2023-06-09 07:00:00 ET
Summary
- Boston Properties is a high-quality office REIT with an 8% yield and a BBB+ credit rating, making it an attractive investment despite its recent decline.
- The company's strong fundamentals, good dividend coverage, and positive underlying trends suggest that it is undervalued and has significant upside potential.
- Boston Properties is given a "Buy" rating with a price target of $80/share, based on a 10x P/FFO valuation.
This article was published at iREIT™ on Alpha on Monday June 5, 2023. This article was coproduced with Wolf Report.
I've been a vocal proponent of investing in office real estate investment trusts ("REITs") at low valuation. One of the higher-quality names in this segment, and one that I particularly like, is Boston Properties, Inc. ( BXP ).
This is a high-quality name that still has plenty of upside despite its recent climb. My own position is actually not far in the negative at this time, despite that office sector's significant decline.
BXP's price has been flat for the past month. I view it as likely that we've finally found the bottom, after a 6-month decline of 25%. It could go lower if circumstances worsen in the real estate sector, and specifically office, due to interest rates. However, no matter how you slice it, what you have here is quality at a cheap price.
Let me clarify.
Boston Properties Group - Plenty to like at this price
Investing in office REITs is riskier than investing in other types of properties. I've recently written about other companies such as Simon Property Group ( SPG ) and Realty Income Corporation ( O ), which offer relative safety as well as appealing yield.
Something like this, however, offers you a better yield, but also a bit more risk. At this time, we're at around 8% yield. Though, calling BXP "risky" is a bit of a stretch. The reason is that Boston Properties actually is BBB+ rated, despite that massive yield.
One of the only safer alternatives out there, with an equal or similar yield, is Simon Properties Group. If you already have plenty of Simon stock, though, or similar safety and yield, then this company could be a worthy addition to a good dividend yield.
BXP is actually the largest publicly traded owner/developer and manager of workplaces in the US. It's a market leader.
You'd be excused for thinking that something must be seriously wrong with the company's earnings this year or on a forward basis, given that the company has lost more than 50% of its market cap and share price in less than about a year. That's right. Since early 2022, the company has gone from trading at $130/share to now below $55/share.
To explain this sort of development, we'd usually expect to see an earnings decline or a funds from operations ("FFO") decline of around 20% - or at least double digits. Something significant. But that's not what we've seen. Since the company started declining, the company's FFO actually went up 15% in 2022, and although it is estimated to drop around 6% in 2023, FFO is still higher than 2020-2021 numbers.
So, the problem that we see is certainly not in any near-term earnings drop. The same is true for the 2024-2025 numbers on an estimated basis. The forecast for those coming years, even with the interest rate and macro, is for FFO to go up around 3%.
Despite that, this is the picture we have now.
BXP Valuation (FAST Graphs)
I don't need to explain to you that based on these numbers, I don't consider the trends as justified - I believe BXP, and companies in similar situations, to represent massive value potential.
This seems to be true for many of the REITs currently on sale, not just office. I'm talking retail and telco as well, I'm talking industrials and others. FFO or earnings are expected to remain at a relatively low growth rate, due to interest rates, inflation, macro, and lower interest for their properties.
This, in turn, has caused a significant decline in valuation across the REIT spectrum, because investors don't believe the companies are "worth" as much when they're not growing, which is a valid point to have.
I wouldn't call BXP interesting when it trades at an FFO premium. At one point it was 20x and above - that's not something I'd pay for this company - but more on valuation later. Let me talk results, for starters.
1Q23 is the latest report we have - and the results are a lot better than the share price would suggest. I'll start off with a quick recap of the facts to get you interested in the company, because there's plenty to like here. BXP is in the S&P 500 Index (SP500), it owns/manages over 190 properties totaling almost 55 M square feet, and is closing in on $2B on annualized EBITDA.
Over 5M of the square footage is in the attractive life science portfolio, something which has become more and more popular for companies in this segment.
A word on fundamentals and debt. Almost 8 years of average weighted debt life, and that at BBB+. Debt is well-covered here, and the company is in no fundamental sort of danger.
TSR for BXP investors since the 1997 IPO comes to over 550% - and that is even at the current valuation. If you had woken up to the company's overvaluation a few years back, you could have easily made double that TSR.
The company's operating areas may not sound like the most exciting, given that we're looking at properties in Boston, Washington DC, San Francisco, Seattle, and Manhattan. Every single one of these geographies is currently mostly out of favor, which goes some way towards explaining at least part of the discount.
However, both the work-from-home trends and the appeal of the areas are things that are changing.
BXP IR
Most underlying trends in this company are going the right way. The company signed 660k worth of leases in terms of square footage in 1Q23 alone, with almost 5.2M sq ft over the LTM period. The company has a successful history of divesting mature assets and deploying that capital attractively, and as of 1Q23 has $3.2B in available liquidity to work with.
The company's own estimates call for FFO growth to continue over the long term, even if near-term trends call for the company's projected 2023 growth to decline somewhat due to higher interest rate costs.
The company is pushing its life science portfolio further...
BXP IR
...but it remains a mostly NYC/Boston sort of company, which accounts for around 60% of the company's current NOI. Boston, in reflection of BXP's name, is 35%+ of the company. The company's clients are attractive, but they do have some exposure to IT/tech, which can be argued to be somewhat riskier.
BXP IR
The company's strategy at this time involves refreshing its portfolio to the degree where it can sustain and resist the current downturns. This is done through recurring upgrades, and recycling assets where necessary.
The company also has a robust pipeline when it comes to development . It's a common misconception at this time that office developers are not building. But the company has delivered plenty of new space, with much more in the development stage - almost $2B.
BXP IR
While risks remain for the company, and there are still questions that need to be answered going forward, I have a very hard time seeing a fundamental risk to the business here that would result in a significant downturn in safety.
The share price will go where investors drive it - but I have a hard time seeing this really impacting safety. If things have not declined at this time, I don't expect them to decline further to any degree that would justify the current valuation.
Let's look at that valuation.
Boston Properties Group - Plenty of upside at any realistic scenario here
Boston Properties is between a rock and a hard place in terms of valuation. It gives the appearance of being a business in dire financial trouble, but the underlying numbers do not support this hypothesis/stance in any way, shape or form.
With an average 5-year FFO growth including the 2024-2025E period of around 0.5% and a FactSet analyst accuracy of 100% , I find any assumption that there will be a massive decline in underlying FFO to be wishful thinking. The numbers, I will say this again, do not support this assertion.
Because of that, I am positive on BXP.
Let's dig in deeper. BXP has one of the better profitability metrics in the entire REIT industry, especially within the office sector. Its premium model has insulated it from the worst of the drops we've seen in the industry. In fact, if you look at BXP from a pure FFO growth perspective, it has grown FFO by a CAGR of 2.75% since 2003.
Of all years since 2003, the company has only ever recorded 4 years of declining FFO. One was in '08, which was the largest at 25%. Then we had another in '10, which was at 15%. Then we had '20 with COVID with a 10% drop. By this point the company was better prepared for a downturn.
And 2023E, we're expecting an FFO drop of 5%.
That's it.
And that's why the company is currently trading at a P/FFO on an average weighted basis of 6.86x?
Color me dubious as to this logic. BXP has been at such a massive premium for so many years that even when it dropped early during COVID-19, I did not invest. However, when the bottom fell out of the office REIT market in the US, I not only picked up BXP, I picked myself a whole basket of high-quality office REITs.
These are, in no particular order:
- Boston Properties
- Highwoods Properties ( HIW )
- Kilroy Realty ( KRC )
- Alexandria Real Estate Equities ( ARE ).
Most of my office REIT investing "budget" is going into these 4 companies. They all share the same appealing valuation fundamentals - declining price per share and earnings, with little or no decline in fundamentals. The decline is caused by fears about the office market, about the company's income, and about where this company is going.
The error as I see it, is equating issues or challenges in office generally with issues and challenges for these specific companies. A decline in NYC or Boston does not automatically mean that all properties there are worthless or vacant. However, that is how the market is currently acting.
Forecasting BXP on a single-digit 8.5x P/FFO gives us a 19.63% annualized upside or a potential RoR of 59% in less than 3 years. Any sort of normalization to multiples that are more valid in the longer term pushes the potential RoR up into triple digits here. A full normalization at 17-19x, at which point I would sell BXP, puts this close to 200% RoR.
BXP Upside (FAST Graphs)
To be clear, I don't expect this to happen in the near term. I am saying that any potential downside you see from this price onward, is likely to be extremely limited. The company has very good dividend coverage even with impaired numbers.
Insiders have been buying shares since early 2023. Investors like Ray Dalio, Jeremy Grantham, and other knowledgeable institutional investors are adding as well.
To those doubting the company or its assets, I pose the following question/challenge. Can you present a scenario based on a realistic decline in this business's actual operating portfolio of assets, inclusive of its pipeline and recently-completed properties, that would severely impair this company's ability to pay its dividend and operate normally?
Because I cannot - not realistically. Doing so requires ratcheting up the cost of debt to unrealistic levels and abandoning BBB+. It would require a complete abandonment of normal office operations, with companies not only reducing their office footprint (because BXP can easily manage if businesses were to reduce, and some are) but eliminating them altogether.
I do not see this happening.
The only reason to ignore the veritable gold mine that is the U.S. quality office REIT market at this time, is that you're already invested at capacity in undervalued safer names in more conservative REIT subsectors, or that you hold the firm view that there is an abandonment coming.
Because I do not see this, here is my thesis for Boston Properties.
Thesis
- Boston Properties is one of the 4 highest-quality office REITs I follow. The company has a solid credit rating, good yield, good safety, and underlying fundamentals that are going the right way. Between encouraging valuation trends, insider buying, excellent scores, and good results, I do not see a long-term negative trend for this company materializing - unless you count low growth as a negative trend.
- Based on this, I am positive on BXP, and give the company a "BUY" rating, though I will follow quarterly results closely to note any sign of serious deterioration.
- My PT for the company comes to a bare minimum of 10x P/FFO, which is around $80/share.
Remember, I'm all about:
1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1. Speaking of dividends, I just returned from REITWeek in New York City and I asked BXP's CEO, Owen Thomas, about the safety of the dividend (see his reply here ):
You can watch the entire interview at iREIT™ on Alpha.
Here are my criteria and how the company fulfills them (italicized).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
BXP fulfills all of my fundamental requirements for an investment. Because of this, I consider it a "BUY."
The company discussed in this article is only one potential investment in the sector. Members of iREIT™ on Alpha get access to investment ideas with upsides that I view as significantly higher/better than this one.
For further details see:
Boston Properties: Plenty To Like, Massive Upside After Q1