June 17, 1998
Stocks for Dad
To Dad from Michael
by Michael Dowd (TMF Yorick)
Boston Properties Inc.
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8 Arlington Street
Boston, MA 02116-3495
http://www.bostonproperties.com
$32 3/16 as of June 15, 1998
For about thirty years, my Dad's office was in Boston's Park Square Building. After two waves of office development, the facade began to look long in the tooth and Dad regretfully moved to the 38th floor of the Prudential office tower. The Pru has sweeping views across Back Bay, Beacon Street, and the Charles River. Dad truly loved Boston, and as an advertising man, he had an understanding of the good-credit businesses that were his clients and his fellow tenants. Boston Properties, Inc. recently announced it is going to buy the Prudential building. If Mr. Dowd were still with us, I think he would have wanted some shares.
Boston Properties, a $4.2 billion REIT, has been a major office developer for thirty years. It went public last June, and by mid-summer will own 102 Class A office buildings with 24.6 million rentable square feet. (These totals include acquisition of Prudential and Embarcadero Centers, but exclude three hotels and a garage.) CEO Mortimer Zuckerman admits he's unhappy with the stock's price, but it has performed as well as the S&P since the IPO. That's good for a REIT lately, particularly since Boston Properties was kicking out a 5% dividend -- about three times the S&P's. The market is not giving the company much credit for that extraordinary performance though, as the following snapshot indicates.
Boston Properties vs. All Office REITS
BXP Weighted Average
11 Office REITs
Dividend Yield 5.0% 5.0%
Dividend Pay-Out as % of FFO 62% 61%
1998E FFO Multiple 13.5 11.1
Debt as % of Market Cap 42% 33%
Price as % of Net Asset Value 129% 116%
Implied Value per SF $200 $185
BXP should hit July with about 32% debt to equity -- level with its peers, but it has much better growth prospects. Analysts expect it to grow funds from operations (FFO) in 1998 at 26.1%, well above the average office REIT's forecast 19.5%. For 1999 analysts forecast BXP growth at 17.6%, while the average office REIT growth is estimated at 11.0%. BXP's CEO confirms management is "comfortable" with those estimates.
Analysts' forecast average office FFO growth in the low teens over the next three years. Zuckerman believes Boston Properties can sustain growth in the 18% range. With the dividends added in, that would give it very respectable returns well over 20%.
Analysts expect that growth because Boston Properties is an active developer, not just an owner/manager. The difference between buying an office building from someone else and building your own balances the risks of the unknown future against the hope of boosting your ingoing return by as much as 50% (from about 8.5% to about 12.5%). Buy a completed and rented office building and you know exactly what the asset will cost, what the completed physical building looks like, and who is renting it. You can take comfort that you will start collecting rent checks about the first of next month.
Developers incur extra risks to find land, get permits, pay engineers and architects, and build multi-billion dollar structures. They won't know what rents will be for 3 or 4 years. It helps if you can "catch a wave" in a strong market. Beacon Properties did in late 70s. There had been little new building, as Boston couldn't absorb the space it had. Then rising employment in the financial services, defense, and computer sectors kicked in. Boomers entered the job market. Office vacancy stuck under 4%. A wave of demand hurled against the region's stagnant building supply. Beacon started leasing its One Post Office Square at $18 per square foot. Class A rents went up 20% in 1981. After 18 months, Beacon was signing the final leases at $30.
Enduringly strong office markets have certain characteristics:
* Strong office job growth.
* Geographic barriers limiting development.
* Complex political structures that make it hard for the next guy to get his deal on the table too soon.
Boston Properties is a major owner in the four largest such markets. Here are Weblinks to (and excerpts from) Grubb & Ellis <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GBE)") else Response.Write("(NYSE: GBE)") end if %> reports on them (Note: to view these reports, readers need to have an Adobe Acrobat viewer).
Boston Market: "Vacancy is at a 16-year low and the space crisis will continue�. Delivery of 550,000 SF..."
New York Market: "Average� rents for Class A space reached $38.29, their highest level in more than four years�"
Washington, DC Market: "Overall employment growth was strong.... there are more than 15,000 unfilled high-tech jobs�"
San Francisco Market: "Average asking lease rate of $38.31 per square foot, up 12% from last quarter and 27% from one year ago�"
Boston Properties is not yet developing in San Francisco, but the jewel in its crown is a $2.8 billion development program concentrated in the other three markets. It has $992 million in Washington, DC, $1 billion in Manhattan, and $776 million in Boston. BXP knows development. Since the IPO, it has completed or put under construction more than $276 million in thirteen properties -- at an estimated stabilized yield of 13%. Zuckerman notes these properties are over 80% pre-leased on ten-year or longer leases to strong companies.
So, that's the good news, but also the risk. Development in major U.S. cities is very political. These big, old cities all have bureaucratic idiosyncrasies. Developing in them is a lumpy, unpredictable process, and today's REIT analysts are accustomed to completed properties with very predictable quarterly earnings. No matter how good Zuckerman and Linde are as developers (they are about as good as it gets), they will have to make analysts and investors comfortable with this niche. (Two investors with a lot of development experience are clearly willing to own BXP. David Rockefeller took $305 million in preferred stock back in the Embarcadero deal, and Prudential committed equity for the Pru Boston transaction.)
Boston Properties still thinks it can buy existing properties that meet its quality and price standards. At its June 1997 IPO, analysts expected the company to acquire about $800 million of new assets over 18 months. In fact, the company has acquired or agreed to acquire $3.6 billion in eleven months. Management says it has $700 million more under agreement, which it expects to close within the next 90 to 120 days at an in-going FFO yield of 9.1%.
Boston Properties has a notable set of financial artillery:
-- By July, it should have about $480 million in cash.
-- It already has a $500 million un-drawn credit line.
-- Smart property owners like David Rockefeller are willing to take its paper in lieu of cash at attractive rates.
-- Developments should cost less than appraisal value, and BXP is a gilt-edge developer. Today it can finance 100% of the cost of its developments with non-recourse mortgage money. Zuckerman says that gives him an advantage in times (like now) when issuing new REIT equity is expensive, and real estate debt is relatively cheap.
You can develop a feel for Mr. Zuckerman on Sunday mornings. As CEO of U.S. News and World Report and the New York Daily News, he guests on the Maclaughlin Group. What you see is pretty much what you get. A smart, well-informed fellow who is very, very sure of himself. He is involved with so many other companies you might think his attention would wander from real estate, but he has complete, detailed, off-the-cuff information on buildings, properties, and markets on the tip of his tongue. BXP's CEO, Ed Linde, is himself one of the most respected developers in the country.
Zuckerman says his only worry is an interest rate spike while he's in the middle of a lot of construction financed with floating rate debt. That's a risk, but I personally worry when I hear the confidence with which he forecasts getting his developments under construction on schedule. In the '80s, Boston Properties put years of work into an office building on New York's Columbus Circle, and a Boston Properties development in Concord, Massachusetts' "Walden Woods" was the subject of national debate. Neither was ever built.
Will Wall Street behave with restraint the first time a major development gets really hung up? No one knows, but then there are no 20%+ total returns without risk. If Boston Properties really tanks, it will be harder to get this world's David Rockefellers to take Boston Properties paper on preferential terms. These are strong people, though, well financed, and in good markets.
At this price, it's a risk Jack Dowd would have taken in stride.
* A Stock for dad represents the opinion of one Fool and in no way should be taken as the opinion of either the Motley Fool, Inc., the company in question or representative of anyone or anything else other than that specific Fool's thoughts.