The first year of the pandemic in 2020 was not a kind one for office real estate investment trusts. The same was true for the biggest office REIT, Boston Properties, which has a market cap of $18.15 billion as of December 2021. Shares of Boston Properties (NYSE: BXP) had dropped 35 percent at one point in 2020, as the threat of seemingly permanent remote work arrangements worried investors. BXP’s market cap fell to $14.71 billion in 2020 from $21.33 billion in 2019, and its revenue in 2020 also decreased by 6.65 percent. It was the first time Boston Properties’ annual revenue had decreased within the past two decades. But it could have been much worse. Boston Properties has actually proven to be quite resilient in the face of remote work trends and a stubborn virus that resurfaces fears with each new variant.
As the largest office REIT in the U.S., Boston Properties specializes in Class A properties in dense urban markets like Boston, New York, San Francisco, and Washington, D.C. The company owns a portfolio of 196 properties totaling 51.2 million square feet of space. While some retail elements are in its portfolio, the vast majority (about 92 percent) of Boston Properties’ rent comes from offices. In its 2020 Annual Report, the company said it collected a stunning 99 percent of rents throughout that first year of the pandemic and experienced limited rollover of office clients, which signals that many tenants don’t want to lose their office space despite remote work. In 2020, the company also completed 184 leases comprising 3.7 million square feet with a weighted-average lease term of 8.3 years. One of the highlights that year was a 400,000 square-foot lease with Microsoft at Reston Tower Center in Reston, Virginia, increasing the tech giant’s 165,000 square feet it was previously leasing in the region.
One of the reasons why Boston Properties has been able to keep rent collections so high, even during the pandemic, has been its switch from manually sending and receiving paper invoices to predictable digital payments. In 2019, BXP implemented a cloud-based accounts receivable solution from a company called Versapay that automated the invoice-to-cash process. Prior to this, Boston Properties dealing with cash and ACH payments was a big issue and slowed down the REIT’s cash flow. About 98 percent of the company’s rental tenants have adopted their new cloud-based payment method, according to Versapay, greatly reducing the time BXP’s finance team spent chasing ‘small dollars.’ The system came in handy at the onset of the pandemic in March 2020 when some tenants were provided rent abatement of up to three months. Versapay says their digital software enabled the REIT to more easily keep track of abatements and contact tenants when the period was up.
The start of the pandemic in the spring of 2020 provided a shock for office REITs, but most have been slowly recovering. Nareit reports office REIT rent collections averaged about 93.2 percent in April 2020, but gradually increased to 95.2 percent by July 2020. Office REITs were collecting a vast majority of rents from office tenants during Q4 2020, but overall rent collections for some REITs were weighted down by retail tenants. For example, Empire State Realty Trust Inc. collected 96 percent of billed rent from office tenants in Q4 2020, but just 87 percent from retail tenants. Vornado Realty Trust collected 97 percent of office tenant rent in that quarter, but 88 percent from retail. Only six percent of Boston Properties tenants are in the retail sector, which helps explain part of the reason its overall rent collection has outperformed other office REITs.
As rent collections for office REITs have stabilized, analysts are looking at office occupancy rates as a better indicator of performance. And that metric has been more of a mixed bag. Office REITs reported a slight decline of 30 bps for an occupancy rate of 89.8 percent in the third quarter of 2021, the number is still 390 bps below pre-pandemic occupancy rates of the fourth quarter of 2019. Compare this to the red-hot industrial sector, where industrial REITs reported an occupancy rate of 96.4 percent in the third quarter of 2021, which was 30 bps above pre-pandemic levels.
Leasing volumes, though, continue to recover for office REITs like Boston Properties, and other macroeconomic indicators show recovery. Market conditions have made it favorable for tenants, and office landlords have had to rely more on negotiating skills. For example, in late 2020, BXP President and Director Douglas Linde said tenants with soon-to-expire leases considered leaving because so many employees were working remotely. Many tenants told BXP that if they could secure a short-term extension, they’d hold onto the space and consider the next steps. Boston Properties agreed to some extensions, and Linde said the approach has paid off. Tenants that agreed to extensions are likely to renew on a long-term basis, Linde said, with terms that are higher than old leases.
Boston Properties gets about 26 percent of its net operating income from the New York City area, where some forecasts for the office market have been dire. Only 28 percent of Manhattan workers are back in the office, according to a recent survey of 188 big employers by the Partnership for New York City. Office vacancy rates in NYC are at a 30-year high of 18.6 percent, and more than a third of employers in the Partnership survey said they expect their office needs will decline in the next five years. The surge of COVID-19 cases because of Omicron has added new fuel to the fire, leading to a rush for at-home tests, closed Broadway shows, shuttered restaurants, and some city employers pushing back return-to-office dates. REITs like Boston properties continue to think strategically and long-term despite the setbacks. According to what CEO Owen Thomas has said repeatedly over the past year, large employers (especially Class A office buildings tenants, which Boston Properties caters to) are waiting out the pandemic and eagerly awaiting the return to the office.
“I think pretty much universally, the CEOs and business leaders we talk to, if they’re not back in the office, they want to figure out a way to get back in the office,” Thomas said in response to a question during the company’s third-quarter 2021 earnings call. “I do think over time, you’re going to see more and more companies bringing their employees back to the office because those leaders are concerned about the future competitiveness and cohesion of their companies,” he said.
All things considered, Boston Properties and other office REITs are weathering the major storm of the pandemic, but it hasn’t been easy. Boston Properties has leased more than 91 percent of its portfolio, and its tenants continue to sign longer-term leases. In the third quarter of 2021, they reported an average weighted term lease of 9.3 years, versus 7.5 years in the second quarter. “As time progresses and the shortcomings of remote work become more apparent, we increasingly hear concerns from business leaders about the decaying cultures of their companies, inadequate training and difficulties in onboarding new professionals as well as the potential for deterioration in innovation and competitiveness,” Thomas said in the Q3 earnings call. “We believe it’s only a matter of time before employers more strongly encourage their teams to return to in-person work.”
Return-to-office dates keep getting pushed back, but this may not have the long-term reckoning on office REITs like Boston Properties many would think. Companies that want Class A offices, like the Google’s and Facebook’s of the world, and even smaller and mid-sized firms are thinking long-term. For example, Facebook (now Meta Platforms) is pursuing a half-million square foot property in the Seattle region. Rent collection has been stable for office REITs, and remote work hasn’t been causing lease terminations or shrinkage of office occupier space, according to a report by Fitch Ratings. Boston Properties management admits hybrid work will change how the office looks, leading to slower days of the week and more flexible spaces, but the need for physical office space isn’t going away. Boston Properties is often a forerunner of the office market. From what they’re saying right now, the panic of the pandemic and remote work won’t have the apocalyptic results on commercial office property some prognosticators have foretold.
Boston Properties’ balance sheet remains strong despite the challenges of the pandemic and the threat of remote work. The company reported liquidity of $3.2 billion at the end of 2020, meaning it has plenty of financial flexibility to make value-added investments and grow its portfolio. And BXP’s executive team doesn’t seem to be super-worried about the ‘office is dead’ naysayers. As Fitch Ratings said in a recent report, “Tenant leasing discussions are focused on long-term planning, as opposed to another wave of infections and local government guidelines.” Boston Properties CEO Owen Thomas has hinted that it’s not a matter of if, but when major companies return to the office at Class A properties.
Boston Properties has continued to execute new lease deals and, despite the pandemic, remains hopeful about the attractiveness of big cities and the downsides of permanent remote work. The company is in an excellent position to capitalize if the office market comes back with a vengeance once pandemic fears tamper down. The REIT’s tenants are diversified across many types of industries, including tech, media, and financial services. The REIT also doesn’t depend heavily on any one tenant. Its largest occupier is Salesforce, accounting for just about 3.5 percent of the REIT’s overall lease obligations. If there’s a drop in urban leasing and the office market continues to erode, it’s not a stretch to say Boston Properties could further weather the storm. The company continues to acquire attractive Class A office properties that appeal to heavy-hitters like Google and Microsoft, who are now looking for more office space, not less, especially in downtown urban centers like New York and San Francisco. It’s too early to tell the office’s fate in a post-pandemic world, but it’s beginning to look less like a collapse and more like an evolution. Either way, you can bet that a massive office REIT like Boston Properties will be in the middle of the action.