Boston Properties: Looks Overvalued But There Is A Serious Value Below The Surface
Summary
- Boston Properties is a stable and reliable office REIT with a 3.4% dividend yield.
- It looks overvalued but there is serious value beyond the price and a great management team is in place.
- The company will have several challenges in 2022 such as the work from home trend, rising cost of capital but the management is actively working on solving these issues.
CHUNYIP WONG/E+ via Getty Images
Investment thesis
Boston Properties, Inc. (NYSE:BXP) could look overvalued at first glance but there is a serious value below the surface. The company will face challenges in 2022 with the rising interest rates causing the rise of the cost of capital and rising payments for variable rate loans and the continuing work from home trend can be challenging as well. But the management handles these issues well and they are prepared to face these with low variable rate loan portfolio structure, and acquiring more biotech/lab offices where home office trends do not matter. BXP might not be an exponentially growing and very high dividend yield company but I am still convinced it is worth a closer look for sophisticated investors.
Business Model
Boston Properties is the largest publicly-held developer and owner of Class A office properties in the United States, concentrated in five markets - Boston, Los Angeles, New York, San Francisco, and Washington, DC. BXP’s biggest holdings are in Boston (34%), New York (29%), and San Francisco with 20% of its office portfolio. The company’s portfolio totals 51.5 million square feet and 197 properties and has a market cap of almost $20 billion. BXP is an office REIT with its Top 20 tenants including Salesforce, Biogen, Google, Microsoft, and the US government. The company currently has a $2.7 billion active development pipeline.
Source: Quarterly Investor Overview
BXP has revenue from 3 major sources but the office leases are responsible for the lion’s share of income. The office lease is responsible for 95% of revenue, the parking space rent is 2.7% and new project development and management is 1% of the total revenue. The company is also committed to environmental issues and the management is proactively reaching its goals. “We are committed to working toward a more sustainable future and to reaching our goal of becoming carbon neutral in our business operations by the end of 2022,” said Ed Steinborn, CFO.
Source: Quarterly Report
Financials & Earnings
Q3 results
Revenue grew more than 5% to $730.1 million for the quarter ended September 30, 2021, as compared to $693.3 million for the quarter ended September 30, 2020. Net income attributable to common shareholders was $108.3 million, or $0.69 per diluted share (EPS), compared to $89.9 million, or $0.58 per diluted share, for the quarter ended September 30, 2020. The increase in EPS of $0.11 per diluted share is primarily related to increased lease revenue and revenue from parking and hotel operations. Funds from Operations (FFO) was $270.5 million, or $1.73 per diluted share, compared to FFO of $244.0 million, or $1.57 per diluted share, for the quarter ended September 30, 2020.
The company signed approximately 1.4 million square feet of leases in the third quarter with a weighted-average lease term of 9.3 years. BXP acquired 2 properties: the Safeco Plaza (approximately 90% of it already leased), an 800,000 square-foot Class A office building in Seattle, Washington, and Shady Grove Bio+Tech Campus, consisting of seven buildings totaling approximately 435,000 square feet in the Shady Grove area of Rockville, Maryland. BXP reported an EPS of $0.69 which is in line with the management’s provided guidance for the full year 2021 with a projected EPS of $3.11 - $3.13. BXP also earned a top ESG rating in the 2021 Global Real Estate Sustainability Benchmark assessment.
Valuation
A good indicator to see how undervalued or overvalued BXP is to check its book value to its current price. In addition, we can make a comparison with its similar market cap peers. In the last 10 years, major office REITs did not trade under their TBV so it would be a bit foolish to say they are all massively overvalued. This is why I would look at the recent years to see a relatively reliable valuation. BXP is still trading under the pre-pandemic levels in terms of TBV. Pre-COVID levels of P/TBV were 3.65 – 4.01 while now BXP trades at 3.15 which indicates the company has internal growth potential. Comparing the company to its peers we can see that Boston Properties might be a bit overvalued. Alexandria Real Estate Equities, Inc. (ARE) an office REIT with a similar market cap and Vornado Realty Trust (VNO) trades relatively closer to their tangible book values. VNO seems cheaper but the reason behind that is that the company has 90% of its revenue from Manhattan offices which were the hardest during the pandemic.
Source: Seeking Alpha
The price-to-FFO ratio is a better way to assess whether a REIT is expensive or cheap relative to its peers. BXP has a forward P/FFO ratio of 18.05, a bit under the current sector median of 19.41. Comparing BXP to Vornado we can see a similar trend to the TBV comparison. VNO has a forward P/FFO of 17.61 which indicates a slightly better valuation than BXP. I think an income investor can choose from any of these 3 companies if wants to get exposure to the office REIT sector because all of them are relatively safe choices.
Company-specific Risks
Since BXP is mainly an office REIT (but it has growing biotech and lab office spaces as well) the pandemic and the home-office trends can hurt the company’s future lease agreements and the bottom line as work from home trends seem permanent with 25-30% of the employees are working from home exclusively. This is why the management started to move towards healthcare real estate projects because this number is far less in the biotech industry due to the nature of work.
BXP derives most of its income from rent received from its tenants. If a tenant experiences a downturn in its business or other types of financial distress, including the costs of additional federal, state, it may be unable to make timely rental payments. Also, when their tenants decide not to renew their leases or terminate early, the company may not be able to re-let the space or there could be a substantial delay in re-letting the space. The Top 20 tenants are responsible for the quarter of the rental income of BXP but the management is actively working on changing the tenant structure. As of December 31, 2019, the U.S. Government was their largest tenant by square feet but by Q3 2021 it only represented a 1% portion of the rental income. The company is subject to compliance with a wide variety of complex legal requirements because they are a Federal Government contractor. Their failure to comply with these laws could subject them to fines, penalties, and damages, cause them to be in default of their leases and other contracts with the Federal Government and bar them from entering into future leases and other contracts with the Federal Government. Failure to comply with Federal Government contractor requirements could result in substantial costs and loss of revenue but not as substantial as a year ago.
Source: Quarterly Investor Overview
BXP is subject to the risks normally associated with debt financing, including the risk that their cash flow will be insufficient to meet required payments of principal and interest. The management anticipates that only a small portion of the principal of their debt will be repaid before maturity. Therefore, they are likely to need to refinance at least a portion of their outstanding debt as it matures. There is a risk that they may not be able to refinance existing debt or that the terms of any refinancing will not be as favorable as the terms of our existing debt. In addition, the company may rely on debt to fund a portion of their new investments such as their acquisition and development activity. There is a risk that can increase the cost and reduce the availability of debt, which may worsen in the future. LIBOR rates are on the rise in the short term and an interest rate hike is on the horizon. On September 1, 2021, BXP entered into a joint venture to acquire Safeco Plaza for a gross purchase price of approximately $465.0 million. The purchase price was funded with cash and proceeds from a new mortgage loan secured by the property. The mortgage loan has a principal amount of $250.0 million, bears interest at a variable rate which will be affected if the interest rates start to rise.
My take on BXP’s dividend
Current dividend
Boston Properties has an impressive dividend history with 24 years of consecutive dividend payments. The company is also an S&P 500 corporation which makes it relatively safe compared to the other smaller cap office REITs. Usually, office REITs do not have a very high dividend yield, the sector median is 3.32% and BXP has a forward dividend yield of 3.40%. The company has not made any dividend increases since the start of the pandemic but as the office market returns to pre-COVID levels I am almost certain we can expect a small dividend raise.
Future sustainability
One of the best indicators of the sustainability of a company’s dividend is the payout ratio (plus the actual cash flow of money). BXP has the best payout ratio of its peers and I do not expect any dividend cuts in the upcoming years but rather a dividend raise in the second half of 2022. Seeking Alpha has a dividend growth estimate of 1.53% which is not a huge number but for 2 years BXP’s management has not declared any increases.
Source: The table is created by the author. All figures are from the company's financial statements and SA Earnings Estimates.
Summary
I would choose BXP for an office REIT among its peers because I like how the real estate portfolio is spread through the country and I also like the constant diversification and acquisitions. The company will face difficulties with the rising cost of capital and the rising work from home trends but I am quite confident that the management makes the necessary steps to overcome these issues such as the rise of biotech and lab office spaces in acquisitions and developments. I think the management is allocating shareholder capital well and their environmental goals are impressive and necessary. For an income investor who wants to get exposure to the office REIT sector (knowing the yields are not the highest) and also cares about the environmental issues, I think BXP can be a great choice.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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