Boston Properties

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Boston Properties is a publicly traded real estate investment trust (REIT) specializing in the development, acquisition, management, and ownership of Class A office properties, primarily in a select few US gateway markets.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

BXP operates as a fully integrated, self-administered, and self-managed REIT, and is one of the largest publicly traded owners, developers, and managers of Class A office properties in the United States. It focuses on a concentrated set of high-barrier-to-entry gateway markets. Its objective is to maximize return on investment over the long term.

Business Explanation

  • Revenue Distribution: BXP generates revenue primarily through leasing office space. As a REIT, its cash flow is largely based on rental income, which is dependent on occupancy rates and lease terms. The REIT structure enables it to offer high dividend yields that can be very attractive for investors. Other revenue sources include management services and property sales or gains. In their most recent earnings reports, they break down revenue into (1) Rental (2) Parking and Other Revenue (3) Development and Management Services. In 2023, Rental generated 95.1%, and the remainder came from other activities.
  • Industry Trends: The office real estate sector has been facing headwinds in recent years due to the rise of remote work and economic uncertainties. This has led to increased vacancies and slower lease demand, which are putting downward pressure on rents and valuations. However, there’s an ongoing flight to quality that is seeing well-located, newer, high-quality office space in prime locations do relatively well, and see more demand, than older properties in less desirable locations. REITs have been facing difficulty in some regards. Interest rates and borrowing costs are much higher than in previous years, especially for debt with variable rates. Debt to equity ratios are also something to pay attention to as this ratio has dramatically changed for some companies. Many companies have been focusing more on share buybacks as they believe this is a good way to increase value to shareholders as they tend to be underpriced in the public markets. At the same time, inflation can make value hard to estimate and also increase costs of doing business. Companies that are able to keep their costs low, and improve upon efficiency of operations are doing well during these turbulent economic times.
  • Competitive Landscape: BXP competes with various real estate owners, developers, and REITs, such as SL Green Realty, Equity Residential, and Alexandria Real Estate Equities. Competition is based on price, location, lease terms, amenities, and tenant services. The office market can be very fragmented within each location, and many companies focus on different geographies or classes of tenants. The scale that BXP possesses gives the company a competitive edge. But with the shift in work culture, companies are having a hard time filling their leases. A main consideration is having good locations that people want to work at. While other competitors may try to have better services and lower rent, companies with high leverage may find their cash flows drying up with little or no rent coming in.
  • What Makes BXP Different?: BXP aims to develop and own high-quality, Class-A office properties in a select number of supply-constrained gateway markets: Boston, Los Angeles, New York, San Francisco, Seattle, and Washington D.C. This concentrated strategy allows them to achieve a strong presence and premium pricing in these key markets. BXP operates with a long term view, and aims to be the best owner in every city they operate in. In their shareholder letter, they explain that the company has a high quality portfolio of assets, deep tenant relationships, a proven development platform, and a talented and experienced team of professionals. Their portfolio is considered the highest quality office properties in the United States, as opposed to other lower graded offices owned by competitors. They have also been on the cutting edge of sustainability in the real-estate world, and that has brought the companies several awards. Finally, their track record of acquisitions and developments have been phenomenal, even though they have not always resulted in positive outcomes.

Financial Analysis

BXP’s business model is dependent on leasing office space in high-demand markets, as such, a robust understanding of its financial performance requires a detailed analysis of key drivers of value.

  • Return on Invested Capital (ROIC):
    • ROIC for BXP is dependent on their specific business cycle, and the overall industry, which has seen large fluctuations in recent years.
    • Their historical ROIC has been good, however, there was a period in 2020-2021 where it dipped below their cost of capital.
    • At a high level, companies that acquire more property for a lower return, will inherently have lower overall ROIC. For REITs, high levels of capital spending may not reflect the long-term value creation, as they are inherently capital intensive businesses.
    • There are no publicly available historical ROIC numbers from the company. As such, I will provide an economic profit analysis for the year ended 2023. NOPLAT = $650 million. Invested Capital is $21.6 billion. The cost of capital is around 7.5% as estimated in previous chapters, and we will assume it’s the same for this calculation. Economic Profit = 21.6 Billion * (.030- .075) = -1 billion. As you can see, the economic profit was negative for the year ended 2023, indicating that they were destroying value. This is an area that must improve for the company.
  • Revenue Growth:
    • Historical revenue growth has been solid and consistent, although there is no publicly available data on it. Instead, I use the change in operating income as a way to estimate this. For 2023, operating income increased approximately 500 million to 1.7 billion.
    • Looking at a 5 year trend, from 2019 to 2023, we see the revenue increased from 2.4 billion to 3.6 billion. This is a 10 year CAGR of about 10%. But it is important to take note that most of these increases came from acquisition rather than operational improvements.
    • However, revenue growth in real terms may be lower, especially in 2023 where their net income was negative.
  • Margins: Operating margins are not high. For 2023, net income to revenue was approximately -15%, whereas if we use operating income, this was about 47% of revenues. Operating costs also increased substantially in 2023 to 1.7 billion from 1.2 billion the previous year.
  • Profitability: Net income was negative in 2023, owing to lower property valuation. However, looking at a 5-year trend, we can see it was positive and strong in years 2019 to 2022. We believe that these are all outliers and the company has maintained profitability over a longer period.
  • Leverage: Debt is a major consideration when evaluating BXP, as they need to borrow to create more properties, and to fund operations. The company’s credit is largely dependent on the amount of debt and interest rates on that debt. From their latest financials, the company has a debt-to-equity ratio of approximately 1.5, indicating they are largely leveraged. In addition, a large portion of this debt is tied to fluctuating interest rates, and can cause huge variation in profitability in the future.
  • Cash Flow:
    • Operating cash flows have generally been good over the past few years. However, these do not include all the money that goes into acquisitions, which is a primary use of cash at BXP.
    • Looking at a 5-year trend of cash from operations, we see that is generally consistent and positive.
    • The company also uses free cash flow (FCF), which for 2023, was -$1.1 billion. As shown in exhibit 7.3, a company’s FCF will be reduced dramatically when large investments are made into capital expenditures. The key is to ensure that these expenditures make up for the loss of cash from the initial spend.
    • To ensure that a company can operate well, it must have good operating cash flow. Companies that are dependent on borrowing for operations will see their value shrink rapidly in times of economic and credit distress.
    • As a result of these data points, and the negative economic profits, the company has a negative cash generating cycle.
  • Other Financial Data (per company):
    • Average interest rate on debt is 4.97%
    • Weighted-average lease term is 6.9 years
    • Occupancy rate of properties in the operating portfolio: 90.1%.
    • Total annual revenue: $3.65 billion
    • Total Assets: $35.7 billion
    • Total Equity: $14.6 Billion.

Moat Analysis

BXP has a Narrow Moat rating of 2/5, indicating limited, but some competitive advantages that it has created that will make their business and profitability sustainable over a long-term time frame.

  • Intangible Assets: BXP does have a degree of intangible value, in that they have a reputation for high-quality property ownership, which may appeal to high-end clients, but the nature of their business involves owning and managing commercial real estate, which does not inherently require brands or patents, so they cannot leverage that into a lasting competitive advantage.
  • Switching Costs: The switching costs in this industry are not very high as they are typically negotiated at market rates. The location of their property can act as a switching cost, because other firms may not have assets in the same location, but the quality of service can be replicated easily.
  • Network Effects: Network effects are not present. They don’t make a stronger portfolio because more people are interested in it, but it has a fixed client number. There is not a growing benefit for the company in this regard.
  • Cost Advantages: The company enjoys some cost advantages by specializing in Class A office properties in high-demand cities, but because they are primarily landlords, cost leadership isn’t their strong suit. There are several other real estate owners that can do similarly to BXP, with varying degrees of success. As such, there are no meaningful economies of scale or unique resources that BXP can leverage.

Risks to Moat and Business Resilience

  1. Economic Downturns: A major recession could hurt the demand for office space, leading to lower occupancy rates and lower rental prices. As shown in the 2023 reports, these are the main aspects of BXP that were most negatively impacted in that year.
  2. Increased Competition: New entrants or expansion by existing players in the REIT space can erode margins and lower market share, leading to less profits. While BXP controls some prime locations, this could be taken away with competitors having better offerings, or building in better locations that cause a decrease in interest.
  3. Rising Interest Rates: Since BXP uses borrowed money to develop and acquire properties, an increase in interest rates could hinder their growth and profitability as they have to make large debt repayments. BXP has a high degree of leverage, and rising interest rates will negatively affect their bottom line.
  4. Technological Disruption: The rise of remote work may continue to depress demand for office spaces and make the existing properties less valuable.
  5. Operational Issues: Large projects can go bad quickly or can become more expensive and have lower revenues than expected. Development and management of projects may have more operational issues or may incur higher cost.
  6. Regulatory Changes: Changes to local regulations can also have an effect on the value of BXP’s portfolio.

Understandability Rating: 3 / 5

BXP is a somewhat straightforward business to understand. It’s essentially a real estate company that buys, builds, and leases buildings, predominantly Class A office properties. The intricacies are in the nuances of real estate markets and various financing tools and accounting methods, which make it slightly difficult for beginner investors to fully understand.

Balance Sheet Health Rating: 4 / 5 BXP maintains a mostly-good balance sheet, although the high debt levels and reliance on debt markets make the situation tenuous. This, coupled with the negative earnings in 2023, mean the overall balance sheet is not perfect.

  • Leverage: As previously mentioned, the company operates with a very high debt to equity ratio, especially when looking at historical data. This can be dangerous as the company has very little buffer for a negative economic downturn, or a change in interest rates.
  • Interest Coverage Ratio: The interest coverage ratio, determined as earnings before taxes and interest divided by interest expense, is approximately 4.6, which is reasonable, but not fantastic, so they are only just able to cover their debt.
  • Liabilities: BXP relies on debt instruments, including bonds and bank debt. The amount of liability is massive, so this does impose a significant amount of risk. There are no significant amounts of current liabilities.
  • Assets: BXP holds high-quality assets, most of which are buildings and land that is readily available for them to rent out and generate future cash.
  • Cash: The company has been producing positive cash flows over the years, which gives them some cushion for times of market difficulty.

Recent Concerns / Controversies and Problems In their recent earnings reports, the management team has noted the following key points: * BXP recognizes that the ongoing shift to hybrid work has made a change in the way their assets are used, and that the company will be adopting their strategy around that. This is a concern for future growth. * They are looking towards AI and other technology innovations as a way to make their properties more desirable for the workplace. * They mentioned that the current market environment has made value harder to estimate, and that they will continue to work with their clients to have long-term sustainable partnerships. * The company saw operating expenses rise dramatically, owing to higher costs of services, and inflation. They will be trying to streamline the company to reduce those costs. * The company also mentioned that the demand for Class A space in core markets is still strong, and they are poised to capitalize on the opportunities that have presented themselves.

  • They believe that even though occupancy is below the average, prices and profitability are still in line with historical data for the company, as demand for high quality office properties is still there.
  • They continue to believe in a long-term return to offices as they believe that there will always be a need for that market segment.
  • They have a very low vacancy rate in their new developments and are looking towards new developments and strategic acquisitions.
  • The management team are closely monitoring changes in credit markets and are actively managing their financing and debt levels. This is something that they are focusing on, but still remains a potential future risk for the company, as they are highly leveraged.

The earnings call for the last quarter and most news reports focused mostly on the ongoing issues in the real-estate market, and the company’s ability to continue generating revenue with those conditions. While their long-term picture looks optimistic, there is still a degree of uncertainty that cannot be discounted. Investors also seemed to be particularly interested in the company’s use of AI and technology in building better spaces, and also in the company’s strategic acquisitions and what they bring to the table for the future.