Boston Properties Reveals Significant Asset Sale, Potential Upside Persists

138

Boston Properties, a prominent office Real Estate Investment Trust (REIT), boasts an A-Class workspace portfolio focusing on major cities like Boston, New York, and San Francisco. Renowned for holding one of the youngest property portfolios, averaging 15 years, BXP has garnered attention for its resilience in the face of challenging market conditions.

Having previously identified BXP as one of the best-positioned office REITs, recent performance, unfortunately, has lagged behind broader market indices, trailing the S&P 500 by approximately 15%. This underperformance is attributed to persistent high yields and a general lack of favorability towards office spaces.

The last two weeks, however, hinted at potential positive shifts. Following the FOMC meeting and the October CPI release, interest rates declined, prompting a notable rally in which REITs, including BXP, outperformed.

Examining the leasing activity in Q3, recent property disposals, and anticipating the impact of future yield changes can provide insight into BXP’s trajectory.

Quality of Portfolio

BXP’s strength lies in its ownership of high-quality office spaces, with a substantial proportion classified as A-Class or premier. Impressively, 90% of BXP’s buildings fall into this premier category, with an additional 5% undergoing redevelopment to meet these elevated standards. The emphasis on premier spaces is strategically beneficial, given their proven ability to retain tenants at higher rates compared to lower-quality alternatives.

Recent data from a CBRE study supports this strategy, revealing that A-Class space in BXP’s market experiences significantly lower vacancy rates than lower-quality options. This trend is also mirrored in net absorption figures, with premier space witnessing positive absorption of 8 million square feet since the start of the pandemic. In comparison, non-premier space faces negative net absorption of 30 million square feet.

The occupancy rates in major locations such as New York City, Boston, and San Francisco are showing signs of improvement, indicating a positive trajectory.

Capital Recycling Initiatives

BXP’s proactive stance involves playing offense in the current market, akin to its approach after the global financial crisis. With a substantial raise of $4.1 billion in gross funding over the past year and $2.7 billion in liquidity, BXP is well-prepared for strategic moves. While recent acquisitions have been limited, a significant disposal deal has been announced.

BXP plans to sell a 45% stake in two premier life science developments in Cambridge, MA, to Norges Bank Investment Management. Despite only acquiring one property for $17 million in Q3, this disposal deal is a major move. The properties, 290 Binney and 300 Binney represent the pinnacle of BXP’s portfolio, with long 15-year leases secured from top tenants.

The deal structure involves BXP receiving $213 million at closing, with future costs shared between the joint venture partners. BXP retains responsibilities for development, property management, and leasing services. While providing immediate cash flow, this deal offers opportunities for debt reduction and accretive acquisitions.

Leasing Strength

Leasing performance in Q3 has been robust, with 1.1 million square feet of space leased, boasting an average lease term of 8.2 years. Positive rent spreads in Q3, particularly the 14% increase in Boston, have contributed to a quarter-over-quarter increase of 88.3% to 88.8% in occupancy.

For the remainder of the year, approximately 1 million square feet of space will expire, with 750,000 square feet already leased. The optimism is reinforced by almost 1.2 million square feet of space currently under negotiation.

Valuation Insights

BXP’s dividend yield stands at 6.9%, and the payout ratio is comfortable at 53%. The expectation is for the dividend to remain stable, posing no imminent threat.

In evaluating BXP’s valuation, a shift in approach is noted. Rather than relying solely on the traditional Price to Funds from Operations (P/FFO) ratio, a focus on the spread to 10-year yields is considered more meaningful. This shift accommodates the dynamics of changing interest rate expectations.

The stock currently trades at an implied cap rate of 8.2%, providing a comfortable spread of 370 basis points above the 10-year treasury yields. A conservative base case forecast anticipates a 4% 10-year yield by the end of 2025, with a slight contraction in the spread from 3.7% to 3.5%. Under these assumptions, a potential upside of 24% over two years is projected, resulting in a price target of approximately $70.

Boston Properties displays resilience through its high-quality portfolio, proactive capital initiatives, and strong leasing performance. Despite recent challenges, strategic moves and positive leasing trends position BXP for potential growth, making it an intriguing prospect for investors.