Boston Properties (BXP) has a lot going for it – not only does the company hold a best-in-class office portfolio, but it also has a strong management team at the helm. Though BXP remains the benchmark, I am not bullish just yet. Despite yesterday’s vaccine announcement boosting the stock, I still think the range of headwinds at play, from BXP’s exposure to COVID-impacted areas like retail and hotels, as well as the secular work-from-home shift, threatens the long-term earnings power. At current valuations, I see more risk than reward in BXP.

FFO Misses the Mark as Operating Metrics Come Under Pressure

BXP reported a 3Q20 FFO/share of $1.57, slightly below consensus and down 4.3% YoY. That said, excluding a ~$0.06/share write-off from accrued rent and accounts receivable (primarily related to tenants in COVID-affected industries), FFO would have been in-line. But same-store NOI trends are also under pressure, down ~8.5% YoY on a GAAP basis and 13.1% YoY on a cash basis (-12.5% YoY reported), on a ~90bps occupancy decline to 91.1%. Much of the NOI weakness was again, down to COVID-impacted areas – the reported cash same-store NOI growth of -12.5% YoY moves to -8.1% YoY excluding deferrals and -2.7% YoY adjusted for parking and hotel revenue losses.

Source: 3Q20 Supplemental

While operating metrics remain pressured given the COVID impact, lease spreads were up ~13.7%, a positive surprise on decent volume. As of 3Q, rent spreads on second-generation space were +20.1%, with spreads strongest in San Francisco (+29.5%), followed by Los Angeles (+19.6%), and Boston (+15.3%), with DC the laggard (+1.06%). With no guidance provided, though, it’s hard to make a call on office fundamentals being anywhere near the bottom at this juncture.

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Source: 3Q20 Supplemental

Occupancy Declines Offset Strong Rent Collection

BXP bulls will likely point to the strong 99% collections of 3Q payments from office tenants (vs. 98% in 2Q20) as a sign of strength. And rent collections from commercial tenants, including retail, were also strong at 97%, though there are pockets of weakness within hotel and retail. But I would not put as much stock in the high collection rates in the office portfolio, given the tenant base consists of well-capitalized public-listed companies with the ability to make rent regardless of utilization.

Instead, I think the occupancy levels are the key near-term metric. Thus far, the occupancy has declined precipitously, with BXP indicating occupancy could drop further to 90%-90.5% in 4Q (down from the 91.1% in 3Q). This trend was particularly pronounced in New York and San Francisco, which declined ~210bps and ~160bps, respectively. And with 6.5% of BXP’s portfolio up for renewal in FY21 (BXP will also redevelop some of the vacant properties), I see a challenged occupancy outlook ahead.

Source: 3Q20 Supplemental

Development/Transaction Updates

BXP has been active in building up its pipeline – in 3Q, BXP acquired a 50% interest in Beach Cities Media Center (6.4-acre site in El Segundo, LA) for $21.2m and a 50% interest in 759 Harrison, San Francisco for $2.3m. BXP did not carry out any dispositions in the quarter. Additionally, BXP also completed and fully placed in service the following – Hub50House (a 320ksf residential development in Boston) and The Skylyne (a 331ksf residential property in Oakland).

As of end-3Q, BXP has a ~$2.4bn development pipeline in place (77% pre-leased), which comprises the following – $2.2bn for office properties and $0.2bn for redevelopment projects.

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Source: 3Q20 Supplemental

A Long Way Off a Full Recovery

My key reservation on BXP remains its exposure to offices. With the consensus narrative on the office space pointing toward a COVID-driven acceleration of work-from-home arrangements among employers, I am concerned about BXP’s long-term earnings power. But I’d note that even pre-COVID, demand for office space had been sluggish outside of tech. Yet, even tech demand has slowed now as more employers look to increase their virtual presence going forward.

As a result, the path to recovery for office, and by extension BXP, seems unclear at this point. Further, the company’s latest plans to expand its presence in life sciences likely points toward internal concerns around the long-term prospects for traditional office demand as well.

A Mixed 3Q, with a Tougher Look into 2021

Net, BXP’s 3Q was a mixed bag, featuring more minuses than pluses, in my view. On the one hand, collections were strong, and so was leasing activity, with Volkswagen signed up for 196k sf post-3Q. Yet, the NOI run rate remains below par, with continued occupancy declines and a lack of guidance pointing toward a challenged 2021 outlook. At ~18x fwd AFFO of $4.95/share, I see more risk than reward with BXP. Downside risks include development and leasing risk with several major projects underway, as well as interest rates.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any 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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