Franklin Resources Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 31, 2024

There are 19 speakers on the call.

Operator

Good day and thank you for standing by. Welcome to BXP's Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer Please be advised that today's conference call is being recorded. I would now like to hand the conference call over to your first speaker, Helen Hahn, Vice President of Investor Relations.

Operator

Please go ahead.

Speaker 1

Good morning, and welcome to BXP's Q2 2024 Earnings Conference Call. The press release and supplemental package were distributed last night and furnished on Form 8 ks. In the supplemental package, VSP has reconciled all non GAAP financial measures to the most directly comparable GAAP measure in accordance with Reg G. If you did not receive a copy, these documents are available in the Investors section of our website at investors. Bxp.com.

Speaker 1

A webcast of this call will be available for 12 months. At this time, we would like to inform you that certain statements made during this conference call, which are not historical, may constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act. Although DXP believes the expectations reflected in any forward looking statements are based on reasonable assumptions, it can give no assurance that expectations will be attained. Factors

Operator

and risks that

Speaker 1

could cause actual results to differ materially from those expressed or implied by forward looking statements we detailed in yesterday's press release and from time to time in BXP's filings with the SEC. BXP does not undertake the duty to update any forward looking statements. I'd like to welcome Owen Thomas, Chairman and Chief Executive Officer Doug Linde, President and Mike LaBelle, Chief Financial Officer. During the Q and A portion of our call, Ray Ritchie, Senior Executive Vice President and our regional management teams will be available to address any questions. We ask that those of you participating in the Q and A portion of the call to please limit yourself to only one question.

Speaker 1

If you have an additional query or follow-up, please feel free to rejoin the queue. I would now like to turn the call over to Owen Thomas for his formal remarks.

Speaker 2

Thank you, Helen, and good morning, everyone. BXP's performance in the Q2 once again demonstrated the relative market strength of the premier workplace segment of the commercial office industry as well as BXP's strength and execution. Our FFO per share was $0.06 above our forecast and $0.05 above market consensus for the 2nd quarter. Further, we raised the midpoint of our FFO per share guidance for 20.24 by 0 point 0 $8 We completed over 1,300,000 square feet of leasing, which is 41% greater than the Q2 of 2023 and close to our 10 year average leasing volume for the 2nd quarter. As our leasing volume continues to escalate exceeding current lease expirations, we expect our occupancy will increase over time.

Speaker 2

Weighted average lease term on leases signed this past quarter remained long at 9 years. On sustainability this past quarter, we released our 2023 Sustainability and Impact Report, hosted our 3rd annual Sustainability and Impact Investor Update and were recognized by Time Magazine as one of the world's most sustainable companies, ranking number 1 in the U. S. Among property owners. Delivering sustainable real estate solutions is increasingly important to our clients, as well as the communities where we operate and decreases our cost of capital given the growing number of ESG investors interested in our debt and equity securities.

Speaker 2

Moving to macro market conditions. We continue to experience market tailwinds for the 2 most important external forces impacting BXP's performance, interest rates and corporate earnings growth. The U. S. Inflation report released on July 11 reflected a 3% inflation rate for June, lower than expectations, sparking new forecasts of accelerated interest rate cuts by the Fed as well as lower market yields for the 10 year U.

Speaker 2

S. Treasury. Lower interest rates are obviously favorable for real estate and BXP's valuation and for broader corporate earnings growth, the second important external factor driving BXP's performance. After remaining flat for all of 2023, S and P 500 earnings growth was 6.6% in the Q1 of this year and is expected to be around 9% for the Q2. As mentioned repeatedly, companies with earnings growth are much more likely to invest, to hire and to lease additional space as demonstrated in our growing leasing volumes this year.

Speaker 2

Premier Workplaces defined as the highest quality 6.5% of buildings representing 13.1 percent of total space in our 5 CBD markets continue to materially outperform the broader market. Direct vacancy for premier workplaces is positive 6,900,000 square feet over the last three positive 6,900,000 square feet over the last 3 years versus a negative 22,800,000 square feet for the broader market. Asking rents for premier workplaces are 51% higher than the broader market, a consistent gap from prior quarters. This outperformance is evident in BXP's portfolio where just under 90% of our NOI comes from assets located in CBDs that are predominantly premier workplaces. These CBD assets are 90.4% occupied and 92.2 percent leased as of the end of the second quarter.

Speaker 2

We are also experiencing moderate but steady increases in workers returning to the office based on the turnstile data we capture for roughly half of our 54,000,000 square foot portfolio. Corporations continue to push for increased office attendance, including Salesforce, who recently announced their new policy shift from primarily flexible work to mandatory office attendance for most employees of 3 to 5 days per week depending on job function. Regarding the real estate private equity capital markets, office sales volume in the 2nd quarter continued to be muted at $6,900,000,000 and has ranged from $6,200,000,000 to $9,100,000,000 for the last 6 quarters, well below volumes achieved before the Fed started raising interest rates in 2022. Completed transaction activity for Premier Workplaces has been very limited, though increasingly owners are testing the market to understand pricing. Moving to BXP's capital allocation activities, we remain active in pursuing acquisitions from owners and lenders, but as mentioned, have seen limited opportunities in the Premier Workplace segment.

Speaker 2

We are in active negotiations for the disposition of 4 land positions, which if successful would generate approximately 150,000,000 dollars of proceeds, half of which could be realized this year. For our development pipeline, we delivered into service the 118,000 Square Foot DICK'S House of Sport on Boylston Street at the Prudential Center in Boston, fully leased at a strong yield. On July 12, we opened Skymark, our 50 8 unit luxury residential tower development at Reston Town Center. We've already leased 21% of the units ahead of schedule, and rents are also modestly above projections. We continue to push forward with several residential projects, primarily on land we control that are being entitled and designed for which we intend to raise JV Equity Capital.

Speaker 2

DXP continues to execute a significant development pipeline with 10 office lab retail and residential projects underway as of the end of the second quarter. These projects aggregate approximately 3,100,000 square feet and $2,300,000,000 of BXP investment with $1,200,000,000 remaining to be funded and will contribute to BXP's external FFO per share growth over time. Though market segment for the broad office asset class remains challenging, BXP continues to leverage its key strengths, which are our commitment to premier workplaces and our clients as many competitors disinvest in the office sector a strong balance sheet with ready access to capital in the secured and unsecured debt and private equity markets and one of the highest quality portfolios of premier workplaces in the U. S. Assembled over several decades of intentional development acquisitions and dispositions.

Speaker 2

So in conclusion, BXP continues to display resilience with a growing leasing pipeline as well as stability and FFO per share and dividend level, and is well positioned to continue to gain market share in both assets and clients during this time of market dislocation for the office sector. Expectations for lower interest rates and stronger corporate earnings growth will also provide tailwinds for our renewed growth over time. So now, Doug, I'd like to wish you a happy birthday, and I'll turn the call over and you can talk about our strong leasing activities.

Speaker 3

Thanks, Owen. I really enjoyed celebrating my birthday with all of you on the call every few years for the highlights. So as we described during our nary June meetings and the webcast that we did, the trend line of BXP's leasing activity in the Q2 of 'twenty four picked up materially relative to what we executed in the Q1 and what we discussed on our last call, all really good stuff. As of June 30, we've completed 2,200,000 square feet of leasing for 24. When we spoke to you during our May call, we stated our pipeline of leases under negotiation at that time May 1 was 875,000 square feet.

Speaker 3

And as Owen highlighted, we signed leases for 1,320,000 square feet between April 1 June 30, a lot more. And our active pipeline of leases under documentation today has grown to 1,390,000 square feet. So if we complete this full of transactions, we will have leased 3,590,000 square feet of space, exclusive of our leases and documentation. We have an additional set of transactions under discussion totaling about 850,000 square feet. So if we execute 50% of those transactions, we will more than achieve our leasing guidance of 4,000,000 square feet for the year.

Speaker 3

This quarter, we completed 73 transactions, 37 lease renewals for 830,000 square feet, 36 new leases encompassing 500,000 square feet. Twelve clients expanded into 228,000 square feet of additional square footage, while we had 4 contractions totaling 63,000 square feet. 45% of our absorption was growth from our existing client pool. As a point of comparison, last quarter, we completed 61 transactions with 29 renewals, encompassing about 400,000 square feet and 32 leases for 194,000 square feet. And we had only 3 expansions for 18,000 square feet and we had 4 contractions totaling 44,000 square feet.

Speaker 3

So again, really big improvements. Q2 activity was concentrated in our East Coast markets with 445,000 square feet in New York, 343,000 Square Feet in Boston and 351,000 Square Feet in Northern Virginia. These three markets made up 1.1 4,000,000 square feet or 86 percent of the activity. Our West Coast activity was almost exclusively in San Francisco with 146,000 square feet. The majority of our client expansions came from Manhattan this quarter.

Speaker 3

The only significant contraction in the portfolio came from a tech company downsizing in Reston. We had 3 transactions over 100,000 square feet, 1 each in Boston, New York and Reston. Expansions or new clients made up 42% of the activity in New York, 40% in Boston, 37% on the West Coast and 16% in D. C. As reported in our supplemental, the mark to market of leases that commenced this quarter, which is about a 375,000 square foot base, was up 6% and transaction costs averaged $11 per square foot per year.

Speaker 3

The overall mark to market of the restarting cash rent on leases executed this quarter, which was a 1,150,000 square feet pool relative to the previous in place cash rent was about flat. The starting rents on leases we signed during the Q2 were up about 8% in Boston, really flat in New York, down 6% in DC and down 7% on the West Coast. Now I want to spend a minute on our occupancy change during the quarter, which seems to have been a focus of many of the analyst reports that we saw this morning and last night. As we stated in February May, we have 2 large known expirations, 1 in April, 200,000 square feet of 6 80 Folsom, which is in the 2nd quarter figures and 1 in July, 200,000 square feet of Times Square Tower. That's a JV asset, so our percentage share is 110, but we report the 200.

Speaker 3

This quarter, we also vacated 148,000 square feet of occupied but non revenue producing spaces. What do I mean? Well, we had some tenants in default where we had stock recognizing revenue, yet they were still in possession and we were in legal proceedings to vacate the space. In addition, we took back 60,000 square feet from WeWork at Dock 72, but there the absolute rent that we were receiving remains the same. It's just on a lower square footage.

Speaker 3

Finally, we terminated a 33,000 square foot lease in Waltham that was simultaneously re leased, but won't be delivered into next quarter. Those movements account for 92% of the reduction in our occupancy in the Q2 from the Q1. As of June 30, we have approximately 1,000,000 square feet of signed leases that have not commenced. Hence the 200 basis points difference between occupied space and leased space. In the Q1, our leasing included 383,000 square feet of vacant space leasing.

Speaker 3

This quarter, that same vacant space leasing was 362,000 square feet. These leases are all part of our leased square footage percentage. Our pipeline of leases in negotiation includes an additional 635,000 square feet of currently vacant space, which if signed, will contribute another 130 basis points to our leased square footage. In addition to the known 200,000 square feet expiration at Times Square Tower in Q3, our 2 Waltham Life Science developments will be added into our in service portfolio in the 3rd and 4th quarters, 180 City Point and 103 Fourth Avenue, respectively. They are a combined 32% occupied, which will reduce our in service occupancy.

Speaker 3

These additions will result in about a 50 basis point reduction at the year end. For those of you that are focused on the next quarter, expect us to be lower by about 40 basis points with a recovery in the 4th quarter where most of the leases that have been signed start to commence, where we project occupied space to be between 87% 87.5%, inclusive of the addition to the in service portfolio. In previous quarters, we have not been including the additions to in service portfolio, but we're doing that now because it's a quarter away. Our leased space will continue to be above 89%. BXP continues to lease space.

Speaker 3

In Manhattan, almost all of our demand continues to originate from financial institutions, alternative asset managers, professional service organizations and law firms. In many circumstances, these clients are expanding. Concessions are flat and taking market rents have risen double digits in 2024. The sub 8% availability in the Park Avenue submarket is a direct reflection of these users growing and competing for limited blocks of space. In one of our assets, we have 3 tenants that would like more space and we have no immediate availability.

Speaker 3

We had more than 130,000 square feet of expansions at the General Motors building and at 601 Lexington Avenue this quarter. Our strongest tour activity in New York City continues to be in the submarket. At the same time, technology demand across the city continues to be light. We completed a single floor lease at 360 Park Avenue South with a digital media firm this quarter, but Midtown South is a tech oriented submarket in the city where transactions over 20,000 square feet have been very limited in 2024. In Princeton, we completed 10 transactions totaling 150,000 square feet during the quarter, including an extension and expansion with a foreign pharma company.

Speaker 3

In the Back Bay and the Financial District of Boston, we completed 195,000 square feet of leasing this quarter. The majority of this activity was in our Back Bay portfolio and the clients were alternative asset managers and professional services firms. The Back Bay continues to outperform the financial district, which continues to have to digest the new construction pipeline. Our remaining activity was in our Waltham urban edge portfolio, where we completed just over 110,000 square feet and 90% of those transactions were on either existing or near term vacancy, not renewals. Here, the demand came from a consumer products company, a homebuilder and a few pharma life science companies with office requirements.

Speaker 3

We did execute 125,000 Square Foot Life Science Lab Lease. The Life Science Lab demand in Greater Boston continues to be lackluster, with tenants displaying little urgency around any potential new requirements or relocations. To date this year, there have been 8 non renewal lab deals in Waltham, Lexington, Watertown and West Cambridge that didn't involve a sublet. Only one was greater than 25,000 square feet. Our Reston portfolio was responsible, as I said, for virtually all of our executed leases this quarter in the DC region.

Speaker 3

Leasing activity and tenant demand growth is coming primarily from 2 industries, cybersecurity and defense contracting. We had just over 30,000 square feet expansions from existing tenants, but we also experienced, as I said, a 50,000 square foot contraction from a traditional tech company. The vibrant residential and retail environment continues to be a natural location for small businesses in the financial services and legal industry as well. And we did do 6 leases at 5,000 square feet or less in the Town Center as well as a handful of retail deals. The District of Columbia office market is becoming more and more bifurcated.

Speaker 3

The private sector tenant demand is dominated by the legal industry in DC, but in almost every case, law firm renewal or relocations are resulting in smaller requirements, which is leading to negative absorption as we have all read and seen. It doesn't look like the government leasing or usage is going to help with this problem. However, with the either existing or near term high vacancy, there are many buildings with over leveraged capital structures unwilling to provide capital for new transactions and therefore they have very little client interest. When clients do want space, they prefer to be in the top of refurbished amenity rich well capitalized buildings. There appears to be limited opportunities in the market that meet these clients' demands.

Speaker 3

So our availability at 2,200 Penn and 901 New York Avenue should fare well over the next few quarters. On a comparative basis, the West Coast markets, particularly San Francisco are seeing more demand in 2024 than 2023. However, additional sublet availability and technology company lease downsizings upon lease expirations continue to mute the positive demand emanating from the AI organizations that continue to look for space. Tech growth away from AI has yet to emerge. The San Francisco CBD also continues to act as the financial center of the West Coast with its own set of asset managers, including private equity firms and venture firms, some hedge funds, a few specialized fund managers and obviously their financial and legal advisors.

Speaker 3

This is the source of the bulk of the transactional activity in the market. And while the brokers correctly report a pickup in tenants in the market, if you look more closely, very little of that demand represents net growth from those tenants. Our San Francisco activity continues to center on traditional non tech demands at Embarcadero Center. This quarter, we completed an 80,000 square foot law firm renewal with no change in square footage and 5 smaller deals, all 12,000 square feet or less with new tenants on currently vacant space. We continue to see many of the professional services in law firms continuing to downsize, which is in stark contrast to the activities of those same tenants in New York and Boston.

Speaker 3

We are seeing a steady flow of potential tenants 12,000 square feet or less, which is about a full floor at our 535 Mission property. But this is in contrast to 680 Folsom whose location is less desirable for non tech demand and where the potential tech clients continue to have inexpensive furnished sublet options. Tenant activity is improving in our research R and D buildings, where we have about 215,000 square feet of availability and uniquely attractive products. These buildings are designed for companies that are making some sort of device, be it a car sensor, photovoltaic panel or a medical device. They don't compete with the large multi story office product that has flooded the market.

Speaker 3

We saw activity come to a halt when the SVB imploded last year. The entrepreneurial device maker companies still exist and they are now slowly making capital commitments once again and looking at leasing space. The lab market story in South San Francisco is not dissimilar to Greater Boston. There were only a handful of new leases completed during the 1st 6 months of the year that didn't involve a renewal or sublease. Though there have been about 100,000 square feet of new deals completed in the last 30 days.

Speaker 3

Overall, we are experiencing an improving operating environment. Leasing available space is primarily driven by gaining market share from competitive landlords and or lower quality building, but not net new market demand growth. While the markets need consistent incremental absorption to show a macro recovery, we have started to see pockets of strength where low availability is driving constructive client behavior. The Back Bay of Boston and the Park Avenue submarket of New York are the obvious examples. As clients choose premier properties in sound financial condition operated by the best property management teams, we will continue to be successful in capturing demand, leasing space and increasing our occupancy.

Speaker 3

And with that, I'll turn it over to Mike.

Speaker 4

Great. Thanks, Doug. Happy birthday. Thank you. So this morning, I'm going to cover the details of our Q2 performance and the increase to our 2024 full year guidance.

Speaker 4

So for the Q2, we reported funds from operations of $1.77 per share that exceeded the midpoint of our guidance from last quarter by $0.06 per share. Our portfolio NOI came in a penny ahead of the midpoint of our guidance. The majority of this resulted from lower operating expenses in the quarter. Our rental revenue was closely aligned with our expectations. And as Doug described, our occupancy decline was anticipated in our guidance as we've covered with you in the last two earnings calls.

Speaker 4

$0.05 of our earnings fee came from a reduction in non cash interest expense that we don't expect to recur and that you should not incorporate in our run rate going forward. The change is due to our reassessing of future earn out payment related to our Skyline multifamily project in Oakland. The reassessment results in the reversal of $9,000,000 of previously accrued non cash interest expense. Our structuring of this deal with the protection of an earn out in lieu of an upfront land purchase is saving us nearly $40,000,000 of projected land payments. So moving to the full year, we're increasing our FFO guidance for 2024 to $7.09 to $7.15 per share.

Speaker 4

At the midpoint, this equates to $7.12 per share and is an increase of $0.08 per share over the prior guidance midpoint. In addition to the 2nd quarter outperformance, we anticipate $0.02 per share of better projected portfolio NOI in the back half of the year from our in service portfolio. We've negotiated 3 lease terminations, all in Boston with payments that will add incremental income in the second half of twenty 24. Net of lost rental income, our NOI is projected to be higher by approximately $4,000,000 or $0.02 a share. The geography of the expected improvement shows up as an increase in termination income and a modest reduction of same property NOI.

Speaker 4

We don't include termination income in our same property guidance and we guide to it separately. So you will see in our detailed guidance table in our supplemental that our full year 2024 termination income guidance is now $14,000,000 to $16,000,000 up $8,000,000 Correspondingly, we've reduced our 2024 same property NOI growth by 25 basis points at the midpoint to a range of negative 1.5 percent to negative 3% from 2023. If not for the terminations, our same property performance expectations would have been in line with our prior guidance. To provide a little more detail, most of our termination income comes from terminations we have negotiated to allow us to sign new long term leases with both expanding and new clients. These transactions are reducing our occupancy by 100,000 square feet temporarily, but the impact will be short term as we have new leases coming in after 6 to 12 months of downtime that will cover virtually all of the space.

Speaker 4

These deals reduce our 2024 occupancy by about 20 basis points and are reflected in our updated occupancy guidance. We've also modified our guidance for net interest expense to incorporate the $0.05 per share of lower interest expense recorded in the 2nd quarter. This results in lower interest expense for the full year and a new guidance range for net interest expense of $578,000,000 to $588,000,000 The remaining components of our prior guidance have not changed meaningfully. And overall, our earnings performance for 2024 is exceeding our prior expectations. I would like to spend a minute on interest rates as there's been no consistency quarter to quarter on Fed rate cut projections.

Speaker 4

Back in January, the street was projecting 4 to 5 rate cuts starting in the 2nd quarter. Then the Q1 data came out and the street changed that to 0 to 1 type. And now with more progress on inflation, the street has reverted back to 3 cuts this year. We have not changed our base model that assumes 1 expense would be about $2,000,000 or a $0.01 per share lower, which is within our guidance range. Another item that could impact interest expense is markets and in general the bond markets have been improving with tighter spreads and lower treasury rates.

Speaker 4

We are evaluating the timing of replacement financing and it is possible we could hit the market this year. We would expect to invest any financing proceeds temporarily in bank deposits that currently earn approximately 5% and then redeem the bond at its expiration. We haven't included the impact of a potential debt transaction in our current guidance. So in conclusion, we're increasing our guidance for FFO to $7.09 to $7.15 per share. This is an $0.08 share increase from the midpoint from our prior guidance.

Speaker 4

The primary reason is the improvement of $0.05 per share of lower non cash interest expense, dollars 0.05 of higher termination income, offset by $0.02 of lower same property NOI from the lost rental income related to lease terminations. That completes our formal remarks. Operator, can you open up the line for questions?

Operator

Thank you, sir. And I show our first question comes from the line of Nick Yulico with Scotiabank. Please go ahead.

Speaker 5

Thanks. Good morning. So I appreciate some of the clarity there on the occupancy guidance and the leasing activity. It sounds like some of this is or a lot of this is sort of timing related in terms of the adjustment to the occupancy and same store guidance. Is there a way to give us a feel for if some of the recent leasing pace continues, how that could translate into occupancy growth next year?

Speaker 5

I know Owen did talk earlier about getting to the point where occupancy will increase over time. I mean any sort of early thoughts on 2025 impact? Thanks.

Speaker 3

So Nick, this is Doug. So I think that Owen's comment was 100% accurate, which is our occupancy is going to increase. Mike would also tell you that we have a cycle with regards to particularly our CBD leasing, which by the way, we're in the mid-90s on an occupancy level right now, where those leases take some time to go from leased to occupied, right? So we have a 200,000 square foot piece of space that's available in a particular building and we signed a lease for it, but we may not see actual occupancy for 12 months to 16 months because the tenant has to actually physically build out the space. And so it's a little hard for us to give you a tight projection on when our occupancy number will actually start to materially increase.

Speaker 3

The trajectory is there's no question it's going up. And if we end the year again with this new adjusted in service portfolio with the availability that we have in these life science buildings, in the mid-87s, we will my guess is be in the 88s in 2025. And we could get lucky relative to delivering some space where the tenant takes it in and as is condition and suddenly we're going to get a big pickup in occupied and therefore we can start recognizing revenue. Those are the kind of things that would make a material difference, but we're not counting on those.

Operator

Thank you. And I'm showing our next question comes from the line of Steve Sakwa from Evercore ISI. Please go ahead.

Speaker 6

Thanks. You guys talked about maybe pursuing some new apartment developments. I'm just curious if you sort of look at pricing today for materials and kind of current rents, what sort of yields do you get on untrended rents today? And it sounds like you might bring in JV partners, but how would you just sort of think about funding those and what percentage of those deals would you likely keep?

Speaker 2

Yes. Steve, it's Owen. So most of what we're pursuing is on land or other assets that we control, that we are re entitling. There is it's no secret that there is a shortage of housing, certainly affordable housing in this country broadly. And I think communities are a lot more interested in entitling housing projects today than they have been in the past.

Speaker 2

And that's a real help to our activities. The obstacle is what you described, which is costs, which have gone up not only for materials, but also capital, given interest rates. But to come to your question, we have a pretty significant portfolio of land that we control that we're pushing through this entitlement and design process, but not all the projects pencil. What we're trying to get on a project basis is mid-six yields and higher. And as you also suggested, our goal would be to bring in JV partners for that.

Speaker 2

I mentioned this Skymark project that we are currently opening in Reston. We own 20% of that project and have an 80% JV partner. And our hope is to establish similar types of joint ventures for these projects in our pipeline. And Steve, this is Doug.

Speaker 3

I just make the following additional comment, which is the stuff works with stick frame. So the things that we are looking at in our suburban, I'd say non office likely potential properties in the greater welfare market as well as in Northern Virginia are the places where you will probably see us being able to start things in sooner rather than later. CBD construction and CBD rents are much harder to pencil right now. And all of our teams are looking at it and studying it, but we don't we're not sure that 2025 will be a position from our economic start of that stuff.

Operator

Thank you. And our next question comes from the line of Michael Griffin with Citi. Your line is open.

Speaker 7

Great. Thanks. Owen, I want to go back to your comments around expectation for forward earnings growth and kind of how that translates to leasing. Should we take it as the fact that there is a pivot to earnings growth improves the outlook versus maybe the magnitude of what corporate earnings growth is expected to be maybe relative to history? And then I imagine that a lot of that growth is coming from tech companies.

Speaker 7

Just given the fact that they've been more hesitant to lease space, as we've seen over the past couple of years, how does that maybe factor into using that metric as a good forward indicator of leasing demand?

Speaker 2

Yes. Michael, good morning. So, we provide in our IR deck a graph of S and P 500 earnings growth versus BXP's leasing activity, there's a clear correlation. Not all of our clients are in the S and P 500, but S and P 500 earnings growth is just an indicator of, I would say, corporate health. And when companies are growing and they're healthy, they're more likely to invest higher lease space.

Speaker 2

So I think it's real. And this year, it's proving itself once again because in 'twenty 3, we had more muted leasing activity. There was no S and P 500 earnings growth. This year, the growth is stronger and our leasing is stronger. So that correlation holds.

Speaker 2

You are 100% right. I think in terms of your comments about tech leasing. When you look at the markets today, I would say outside of tech and life science, our leasing is almost back to normal, whatever that is defined as pre pandemic. Those are the 2 places that there is a gap. And I recognize some of the S and P 500 earnings growth is coming from tech companies.

Speaker 2

But again, when you look at the data that correlation holds, S and P 500 earnings growth to leasing and it seems like it's holding this year in 2024.

Operator

Thank you. And our next question comes from the line of John Kim from BMO Capital Markets. Please go ahead.

Speaker 8

Thank you. You pushed back the stabilization dates of several development projects. How should we think about the likely lease up period versus those new dates? And Mike, if you can remind us of your capitalization interest policy. I know in the past you stopped capitalizing as soon as initial occupancy took place.

Speaker 8

And I just wanted to clarify that position.

Speaker 3

So John, I think that the stabilization dates assume a 85% occupied square footage of the building. So that's sort of how that works. So presumably, the leasing would be done in 12 to 18 months prior to that date occurring and we would be building out space and generating revenue when those tenants actually moved in. I'll let Mike talk about our capitalization methods. So

Speaker 4

the policy around capitalization is that we stopped capitalizing interest and any expenses associated with asset like real estate taxes 12 months after the base building is completed. So like for 103 City Point and 180 City Point that Doug described that is going into the in service portfolio later year. Those base buildings completed in the 3rd Q4 of 'twenty three. So in 3rd Q4 of 'twenty four, the capitalized interest will stop on those assets. And so they're not fully leased, so we'll have some impact there.

Speaker 4

The 751 Gateway asset completed its base building in the Q2 of 2024 and 360 Park is later this year. So those will have some impact next year and then later next year for 360 Park. That's kind of the timing associated with the capitalized interest works.

Speaker 3

And again, unfortunately, it's just geography, but we throw all of these development assets 12 months after we completed base building into our in service portfolio wherever they're leased. And so they have an amusing effect on our occupancy even though they're not really apples to apples part of the in service portfolio that we're describing on a sort of quarter by quarter basis.

Operator

Thank you. And I'm showing our next question comes from the line of Blaine Heck from Wells Fargo. Your line is open.

Speaker 9

Great, thanks. Good morning. Owen, conversations about the potential impacts of the election are ramping up. So wanted to get your thoughts on whether you see any possible changes in regulations or the overall economic or political environment that would be impactful to your business under either party?

Speaker 2

Yes. I don't think that's a huge difference for us. I mean, clearly, there's some tax issues that are coming up over the next couple of years where there's a one party or the other gets elected, it could have some impact. But I will say state and local elections have a larger impact on our day to day business. What's going on with real estate tax in our city?

Speaker 2

What's our ability to entitle real estate? What's going on with commuter transit? What's going on with safety and crime in the streets of our cities. Those types of issues have a bigger impact on us than issues at the federal level.

Operator

Thank you. And I'm showing our next question comes from the line of Camille Bunnell from Bank of America. Please go ahead.

Speaker 10

Good morning. I wanted to pick up on the portfolio's CapEx spend for the first half of the year, which looks to be tracking in line with 2023 levels and well below your historic average. So could you provide an update on the CapEx assumptions you have planned given expectations for higher lease commencement?

Speaker 4

So our maintenance CapEx, I would suggest is going to run somewhere between $80,000,000 $100,000,000 this year, which is in line with, I would say, historical type of averages, maybe a little bit lower. We do have some repositioning CapEx that is more meaningful this year than it was last year, primarily at 200 Clarendon Street, where we're putting in a pretty significant amenity center that is going to result in tenant retention and higher rents in that asset. So you may have noticed this quarter there was a little bit more repositioning capital. On the leasing side, this quarter was lower because we just didn't have that many leases commenced this quarter. It was just a little bit bulky obviously quarter to quarter on our leases commenced.

Speaker 4

And I think that a run rate annual run rate is $200,000,000 to $240,000,000 of lease transaction costs that would be part of our AFFO calculation.

Operator

Thank you. And I'm showing our next question comes from the line of Connor Mitchell with Piper Sandler. Please go ahead.

Speaker 11

Hey, good morning. Thanks for taking my question. Kind of following along with Mike's answer there and providing some CapEx on adding some amenities. Just wondering with the leasing coming back, you guys had a good quarter of leasing volume and building out the pipeline some more. Do you feel it's time to really reengage in building amenity upgrades in existing buildings?

Speaker 11

Or are you still looking for a little bit more of a push from the demand side?

Speaker 3

So this is Doug. What I would say is I'm going to ask some of the regional management teams to discuss what's going on. But we have effectively done as almost every building from a sort of a re imagination, re amenitization project perspective. It's either underway or it's just about complete. And I can let Rod talk about what's going on in Barkadero Center and I'll let Peter, Jay talk about the things that we've been doing in the greater DC market and then Brian can discuss 2 100 Clarendon Street, but that's kind of the last of the major changes.

Speaker 3

Hillary has a few little things going on on the margin in some of her buildings. But why don't we start with Rod?

Speaker 12

Yes. So as Doug mentioned, we are in the process of doing an amenity center at Embarcadero Center. And this is we have always had a conference facility. And what we've done now is basically decommissioning that conference facility and we're building a brand new both conference and amenity center over at 3 Embarcadero. So that is under construction and it's got both indoor and outdoor space.

Speaker 12

It's going to be available primarily to our tenants, but it will be available to the general public as well. And we're excited about it. And it's an absolute must. I mean, we are making those same improvements similar in concept anyway at our other projects and it's demanded by the tenants. So I'm very excited about getting this one done.

Speaker 3

Pete?

Speaker 13

Hey, good morning. This is Pete Donnie in DC. So, I would say we've been, as Doug said, through several major projects here in the DC market. We just opened Wisconsin Place in the Chevy Chase, Maryland market here recently to great fanfare, and we're optimistic that that's going to translate as Rod was just describing and Doug did into both increased demand and retention at the property. We're under construction at Sumner Square and that'll be done later this year.

Speaker 13

That's the result of some leasing that we have Jake and his team have mostly already done and that was demanded by

Speaker 2

some of those tenants through part of

Speaker 13

their renewal. And then upcoming is at 901 New York Avenue as part of our lease renewal with Finnegan late last year early this year. We're doing a pretty major renovation of both that lobby, the existing lobby and replacement of the amenity center on the lower level. So I would say we are mostly through that in the DC market. There's no major ones on the horizon.

Speaker 13

And I'll see if Jake has anything to add.

Speaker 14

No, nothing to add other than in terms of the repositioning that we just opened at Wisconsin Place, it's been met with quite a bit of fanfare. We've had some broker events and there's definitely some activity and interest in that space now, which is exactly what we wanted to have happen. And at 901 York Avenue, we will hopefully commence construction on those renovations in Q1 of next year. And again, a lot of that information has been shared with brokerage community and with the plus or minus 100,000 square feet of vacant space we have in that asset, we've got some really good activity on that space.

Speaker 3

Brian, you want to just sort of talk about what 200 Clarendon is?

Speaker 2

Yes. We're towards the tail end of our investments and execution. Doug mentioned at 200 Clarendon, that's a 3 year process of design and inclusion with our clients in that building and also tied to commitments to renewal. And that is under construction as we speak and going well. At the Prudential Center, our View Boston should be included in upgrade of amenities for our clients.

Speaker 2

View Boston has a tremendous amount of design factors that were put in by input from the clients, the major clients at the Prudential Center for a vet space, for meeting space, etcetera. And then we finished at 140 Kendrick in the Urban Edge portfolio to tremendous success, really great feedback on that, high utilization. And if we do any others, it will be on the margin in, let's say, one of the possible Urban Edge larger assets, but it would be insignificant compared to our other investments.

Operator

Thank you. And our next question comes from the line of Caitlin Burrows from Goldman Sachs. Please go ahead.

Speaker 15

Hi, good morning everyone. You guys talked about how the tech and life science areas are to where leasing is not quite back to normal, whatever that might be, but that the other areas are. So just thinking of the tech and life science, I think the details are different for each of them, but like what do you think gets them back? How much downsizing is there still to see? But yes, could you talk about that a little bit more?

Speaker 3

Sure. So Camille, this is Doug. So on the tech side, I actually don't think it's about downsizing much anymore. Calin,

Speaker 2

it's really

Speaker 3

at this point about whether they want to make high value added investments in their real estate relative to their current platform of human beings and where their spaces are. So as an example, you may see some tech companies, large tech companies making incremental expansions in particular cities because that's where they think talent is. But on the margin, those companies are not growing quickly. We are starting to see dollars, right, and you're seeing this both on the life science side as well as the venture side being raised by companies that will be the next group of organizations that are doing something that to create value for the world at large, the business community, the improvement in human condition and from the perspective of life science and elongating the value of people's lives. That pipeline of money takes time to move into the organizations and those organizations to really create for new opportunities for growth from an office perspective.

Speaker 3

It's been going on. We're hoping that we'll start to pick up. But I'm not smart enough to know when that's going to happen, but we know it will happen. And as we think about our cities and our portfolio, we have a view that there will be more creation of new jobs and new economic activity in life science and in technology broadly thinking, than there will be in traditional financial services, asset management, professional administrative services. So we're banking on that happening.

Speaker 3

It's just a question of when. And it's really hard to be able to sort of give you a timeframe for that. So, and just to add a

Speaker 2

little bit to what Doug said, and I've mentioned this on prior calls, a lot of the large tech companies took a lot of space in 2021 2022. And I think there's a digestion process that's underway. And we can't really forecast when that completes. But again, I would reiterate Doug's point about where the relative growth will be. And then I think the other thing that's interesting that I mentioned in my opening remarks is, what are the in person work policies of the tech companies and sales force just this last month or last couple of months announced that starting in October, they expect almost all their employees to be in the office 3 to 5 days a week, and that's a big change in their policy, and they're one of the biggest employers in San Francisco.

Speaker 2

So I think that's going to have an impact as well.

Operator

Thank you. And our next question comes from the line of Vikram Malhotra from Mizuho. Please go ahead.

Speaker 16

Thanks for taking the question. Just two clarifications to the comments. I guess, one, you've described sort of East Coast and financial leasing picking up particularly in New York, but maybe more broadly. How much of that is focused primarily on the premium product versus sort of the general market? In other words, is it still the divergence or is the market actually picking up, number 1?

Speaker 16

And then number 2, just in your comments on leasing and what that may mean for occupancy, could you maybe give us more color how much of that is actually renewal or how much visibility today you have on renewals into 2025? Thanks.

Speaker 3

You want to take the first question? Yes.

Speaker 2

I mean, Vikram, the pickup is clearly in the premium buildings. I gave you all the statistics on it, the asking rent gap. There's a lot of speculation. Well, as the market improves, this gap is going to decrease. So that hasn't happened.

Speaker 2

It's definitely stayed flat, if not grown. I do think in certain locations, though, that are very desirable, like around Grand Central Station, market strength does creep into the beyond the premier segment. I think that's true for special locations.

Speaker 3

And Vikram, on your question about sort of renewal versus new, so I one of the things I provided in my remarks were the amount of vacant space that we leased in each quarter and what's going forward. And so that number is coming out to somewhere around 40% of our leasing is those types of added occupancy generators and the rest of it are renewals. And generally, when we're doing renewals, the majority of it is forward, but some of it is relatively broadly speaking sort of in the contractual expiration period of the given year. So we do have a bunch of leasing that we're doing for 2020 for expirations, but the majority of that is for 20252026.

Operator

Thank you. And I show our next question comes from the line of Boris Van Dijkke from Compass Point LLC. Please go ahead.

Speaker 8

Good morning, guys. Thanks for taking my question. Owen, you mentioned something in your comments about potentially transaction activity in the office market maybe starting to pick up and some of the pipeline of as we think about it, the foreclosures maybe starting to transact. Could you maybe talk a little bit more about that part of the market? What percentage of those assets could be premium or the ones that you would target?

Speaker 8

And maybe also talk about the disconnect between buyers and sellers and what does that mean for your are people closer to your cost of capital or are they are expectations on the seller and on the lender still too high?

Speaker 2

Yes. Good morning, Floris. First of all, on the foreclosure activity and short sales, loan sales and things like that, there's very there have been very limited activity in those areas for Premier workplaces. I think generally the premier assets, usually they're less leveraged, they're in stronger hands. And if they are leveraged, they're usually performing pretty well.

Speaker 2

And if they have a problem, the owners are doing whatever they can to fix the loans. So we just haven't seen much foreclosure or distressed activity with the Premier assets for all those reasons. That all being said, we've gone we've had a deal drought here for a couple of years. And investors, other owners, they got to get on with their business plans and at some point they need to transact. And so I do think we're seeing increased, as I described in my comments, testing of the market of certain assets.

Speaker 2

I won't get into any specifics, but there are definitely a handful of buildings right now that are being offered in the market. I think they're premier. And it's just going to be interesting to me if that bid ask spread gets bridged. Because right now, I do think there's a bid out there for Premier assets and so far no owners have decided have elected to take it. And I think the second half of this year will be interesting to see if any of those deals come to fruition.

Operator

Thank you. And I show our next question comes from the line of Rene Peer from Green Street. Please go ahead.

Speaker 8

Hi, guys. Thanks for taking the question. Just curious, appreciate your comments on the difference between premier assets versus the broader market averages, but just trying to get a sense for at what point you think you can start to see a pickup in net effective rents for your guys' premier portfolio. Is this something that given the difference in rents between Premier and non Premier that you don't think you'll start to see or sort of just how should we be thinking about prospects for net effective rent growth?

Speaker 3

So I'm not entirely sure what you want to use as your from when to when point, but I can tell you that net effective rents in our Park Avenue submarket of Manhattan, and I'll let Hillary comment, are higher today than they were 6 months ago and they're higher today than they were a year ago. I can say the same thing definitively about the Back Bay submarket of Boston, but it's going to take a long time for that to occur in markets where there is a significantly larger availability rate because of the nature of having to basically steal market share from existing embedded occupancy. And Hillary, if you can maybe comment on sort of transaction costs and what's going on with the rents in Manhattan because it's obviously the clearest example of what's going on from an NER perspective.

Speaker 17

Sure. Thanks, Doug. So in the Park Avenue submarket, which I think is the easiest one to focus on in Manhattan, The vacancy rate as noted earlier in the call is less than 8%. And when, vacancy drops below, I'd say about 10%, folks start realizing that if they want to be in that submarket, the pickings are very, very slim and they have to move if they want to get lease is done. And that's exactly what we've seen.

Speaker 17

We first saw face rates rise and concessions remain stable, which is a little bit unusual. In past cycles, you would first see concessions bleed out of the market before face rates began rising. Nevertheless, that's what happened. Face rates have risen, concessions have remained roughly stable. And so that has caused an increase in net effectives.

Speaker 17

Now anecdotally and very, very inconsistently, we're starting to see concessions move in a little bit. And so we're hopeful that that means that net effectives will accelerate. But I would just reiterate that there isn't a lot of availability in the strongest submarkets to test that theory against. In addition to the tightness in the Avenue submarket and what that's done for net effectives, I would say that it has bled outward in the sense creating more leasing velocity in adjacent submarkets, but those submarkets remain sort of full with concessions. And so think until those markets demonstrate more tightness in occupancy, we'll see stable concessions and rents flat for the near term.

Operator

Thank you. And our next question comes from the line of Peter Abramowitz from Jefferies. Please go ahead.

Speaker 3

Yes, thank you. Just noticed that the operating expense growth was a little bit elevated in the same store portfolio this quarter. I'm just wondering if you could comment on that, anything you would call out and anything to look forward for the rest of the year?

Speaker 4

I actually think our operating expenses were less than we expected them to be. So I think maybe they increased a little bit because there's a little more utilities expenses in the second quarter and repair and maintenance in the Q2 versus the Q1. We generally get started a little bit slower at the beginning of the year on some of those items. And I think the Q3 is generally higher than the Q2 seasonally as well because of weather conditions, again utilities. And I would expect R and M to be a little bit higher too.

Speaker 4

And that's kind of in line with where our budget is. And then it would be probably a little lower in the 4th quarter.

Operator

Thank you. And I'm showing our next question comes from the line of Oma Tayo Okusanya from Deutsche Bank. Please go ahead.

Speaker 18

Yes. Good morning. Thanks for taking my call. A quick question on leverage. Again, by our math, picked up again a little bit this quarter.

Speaker 18

You do have kind of debt that matures next year that probably refinance it to a higher rate. Just curious how we should kind of think about the trajectory for leverage over the next 6 to 12 months? And also if the rising leverage is causing any issues, concerns, if I may use those words, with credit rating agencies?

Speaker 4

So our leverage ratio is impacted by the funding of our development pipeline in a negative way and then in a positive way when that development pipeline delivers and starts generating EBITDA, right. So every quarter, we're funding developments that aren't going to be completing and delivering for a year or 2 or 3. We have 2 major developments in Cambridge that are going to be delivering 1300 Benny Street delivering in the Q1 of next year. And the other one is 290 Benny Street that is 3 times the size of that one, that's going to be delivering in 2026. Both of those are 100% leased.

Speaker 4

So when that comes in, it will moderate the leverage. The other developments, as was mentioned earlier, we pushed out a little bit, but when they stabilize, they will also moderate the leverage. So that will be, I'd say, impactful. And when we think about leverage, we think about kind of pro form a leverage for those types of investments, which would reduce our leverage probably a full turn or so plus or minus, which would bring it back down below into the 6.5x to 7.5x range, right, which is where we kind of typically target. So I think we're temporarily higher than that, but we're going to stay higher than that for the next several quarters, the timeframe that you just described, as we complete this pipeline.

Operator

Thank you. And our next question comes from the line of Uphol Rana from KeyBanc Capital Markets. Please go ahead.

Speaker 13

Great, thanks. Good morning. Could you give us a little more detail on the terminations? It looks like one of them was from Aloe Vera at 1100 Winter. But what were the others and how do these transpire?

Speaker 13

Any timing associated with these would be really helpful. Thank you.

Speaker 4

So, the terminations, not all of them have occurred. The one that you mentioned was in the media. And one of them that one was a pure termination. The square footage in the media was inaccurate, however. It only impacts 20,000 square feet of our occupancy in the near term.

Speaker 4

The other 2, one is the tenant that we're downsizing and relocating within our portfolio. They're staying with us. And we've got another tenant that is 4 or 5 times their size, that is going to be coming in and taking their space as well as other vacant space that is in that building. So that deal is not signed yet, but it's something that we're working on and we're confident in. And then the last one is a tenant at the Prudential Center, where we have a tenant whose business plan has changed.

Speaker 4

They've been looking to vacate their space and we have somebody else that wants it. So that tenant is going to be coming in, but the exiting tenant will be leaving in either the 3rd or maybe the beginning of Q4, probably Q3. But the new tenant is not going to be coming until the Q1 of 'twenty five. And so that's really the situation we're dealing with on these is the exiting tenants are leaving in 2024 and the new tenants aren't coming until 2025. We also had a similar situation in the New York City market at 601Lex, where we have an expanding tenant that's looking for space and we found somebody that would exit.

Speaker 4

And so that tenant has exited, but the expanding tenant will not be going in until mid-twenty 25. So it's just an example, if you add up all that square footage, it's 100,000 square feet of occupancy that's hurting us this year, where we're really it's really a good thing because we're bringing in a client that's a growing client, wants to sign a long term lease, with a client who's closer to their expiration date, maybe their plans have changed. In the case in New York, the client had already signed a lease in another building a couple of years ago because they needed space. And so they're able to just consolidate into that building. So every situation is a little bit different.

Speaker 4

It's all case by case. But this is kind of what we do. We try to manage these buildings and work these buildings, so we can limit downtime, increase rents and cover exposure.

Operator

Thank you. And our final question comes from the line of Ronald Kamdem from Morgan Stanley. Please go ahead.

Speaker 18

Hey, just a quick one for me. Look, if I think about this year on the same store NOI front, some explorations that you guys have been able to backfill quite nicely, but still sort of end up being a headwind to the same store NOI. So as we roll into next year, maybe if you could talk about whether it's commencements or sort of larger exploration, sort of those two aspects, how should we think about as you're rolling into next year, sort of potential headwind, tailwinds either from commencements or expiration? Thanks so much.

Speaker 4

So the same story in OI this year, which is modestly down, right, is due to occupancy being a little bit lower this year than it was last year, right? We've actually offset that a little bit with rent growth. So rents are actually higher than they were last year, but the occupancy has a much bigger impact than the roll up or the roll down of a lease by 5% or 10%. So as Doug described in his occupancy views and we can't we don't know the exact timing, but our expectation is that we will start to have more some occupancy growth next year. And if we get occupancy growth, that should go into the same store.

Speaker 4

So that will help the same store.

Operator

Thank you. And this concludes our Q and A session. At this time, I would like to turn it back over to Owen Thomas for closing remarks.

Speaker 2

We have no more closing remarks and I would like to thank everybody for their interest in BXP. Have a good rest of the day.

Operator

And this concludes today's conference call. Thank you for participating. You may now disconnect.

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Franklin Resources Q2 2024
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