Boston Properties says it is well positioned for a coming rebound in tenant demand
By Murray W. Wolf
A joint venture of BXP and Alexandria Real Estate Equities is doing an office-to-lab conversion of the 651 Gateway Blvd. building in South San Francisco. (Rendering courtesy of Alexandria)
Boston Properties Inc. (NYSE: BXP) reported solid second quarter (Q2) financial results last Tuesday (Aug. 1), surpassing market expectations. But there was bad news, too.
Executives of BXP, which is active in the office, life sciences and residential markets, said during the firm’s earnings conference call last Wednesday (Aug. 2) that they expect leasing to be down in every quarter of 2023 relative to 2022. And the firm has paused vertical construction of the first phase of the planned three-building, 1.078 million square foot Platform 16 office project in downtown San Jose, Calif., citing a lack of demand. The real estate investment trust (REIT) owns 55 percent of the development in a joint venture (JV) with Canada Pension Plan.
BXP CEO & Chairman Owen Thomas said during the earnings call, “Whether or not we have an economic recession, U.S. companies are experiencing a recession in earnings, which for the S&P 500 are predicted to drop over 6 percent year-over-year in the second quarter.
“With lower earnings, companies look to cut costs, including expenditures for space, which is the primary driver of our slower leasing in the first half of 2023 versus last year. Large tech companies, the most significant source of new employment and net absorption of space last cycle, are largely absent from the current leasing market.”
So what does this mean for BXP’s life sciences real estate (LSRE) segment and the life sciences category as a whole?
On the acquisitions side, Mr. Thomas said, “We are being patient with new investment activity as we believe acquisition opportunities will grow in number and become more attractive in this environment. We will remain opportunistic and solely focused on premier workplaces, life science and residential development in our six target markets.” (BXP refers to its office portfolio – which consists of “high-quality buildings” in “the most desirable locations” in “six dynamic gateway markets”: Boston, Los Angeles, New York, San Francisco, Seattle and Washington, D.C. – as “premier workplaces.”)
As for leasing, BXP President Douglas Linde noted later in the call, “During the quarter, we completed three life science leases,” including a 55,000 square foot extension at a facility in Lexington, Mass.
“We (also) re-let the 12,000 square foot suite at 880 Winter St. (a life sciences conversion project in Waltham, Mass.), where we had a pharma biotech company shut down its operations in March. We did it on an as-is basis and the rent was 9 percent higher than the prior rent.
“And we completed our second full-floor lease at 651 Gateway in South San Francisco,” he said. That project, a roughly 327,000 square foot office-to-lab conversion, is a 50-50 JV with the pure-play life sciences REIT Alexandria Real Estate Equities Inc. (NYSE: ARE)
Mr. Linde continued, “We are also negotiating a third full-floor lease at 651 Gateway, and we intend to complete a speculative turnkey installation on an additional floor. The property will open in ’24 and, to date, each lease at 651 Gateway requires our partnership to complete turnkey build-outs.
“Activity in the life science market continues to be moderate across both Boston and South San Francisco, and there is new unleased supply being added to the market. There are a few large requirements that are touring. But … the bulk of the demand is from small private companies that are looking for fully-built space. Our new client at 880 Winter fits this profile.”
During the question and answer (Q&A) session near the end of the earnings call, Mr. Linde was asked about BXP’s overall leasing expectations.
“If you’re talking about the amount of leasing that we are doing on a quarter-by-quarter basis compared to the previous years, it’s going to be down for every quarter in 2023 relative to 2022,” he replied.
Part of the reason, he noted, is that “we did build-to-suits in 2022 that we’re not doing in 2023, including almost 1 million square feet just in Cambridge, (Mass.),” including a 570,000 square foot project for the biopharmaceuticals giant AstraZeneca plc (Nasdaq: AZN).
Mr. Linde also specifically addressed leasing demand in the Greater Boston market.
“The suburban Boston office demand market is slower than the CBD (Central Business District) market by a material amount right now. And so we are well positioned to capture incremental demand as the life science market recovers.
“And, as we’ve said time and time again, we’re not going to simply build for the sake of building. We’re going to wait for the demand to come to us and for the market to tighten to the point where it makes economic sense to do this.”
He added that the firm’s extensive Boston-area holdings, particularly in the Waltham-Lexington area, present good opportunities for future redevelopment.
“We have such a low basis in these buildings because we have effectively free land or buildings that were purchased for $150 or $250 a square foot, where we can rationalize incremental investment and get a strong return when the market is a stable market from a life science perspective,” he said.
Asked about space demand from life sciences companies, Mr. Linde noted that after an “enormous spike” in venture capital (VC) funding from 2019-21, VC funding has “normalized,” although it is still greater than before 2019.
“And so I would say that there is lots of available capital, but the capital is being very thoughtful,” he observed, “and it’s taking advantage, quite frankly, of dramatic drops in valuations for companies that were funded by people who probably shouldn’t have given them capital, and gave it to the valuations that were not appropriate for whatever the discovery was in the stage of those businesses.”
As a result, Mr. Linde says BXP expects to see “what I refer to as sort of small life science demand continue in the marketplace.
“The issue is that there are not a lot of big demand drivers other than … one or two consolidations that are occurring, with some pharma companies that have acquired some medicinal biotech companies over the last few years and are starting to put those requirements together in both South Francisco and in the greater Boston marketplace.”
Adding to the leasing challenge, demand has fallen while supply is growing significantly. In a recent research report, CBRE Group Inc. (NYSE: CBRE) noted that nearly 41 million square feet of new life sciences space and conversions was under construction as of Q2, with only 25 percent of it pre-leased, and about 12 million square feet is scheduled for delivery this year. And that’s on top of the almost 3.4 million square feet of lab/research and development (R&D) space that was delivered last quarter, with 45 percent of it pre-leased.
That increase in supply is definitely an issue, Mr. Linde said.
“When that (VC) money was going into the sector, lots and lots of people who had property said, ‘Aha! This is the perfect way for me to solve the problem of lack of demand on the office side. I’m going to take this building and convert it, or I’m going to take this land and build a new building.’
“And we’re going to have to deal with the rather a large amount of supply that’s going to be in the marketplace for the next couple of years. And it is clear that there are winner locations and there are loser locations, and these ecosystems matter a lot.”
Mr. Linde said BXP believes it is well positioned for life sciences, especially with 651 Gateway and the properties it has under development in Waltham. “And so we believe we’ll lease these things up,” he said.
“Are the economics going to be what we had hoped? They’re not…,” he acknowledged, noting that BXP is “going to have to do more turnkey installations for these companies, as opposed to giving them an allowance and then putting their own money in. But we will deal with that. And we have the capital to do that, which again, many of, I believe, our competitors with product may or may not have the desire or the capability of doing.
“So we’re going to get these buildings leased as the demand comes,” he said. “The demand is going to get better, not worse. And we just – it’s going to take a little bit of time. I can’t give you a projection of whether it’s 12 or 24 months, but that’s the way we’re thinking about it.”
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