Boston Properties: Interest Expenses and Vacancy Rate Keep Me on the Sidelines (NYSE:BXP)

boston real estate, inc.New York Stock Exchange: BXP) is a real estate investment trust (“REIT”) that specializes in owning/leasing office buildings primarily in major metropolitan areas throughout the United States. Challenges in office real estate haven’t evaded Boston Real Estate like the company The stock price is down more than 50% since early 2022. Recently, BXP announced The leasing activity has improved due to increased market share. After reviewing the company’s financial trends, I’m still interested, but committed to staying on the sidelines.

Boston Real Estate first quarter financial performance

Boston Properties saw improved financial performance in the first quarter. The company’s revenues increased by $36 million to reach $839 million compared to the same period last year. Expenses grew, but at a lower rate than revenue growth, as operating expenses increased by $25 million and SG&A costs decreased by $5 million. Boston Properties’ positive variance was almost completely consumed by $27 million Interest expense increased to $162 million. Overall, net income rose slightly, which may not be impressive in the grand scheme of things, but is noteworthy for a company that invests in office real estate.

Boston Properties’ balance sheet had a fairly quiet first quarter. Investors should note that the primary asset on the company’s balance sheet is real estate assets, but accumulated rental income, deferred fees, and investments in unconsolidated joint ventures are also prominent components. Cash fell from $1.5 billion to $700 million in the first quarter. A significant portion of this cash decline likely came from a $700 million decrease in unsecured securities, which was partially offset by a $200 million increase in mortgage securities. The company also has a comfortable credit line. Shareholder equity rose by about $100 million to just under $8.3 billion in the first quarter.

Boston Properties’ cash flow statement can shed some light on its ability to pay its dividend and repay debt. Operating cash flow in the first quarter decreased by $37 million to $197.5 million. Excluding construction work in progress, free cash flow was $86 million compared to $68 million last year. The increase in free cash flow is due to lower capital spending. Fortunately for investors, Q1 operating cash flow is historically the lowest quarter of the year, and operating cash has been up on a 12-month basis since 2021 and remains stable.

Boston Properties’ large cash draw came from the company’s repayment of $700 million in unsecured notes. Most of the remaining cash burn was derived from construction expenses in progress and to fund dividends but was partially offset by the sale of interest in the partnership. While Boston Real Estate does not need to borrow or sell assets to fund its dividend, these cash flow metrics are worth constant monitoring.

Strengths in leasing rates and joint ventures

There are two promising areas for Boston real estate. First, the company is seeing healthy increases in lease renewals, with the average lease renewal lasting nine years and increases of just under 7% in gross rents and more than 9.5% in net rents. The second area is the performance of the unconsolidated joint ventures that appear ready to return capital to the parent company as the culmination of the joint ventures paid off debts of about $200 million in the first quarter.

Identify and understand risks

With the challenges facing the sector, investors must be more vigilant when monitoring the risks associated with Boston Real Estate. The first risk is interest expenses. Over the past year, Boston Real Estate saw a $28 million increase in interest costs, associated with the issuance of new mortgage debt and new unsecured bonds. These increases came despite the repayment of unsecured bonds with available cash and a general decline in debt.

Over the next two years, the company will see an increasing amount of debt maturities, peaking at $3 billion in 2027. These maturities will expire at rates well below market and much of it will be refinanced at much higher rates. While investors expect interest rates to start falling soon, a credit rating downgrade could further erode the cost of financing. Management is trying to keep up with this trend, but in the first quarter earnings call, they had to adjust FFO guidance less to account for interest expense.

The other danger is vacancy. Boston Properties reports vacant space available for rent by square footage and total square footage, which is a useful way to monitor occupancy/vacancy. This is important to keep an eye on since Boston Properties’ portfolio is concentrated in offices and urban areas. Since the beginning of 2021, the vacancy rate has exceeded 10%, up from about 7% before the pandemic. It was trending in the right direction in early 2022 but has since reversed and reached a new high post-pandemic. Tangible progress here would go a long way toward making the stock attractive.

Conclusion

Boston Properties has weathered the challenges of the office sector, but the recent pressure on its cash flows keeps me on the sidelines. The company is seeing an uptick in job openings, as well as higher interest expenses, and continues to face headwinds. Also, the premium between market value and book value raises the bar beyond what I’m comfortable with. A positive change in occupancy on a sustainable basis would go a long way to opening a position, and until then, I will continue to wait.