-time. We had both clients paying us for delinquency and we had termination income in the first quarter that we don't expect to repeat. Our termination income was about $4.5 million for the quarter, so that's above normal. I would say about half of the occupancy we lost in the first quarter was space that had not been paying rent in 2020, so that explains part of the decline. There is probably about a $0.03 to $0.04 quarter-to-quarter impact on portfolio NOI from that, and then a couple of cents related to termination income. Overall we're sequentially up and we think the second quarter should be the bottom with exposure to rollover significantly lower in the last two quarters of the year and with signed leases coming on.

Got it, thanks. And second, I know it's a little far out, but about the observatory, how did you think about the underwriting for that as you thought about visitors and the expense load? I know other operators have observatories — how did you model that revenue and expense structure?

Steve, at this point it's an estimate and a projection. We obviously don't have observatory experience in Boston that we can point to, but we do have several in New York and we took a conservative view on the number of visitors relative to New York City visitation. We have a price point that's lower than the price points in New York, and we have a long ramp up. We looked at destinations like Duck Tours, The Freedom Trail, The New England Aquarium, The Science Museum and the Museum of Fine Arts to triangulate a range of where we might start and where we might get to. There is an expense load that we will ramp up or down depending on volumes, and we don't expect to be cash flow positive in the first six months of operations, but over time we believe it will be productive and a unique offering in Boston. The observatory will have both indoor and outdoor experiences and can capture significant visitor traffic.

Some additional items that went into our modeling were service providers and consultants who operate several observatories globally and provided advice. We also had historic numbers from Boston's prior observatory experiences, plus the Hancock Tower historically. We reviewed peak daily pedestrian traffic counts at the Prudential Center and estimated capture rates. We also met with the city last week and received enthusiastic support from the mayor's office and state officials.

As a quick follow-up, do you expect this to be a double-digit return on capital or maybe not quite that high?

I would hope it starts out in the low single digits and over a couple of years works toward double digits. We will have to make additional capital investments if we get the traffic we expect, but it could be a substantial opportunity for revenue and net income for the company.

Your next question comes from the line of Manny Korchman with Citi.

Just in conversations with you and other landlords and brokers, there's commentary that tour activity is up but leases haven't actually been signed and occupancies have dipped. Is that tour activity tenants potentially exploring and just changing their space within the market, like going to open houses, or is there a more fruitful result and it just hasn't closed yet?

I want to ground you in the timeline. When we spoke in late January we were into the last COVID wave. We are 60 days from that and probably 40 days out of the worst from a virus perspective. It takes time for leases to get signed. That's why we said first quarter activity would be low. We are seeing a lot of activity now, including many expanding tenants and tenants looking to upgrade their facilities. There is a lot of 'musical chairs' with space — some tenants will relocate and that creates availability and opportunity. But the tours we're seeing are very specific requirements; they are not casual open-house visits. They often include clear square footage requirements and are part of serious sourcing processes. So while not all tours will immediately turn into signed leases, many are high-quality prospects.

Great, I appreciate that. And on the acquisition partnership, is the venture targeting value-add type deals rather than core low-cap-rate assets? How do you see the target asset profile?

We're not targeting core assets at low cap rates as our main goal. We're a property company; we want to use our real estate skills to create value. We'll target assets that need to be reimagined, repositioned or simply leased up. We'll be a major co-investor and the sovereign partners like the plan. Most transactions in the market today are core because they are easier to trade, but our pipeline of value-add deals is growing and we've seen more of these opportunities recently as some owners want to sell after the pandemic. The initial allocation for the venture is $1 billion of equity capacity reserved by the investors; this is not a committed fund, and leverage will be considered on an investment-by-investment basis and is anticipated to be roughly 50% at the property level.

Great, thanks very much.

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

Great, thank you and good morning. I wanted your thoughts on co-working and flexible space providers across the markets as tenants think about coming back. How do you think those users or space providers will fit into plans and has that viewpoint changed?

I think there will be demand for shared workspace product going forward. There will be demand from individual users, small companies, and large occupiers who will want to procure a small percentage of their space on a flexible basis and will pay a premium for it. There's plenty of product in the market created by co-working operators and there is also landlord-offered flexible product. I think demand will come back, though the offering mix may evolve.

You realize Jamie there's a flexible operator 2.0 happening where large brokerage platforms and institutional owners are partnering with operators. There seems to be a change toward a service-focused offering versus the old arbitrage model. The big question is how profitable this business can be, particularly given density and build-out costs. We'll see how the economics evolve once existing supply fills up.

Doug and Bryan hosted a property management seminar with groups of our top tenants — professional services, law firms, tech and others — and posed the question whether co-working plays a role in their future space needs. Every single one said yes, co-working does have a role in meeting their future needs. That feedback is directly from the user community.

Do you think from a BXP perspective those types of tenants will grow on the portfolio or do you think you just need more flexible leasing structures to compete for larger tenants?

First, we expect demand to increase and there is a lot of currently vacant flexible space out in the market that will get refilled. The interesting question is whether the economics will support building more flexible inventory once existing product is full. That outcome will determine whether the flexible space footprint expands materially in the future.

We're seeing a flight to quality in co-working which benefits our portfolio. In most of our markets, the best co-working experiences are in our Class A buildings. Less attractive co-working offerings may go away and the best options will consolidate, which should be good for our assets.

Thanks for the color. You had mentioned both Dock 72 and Platform 16 as seeing more interest. Platform 16 is larger and longer-out, but what changed for those assets and how are you thinking about activity?

There are more tenants asking for proposals because people have emerged from hibernation. For example, Dock 72 is a superb product that now looks great and people are touring it; we weren't negotiating leases 90 or 180 days ago. As more tenants restart their sourcing, buildings like Dock 72 get traction. For Platform 16, there is also demand from large tech tenants and we are chasing them if our timing aligns with their needs.

Is it more that it's closer to where people live, or is it just the building is finally built and people can tour it?

It's more the latter. As Doug said, the building now looks great. We finished amenities that are an important part of the product and people are ready to start the process of returning to the office. Some of the recent tenant interest is from Manhattan tenants and from Brooklyn. The building shows very well now.

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

Hi everybody. From our data this is probably the second-softest leasing quarter in over a decade on volumes. With concessions elevated, are you starting to reduce TIs and free rent as reopening momentum gains steam or are concessions still required to get deals done in this environment?

There was very little activity in the first quarter because of the pandemic, and there's more activity now. The leasing sales cycle is relatively long so I don't expect dramatic changes in concession levels over the next few quarters. Over 2022 I would expect concessions to reduce as leasing volume recovers. In the near term, concessionary pressure will vary dramatically by building and submarket. You could have a prime building in New York, San Francisco or Boston where rents hold and concessions don't increase, while a neighboring building could be very aggressive on concessions. It will be building-by-building.

Okay, that makes sense. How would you describe the pipeline today versus pre-COVID and versus Q3 or Q4 2020?

If by pipeline you mean leasing activity, in New York City we have more tours this year-to-date than in the comparable periods in 2020 and 2019 for our portfolio. We have a lot of activity across the BXP portfolio that feels similar to 2019, with one big exception: we are not negotiating large new-office leases on new buildings right now. Over the preceding years, a lot of our volume came from large preleasing of new developments such as the Google building in Cambridge, Verizon at Causeway, and so forth. We are not seeing the same level of large-scale commitments on new developments today, which is a substantial difference versus pre-COVID.

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

Good afternoon. You commented in San Francisco that about half the tenants you are seeing are expanding and half contracting. Could you give more color on that, and could you compare and contrast San Francisco versus New York in terms of rent trends and activity?

In our portfolio transactions under discussion in San Francisco, roughly half are growing and half are shrinking slightly; these are generally modest changes. There is no meaningful rental rate growth in San Francisco or New York today. New York conditions are relatively stronger than San Francisco because New York has been opening earlier and more fully, while San Francisco really reopened in March and has been slower. San Francisco is behind New York in recovery, but we are starting to see technology demand and activity in San Francisco, such as proposals for our space at 680 Folsom and Gateway Commons lab activity.

Is office utilization or census lower in San Francisco than New York?

Yes, San Francisco census runs marginally lower than New York. Roughly, if we're running 20%-plus in New York, San Francisco is closer to 10%-plus at the moment.

Got it. And on your plan to go carbon neutral by 2025, can you give more color on what that requires in spend or strategy and whether that brings competitive benefits?

Three things: reduce energy intensity of our assets, which we've been doing for years — we are down roughly 30% off a 2008 base and improving; electrify building equipment and convert power sources from brown to green, which we've been doing with limited cost increases; and lastly, potentially purchase offsets to achieve the final steps. There are costs associated, but they are not material relative to overall company results. Being a leader in ESG is the right thing to do and increasingly important to customers, cities and capital providers. We believe doing this is both the right and a smart business decision. We also saw some modest benefit in marketing our green bond issuance.

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

Can you talk more about LA in general and Santa Monica in particular? It seems like the west side of LA has had a lot of sublease come to market. You guys had substantial occupancy drops in LA this quarter. Is that sublease competitive to your vacancy or mostly opportunistic? Any additional prospects and the profile of tenants kicking the tires, and expected timing to get those assets back to stabilized occupancy?

There are a decent amount of small and large sublet blocks available in the market. As Doug mentioned, many are opportunistic. Some competing sublet spaces are not directly competitive with our offerings. Our tenants have been flexible and may come to market with a sublet listing while not actually leaving; they may downsize or reorganize. The tech, media and content companies in West LA continue to grow and we're seeing new leasing interest from high-credit tenants. We are fortunate to have Class A space in West LA which is in demand.

Colorado Center is a market leader and currently around 90% occupied; based on recent activity, it could be 100% leased within the next six months. Santa Monica Business Park is a slightly older product and we lost a large tenant, but internal demand led by Snap and others gives us confidence that the park will return to stabilized occupancy soon. The west LA market may have paused, but activity is coming back strong led by technology, entertainment and content firms and there is not a lot of new supply coming on. Our product is well-positioned.

On economics, the proposals we're putting out to the tech, media and content firms show net effective rates close to pre-COVID levels in many cases. There is renewed activity on our prospect list from strong-credit tenants and large-scale firms seeking quality space.

Great, that's helpful. Second, on life science demand outside Boston and South San Francisco — what gave you the confidence to go ahead with three speculative developments there? Any concerns about potential oversupply?

The strongest life science markets by far are Cambridge, Waltham/Weston and South San Francisco/Brisbane. Demand growth in those markets gives us confidence to start these buildings on a speculative basis. The projects are fully permitted with construction drawings and known cost and delivery timelines, enabling relatively short delivery. We have RFPs underway — for example, for 751 Gateway we are already responding to RFPs and for 880 Winter Street we've had significant tour activity and proposals. Demand is strong, and vacancy rates for lab space in Boston are under 5% and in South San Francisco probably under 7% when accounting for committed new development. That's why we are comfortable with the investment.

Before making the investments we studied market requirements and forecast deliveries carefully. We believe demand far outweighs supply in these life science clusters. Also, the three projects differ in timing and type: some are ground-up and some are conversions, and their delivery schedules vary, which staggers the capital deployment and absorption timing.

Great, thank you both.

Your next question comes from the line of Brent Dilts with UBS.

Thanks. One question: what impact do you think some of the current federal and local tax proposals might have on your tenant base and the leasing market if they get enacted, given many of your key markets are already high-tax jurisdictions?

The most relevant change that already occurred was the New York City/State tax changes. Higher taxes are not great for business, though they primarily affect high-earners, which is a smaller percentage of the population. Many employers attracted to New York employ broader populations not materially affected by those increases, but it's not positive overall. At the federal level, proposals remain plans and are not enacted yet. Changes like capital gains tax increases or higher taxes for high earners would impact a small segment of the population. Repeal of 1031 exchanges has been discussed historically and generally doesn't pass; if it did, it could change some transactions but it's uncertain. Repeal of the SALT cap would be beneficial to our footprint if enacted. We will monitor legislation closely.

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

Thank you. You mentioned that tenant requirements have not materially changed due to the pandemic. Does that include changes on densification due to health concerns or is it too early to tell?

We haven't seen tenants materially reduce density due to health concerns per se, and as John said, no-one has pulled permits for significant changes. Many companies are thoughtful about furniture and configuring space going forward, and some separation in open office areas may be slightly more generous, which can be a tailwind as it could increase space needs, but it's not a significant factor at the moment.

Makes sense. Doug, you mentioned parking starting to pick back up and ancillary revenue streams improving in the back half of the year. How does pricing compare to pre-COVID levels — has there been degradation in parking rates today versus pre-COVID?

We have not changed our pricing on monthly parking spots. Our monthly spot is a monthly spot. We expect to reach a point where we have more demand for monthly parking and less availability, which would support revenue, but we generally look at parking pricing annually and we don't use highly dynamic pricing by hour or month to push demand off. We are in this for the long term.

Last one from me: on the carbon neutral commitment, how many tenants or potential tenants are demanding ESG commitments? How large is the competitive advantage of the 2025 carbon neutral commitment versus peers?

It's hard to quantify. There's no downside and some tenants and sectors care a lot about ESG in selecting landlords and buildings, while others are less focused. The importance of ESG is growing every year across customers, cities and capital providers. Being a leader does create competitive advantages, even if it's hard to translate precisely into rent today.

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

No closing remarks. Thank you all for your interest in Boston Properties. That concludes the call.

This concludes today's Boston Properties conference call. Thank you again for attending and have a good day.