Company Reports

Despite a rally over the past two months, we still view the US REIT sector as being undervalued. While the pandemic hurt REIT valuations in 2020, the recovery of fundamentals across most sectors led combined with low interest rates led to strong total returns in 2021 and early 2022. However, despite fundamentals continuing to perform well over the past three years, with many reaching historical levels of net operating income growth, the REIT sector has underperformed the broader equity markets in 2023 and into the first half of 2024. We believe that the cause has been due to the sector's negative correlation with interest rates as income-oriented investors rotate out of the sector, higher rates lower the value REITs can create with external growth, and property valuations fall in line with higher rates. However, interest rates have fallen since the end of July, leading to a rally for the REIT sector. We believe that US REITs will continue to see share price movements that are inverse of interest rate movements.

BXP develops, owns, and manages Class A office properties that are mainly concentrated in six markets: Boston, Los Angeles, New York, San Francisco, Seattle, and Washington, D.C. It owns over 180 properties consisting of approximately 53 million rentable square feet of space. The company has positioned itself to benefit from the burgeoning life sciences sector, as it owns approximately 5.3 million square feet of life sciences space and has significant potential for future development here.

No-moat-rated BXP posted a middling set of numbers in the second quarter as the firm reported funds from operations, or FFO, of $278 million or $1.77 per share, down 5% compared with the $293 million or $1.86 per share in the second quarter of the previous year. The company slightly updated its 2024 full-year FFO guidance to $7.09-$7.15 per diluted share, an increase of approximately $0.08 per share at the midpoint. The higher FFO guidance was mainly due to $0.05 per share of lower-than-projected noncash interest expense on the reassessment of the finance lease with the rest related to better performance of the company's operating portfolio. We are maintaining our $91 per share fair value estimate for BXP after incorporating the second-quarter results.

The US REIT sector remains significantly undervalued, in our perspective. While the pandemic hurt REIT valuations in 2020, the recovery of fundamentals across most sectors combined with low interest rates led to strong total returns in 2021 and early 2022. However, despite fundamentals continuing to perform well over the past two years, with many REITs reaching historical levels of net operating income growth, the sector has underperformed the broader equity markets over the past two years. We believe that the cause has been the sector’s negative correlation with interest rates as income-oriented investors rotate out of the sector, higher rates lower the value REITs can create with external growth, and property valuations fall in line with higher rates. However, we don’t believe that higher rates significantly change our fair value estimates for the sector. Additionally, interest rates are down from the October 2023 highs, and REIT share prices have generally inversely followed the movements of the US 10-year Treasury.

No-moat-rated Boston Properties reported a decent first quarter, with funds from operations of $271.3 million, or $1.73 per share, flat compared with the $272.0 million, or $1.73 per share, in the first quarter last year. The company updated its 2024 full-year FFO guidance to $6.98-$7.12 per diluted share, a reduction of approximately $0.06 per share at the midpoint. The lower FFO guidance was mainly due to the $0.05 per share impact from noncash fair value interest expenses related to finalizing the market value of the in-place debt and interest-rate swaps for recent acquisitions. We are maintaining our $91 per share fair value estimate for Boston Properties after incorporating the first-quarter results.

We believe that there are several attractive opportunities across the US REIT sector for investors to consider. Following the recovery of many REIT sector fundamentals from the pandemic by mid-2021, we viewed the REIT sector as fairly valued through early 2022. However, the past two years have seen the rapid rise in interest rates and a slowing economy, which has led to major valuation declines across the sector. Our analysis of the REIT sector over the past 25 years suggests that the relative stock performance of REITs is negatively correlated with interest rate movements. The second and third quarters of 2023 saw large interest rate increases with the 10-year Treasury approaching 5%, which led to the sector underperforming. This occurred even as many REITs reported same-store net operating income, or NOI, growth at historical highs in 2022 due to high inflation. Higher interest rates, lower liquidity, tighter capital market conditions, and decelerating same-store NOI growth all led to a significant correction in the stock price for many REITs.

Boston Properties develops, owns, and manages Class A office properties that are mainly concentrated in six markets: Boston, Los Angeles, New York, San Francisco, Seattle, and Washington, D.C. It owns over 191 properties consisting of approximately 53 million rentable square feet of space. The company has positioned itself to benefit from the burgeoning life sciences sector, as it owns approximately 5.5 million square feet of life sciences space and has an additional 5.8 million square feet of future development potential.

No-moat-rated Boston Properties posted a middling set of fourth-quarter numbers. Funds from operations of $286.2 million, or $1.82 per share, came in around 2.3% lower than the $292.9 million, or $1.86 per share, of the year-ago fourth quarter. The company’s 2024 FFO guidance is in line with our estimates as management expects $7.00-$7.20 per diluted share. The midpoint of the 2024 FFO guidance is 2.5% lower than full-year 2023 FFO primarily because of higher net interest expense of $0.31 per share, lower contributions from same-property portfolio performance of $0.26 per share, and reduced fee and termination income of $0.14 per share. 2024 FFO is expected to be positively affected by an estimated $0.42 per share from acquisitions, disposition activity, and development deliveries. We are maintaining our $95 fair value estimate for Boston Properties after incorporating the fourth-quarter results.

No-moat-rated Boston Properties’ posted a mixed set of numbers in the third quarter as the firm reported funds from operations, or FFO, of $292.8 million or $1.86 per share, which was around 2.3% lower than the $299.8 million or $1.91 per share in the third quarter of the previous year. The slight decrease in FFO compared with the previous year was mainly due to an increase in interest expenses of $19.0 million that was partially offset by greater contributions from portfolio operations of approximately $13.0 million. The headwind of higher interest expenses on FFO can turn into a tailwind when interest rates eventually start to decline from the currently elevated levels. The company tightened its 2023 FFO full-year guidance to $7.25-$7.27 per diluted share, which is around 4% lower than the 2022 full-year FFO. We are maintaining our $95 per share fair value estimate for Boston Properties after incorporating the third-quarter results.

The share prices of U.S. real estate investment trusts have fallen by approximately 30% from their 2021 highs because of higher interest rates and stress in some commercial real estate sectors. We think that the correction is overdone and the current valuations offer an attractive entry point for patient investors. Our core REIT coverage is trading at a discount of approximately 25% to our fair value estimate. We estimate that the average REIT within our U.S. coverage is currently trading at a dividend yield that is 126 basis points higher than the historical average. We see marked differences in valuation across different REIT sectors in the United States. For instance, the industrial sector is fairly valued, with stock valuations already accounting for future growth, but other sectors like offices, hotels, and malls are trading at attractive discounts.

Higher interest rates and a challenging office market environment weighed on Boston Properties’ second-quarter results. The no-moat-rated firm reported funds from operations, or FFO, of $1.86 per share in the second quarter, which was about 4% lower than the $1.94 reported in the second quarter of the previous year. The decrease in FFO from the previous year was primarily due to higher interest expenses, which were partially offset by higher contributions from portfolio operations. The company also updated its full-year 2023 FFO guidance to $7.24-$7.29 per diluted share, which is about $0.10 per share higher than the previous full-year guidance. We are reducing our fair value estimate for Boston Properties to $95 per share from $98 after incorporating the second-quarter results.

Boston Properties develops, owns, and manages Class A office properties that are mainly concentrated in six markets: Boston, Los Angeles, New York, San Francisco, Seattle, and Washington, D.C. It owns over 191 properties consisting of approximately 54 million rentable square feet of space. The company has positioned itself to benefit from the burgeoning life sciences sector, as it owns approximately 5.6 million square feet of life sciences space and has an additional 5.8 million square feet of future development potential.

No-moat-rated Boston Properties reported a decent set of numbers in the first quarter as the demand for office real estate remains muted because of macroeconomic factors and a slower recovery in physical office utilization rates. The firm reported funds from operations, or FFO, of $1.73 per share in the first quarter, which was around 5% lower than the $1.82 per share FFO reported in the first quarter of the previous year. The decrease in FFO compared with the previous year was primarily due to higher interest expense that was partially offset by higher contributions from portfolio operations. The company also updated its 2023 FFO full-year guidance to $7.14-$7.20 per diluted share, which is about $0.04 per share higher than the previous full-year guidance.

Boston Properties develops, owns, and manages Class A office properties that are mainly concentrated in six markets: Boston, Los Angeles, New York, San Francisco, Seattle, and Washington, D.C. It owns over 190 properties consisting of approximately 54 million rentable square feet of space. The company has positioned itself to benefit from the burgeoning life sciences sector, as it owns approximately 4.6 million square feet of life sciences space and has an additional 5 million square feet of future development potential.

No-moat-rated Boston Properties reported a respectable set of numbers in the fourth quarter amid a difficult office market environment. The firm reported funds from operations, or FFO, of $1.86 per share in the fourth quarter, which was mostly in line with the FactSet consensus FFO estimate of $1.84 per share. The company also updated its 2023 full-year FFO guidance to a range of $7.08 to $7.18 per diluted share, which was $0.09 per share lower than the previous full-year guidance. The midpoint of the updated 2023 FFO full-year guidance is approximately $0.40 per share lower than the 2022 FFO, mainly impacted by higher interest expenses. After incorporating the fourth-quarter results, we are maintaining our fair value estimate of $107 per share for Boston Properties.

No-moat-rated Boston Properties reported third-quarter results that were in line with our expectations as share prices of office REITs have declined significantly in the past few months. The firm reported funds from operations, or FFO, of $1.91 per share, 10.4% higher than the $1.73 in FFO during the third quarter of 2021. The company also provided 2023 FFO full-year guidance of $7.15 to $7.30 per diluted share, which was slightly below our expectations. The midpoint of the FFO 2023 guidance is around $0.30 per share lower than the guidance for full-year 2022 FFO. The difference between the two years is on account of $0.69 per share of higher interest expenses and $0.23 per share impact from dispositions and lower fee income that was partially offset by $0.62 per share of higher FFO contributions from acquisitions and developments. We have reduced our fair value estimate for Boston Properties to $107 per share from $112 per share after moderating our long-term rent growth, occupancy, and interest expense expectations for the company.

Boston Properties develops, owns, and manages Class A office properties that are mainly concentrated in six markets: Boston, Los Angeles, New York, San Francisco, Seattle, and Washington, D.C. It owns over 200 properties consisting of approximately 53 million rentable square feet of space. The company has positioned itself to benefit from the burgeoning life sciences sector, as it owns approximately 4.6 million square feet of life sciences space and has an additional 5 million square feet of future development potential.

No-moat-rated Kilroy Realty’s high-quality office portfolio now looks appetizingly cheap amid the steep selloff of office REITs in the last few weeks. We recognize the uncertainty surrounding the future of the office and believe that the environment will remain challenging for office owners in the near to medium term. Having said this, we also believe that the selloff has been overdone and the current implied valuation of Kilroy’s shares is completely divorced from the current private market valuations of its office portfolio. We think that long-term-oriented investors can consider this stock for their portfolios as the company is currently trading at approximately 40% below our fair value estimate of $69 per share. Our U.S. office REIT coverage is approximately 30%-40% undervalued. Kilroy Realty is our preferred pick in this sector given its risk-return profile.

With the United States experiencing historically high inflation growth, many investors are wondering if real estate provides a natural hedge against inflation and if the REIT sector should therefore outperform the broader equity market. Many REITs in our coverage have reported rent and revenue growth at or near historic peaks over the past several quarters, with inflation being one of the largest reasons for the high growth. Given this and some historical evidence that REITs outperformed in the 1970s and early 1980s when inflation was similarly high, some investors are questioning why REITs have not outperformed in 2022.

No-moat Boston Properties reported middling second-quarter results as workers remain reluctant to return to offices. Physical attendance in restaurants, movies, and other entertainment-related events has reached prepandemic levels, but the recovery in physical office occupancy levels has remained tepid. We believe that the employee behavior is primarily driven by preference and flexibility with regard to returning to office. This is different from the early stages of the pandemic, where the risk of getting the coronavirus was the main reason for lower office utilization. This dynamic does not bode well for the owners of office real estate, as it points to a more permanent shift in worker and employer behavior. Remote work has now become a norm in corporate America. We are also seeing increasing signs of employers accepting remote work and becoming comfortable with the new normal.