Q2 2023 Boston Properties Inc Earnings Call
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Good day, and thank you for standing by and welcome to Q2, 'twenty twenty-three DXP earnings Conference call. At this time, all participants are in a listen only mode.
After the Speakers' presentation, there'll be a question and answer session.
To ask a question during the session you will need to press star one one on your telephone you were down here, an automated message advising you handle.
Two of which are your question. Please press star one again please.
Please be advised that today's conference call is being recorded I would now like to hand, the conference over to Helen Hahn Vice President Investor Relations. Please go ahead.
Good morning, and welcome to Dxp's second quarter 2023 earnings call.
Our press release and supplemental package were distributed last night and furnished on form 8-K in the supplemental package DXP has reconciled all non-GAAP financial measures most directly comparable GAAP measure in accordance with Reg G. If you did not receive a copy. These documents are available in the investors section of our website at investors that DXP Dot com.
Yeah.
A webcast of this call will be available for 12 months.
This time, we would like to inform you that certain statements made during this conference call, which are not historical may constitute forward looking statements within the meaning of the private Securities Litigation Reform Act, although DXP believes the expectations reflected in any forward looking statements are based on reasonable assumptions. It can give no assurance that its expectations will be attained.
Factors and risks that could cause actual results to differ materially from those expressed or implied by forward looking statements were detailed in yesterday's press release and from time to time in <unk> filings with the SEC BSP does not undertake a duty to update any forward looking statements I'd like to welcome Owen Thomas Chairman and Chief Executive Officer.
Doug Linde, President and Mike Labelle, Chief Financial Officer during the Q&A portion of our call Ray Ritchey Senior Executive Vice President and our regional management teams will be available to address any questions. We ask that those of you participating in the Q&A portion of the call to please limit yourself to one question. If you have an additional query or follow up.
Please feel free to rejoin the queue I would now like to turn the call over to Owen Thomas for his formal remarks. Thank you Helen and good morning, everyone. Today I'll cover Bx piece above expected operating performance in the second quarter key economic and market trends impacting DXP Dxp's capital allocation Act.
<unk> and our personnel and organizational announcement.
DXP continues to perform in the second quarter once again demonstrating sentiment in the office industry is worse than what we're experiencing.
Our <unk> per share was above both market consensus and the midpoint of our own forecast and once again this quarter, we increased our <unk> per share guidance for all of 2023.
We completed 938000 square feet of leasing in the second quarter with a weighted average lease term of eight years, despite continued challenging leasing market conditions.
We completed multiple company and asset specific financings, both elevating our liquidity position and demonstrating DXP sustained access to the capital markets.
Yeah.
U S economic growth is challenging to forecast as there are currently two competing and viable theories predicting very different trajectories.
The first theory is that inflation is increasingly under control due to pandemic economic anomalies wearing off and federal reserve interest rate hikes and the economy has and will remain healthy with a strong labor market and continued GDP growth driven by consumption.
The second theory is that inflation is already well under control and the federal reserve has been overly aggressive in the magnitude and timing of its interest rate increases, which will create dislocation in sectors of the economy. As it has already started to occur with regional banks in commercial real estate and will result in a recession, possibly as soon.
Later this year.
We are obviously, hoping for the first outcome, but if prepared DXP for the second by increasing liquidity currently at $3 1 billion.
Pursuing additional capital raising opportunities and being measured and discretionary capital expenditures and new investment activity.
Whether or not we have an economic recession U S companies are experiencing a recession in earnings.
For the S&P 500 are predicted to drop over 6% year over year in the second quarter with lower earnings companies look to cut costs, including expenditures for space, which is the primary driver of our slower leasing in the first half of 2023 versus last year large tech companies. The most.
Significant source of new employment and net absorption of space last cycle are largely absent from the current leasing market.
In analyzing the market demand for office space. It is important to understand the behavior of underlying users, which in the broadest sense, our bifurcated into two groups first their knowledge workers, who are client into a product facing and execute the core functions of our business, where creativity and collaboration are critical to us.
Success.
And second support workers, who provide services to the core functions of our business in areas such as it and accounting where tasks are more repetitive and collaboration less of an imperative.
Knowledge workers generally have dedicated workstations and are increasingly in the office as business leaders to understand the importance of in person work for this group.
Our enforcing firmer in person work policies.
In many cases companies working remotely or announcing returned to office plans companies working on a hybrid basis are increasing the number of days expected in the office companies or time year end evaluations in bonus levels to office attendant.
On the other hand support workers often work in shared workstations with more workers in seats, which must with much less prescriptive office attendance policies.
This workforce bifurcation is creating the ever increasing performance gap between premier workplaces, and the balance of the office market.
Our primary tool companies utilize to increase knowledge worker attendance is to provide modern workspace rich with amenities and an easily commutable location the definition of a premier workplace.
Firstly support functions are not as commonly located in premier workplace assets. Therefore remote work in shared workstations puts more pressure on the market for lower quality buildings in secondary locations.
The divergent impact of AI, our knowledge and support jobs could also continue to widen the building quality performance gap.
AI drives knowledge job growth and automate support processes.
We share in our IR materials every quarter CBRE report on the performance of the Premier workplace segment.
In the <unk>, where DXP operates premier workplaces represent approximately 18% of the total space and 10% of the total buildings at the end of the second quarter direct vacancy for Premier workplaces was 11, 6% versus 16, 5% for the balance of the market, but also for the second quarter.
Net absorption for the Premier segment was.
Around 800000 square feet positive versus a negative $2 1 billion square feet for the balance of the market.
For the last 10 quarters net absorption for the Premier segment was a positive $6 7 million square feet versus a negative 31 9 million square feet for the balance of the market.
Rents and rent growth are higher for Premier workplaces, and we believe the segment segment captures most of all gross leasing activity.
Including two buildings undergoing renovation, 94% of DXP CBD space is in buildings rated by CBRE as Premier workplaces, which has been important in driving the increasing office attendance statistics in our buildings and is a critical differentiator for DXP and the marketplace.
Moving to private real estate capital markets U S transaction volume in the second quarter rose, 43% from the first quarter to $9 $6 billion. The volume is down 50% versus the second quarter last year interestingly sales volumes for other asset classes as weaker up less in.
Office in consecutive quarters and down more versus last year.
Real estate values have reset down due to higher capital costs and demand challenges in specific sectors and most sellers continue to be unwilling to accept lower prices, creating a slowdown in transaction activity common in declining markets.
New mortgage financing for office is not available from domestic lenders non U S. Banks will consider financing only for the highest quality leased assets and sponsors and at modest loan to values.
Completed office sales and recapitalization and variably involve buildings with long weighted average lease terms <unk> seller financing given the dearth of transaction activity office asset pricing is difficult to determine but there were a small a small number of relevant data points this past quarter.
A fund manager backed by private equity firm purchased two lab portfolios in the Boston area from a public REIT three.
Three buildings on second Avenue in Waltham, comprising 329000 square feet, which are 100% leased for over six years sold for $266 million, representing pricing of $809 a foot and a five 8% initial cap rate.
Also in the deal two buildings on Memorial drive and Cambridge Court, comprising 99000 square feet and vacated for redevelopment sold for $99 million, which was the price of just under $1000 a square foot.
Also located in Santa Clara next the Bsp's Peterson way development site campus at 3333 sold for $183 million, representing pricing of $742, a square foot and a six 1% initial cap rate.
The building comprises 246000 square feet is fully leased on a long term basis and was sold by domestic pension fund to domestic fund manager.
Now moving to Bx piece capital market activity for the second quarter, we are being patient with new investment activity as we believe acquisition opportunities will grow in number and become more attractive in this environment.
We will remain opportunistic and solely focused on premier workplaces life science, and residential development and our six target markets.
We are considering additional capital raising through dispositions and joint ventures with our in service residential assets in select pre leased developments.
This quarter, we placed fully into service 2100, Pennsylvania Avenue of 476000 square foot market, leading premier workplace in Washington D. C that is 91% leased.
In late June we opened and placed into surface service view, Boston, a three storey observation pavilion, a top Prudential tower in the back Bay of Boston that offers panoramic views of the city as well as an immersive experience showcasing Boston as many neighborhoods and cultural landmarks.
DXP has been constructing the first phase of the platform 16 Premier workplace development adjacent to Google's downtown West project in San Jose <unk>.
DXP owns a 55% interest in the project and the first phase includes the 390000 square foot building as well as the garage and foundation for all three phases, which in total will comprise one 1 million square feet.
Unfortunately market conditions in the Silicon valley, including San Jose have deteriorated meaningfully with rising direct vacancy few large space requirements and technology companies, including Google putting significant space on the sublease market.
As a result, we have decided to pause construction of the project at grade with completion of the garage and foundation scheduled for year end 2023.
So disappointing as market conditions recover we will have a project that can be delivered to users in under two years, which is 12% to 14 months more quickly than a ground up development.
Further this decision reduces our near term development spend by approximately $200 million, thereby.
Thereby enhancing our liquidity.
DXP recently accomplished two important milestones in the pre development of the 900000 square foot $3 43, Madison Premier workplace in Midtown Manhattan.
We completed a joint venture with a leading global real estate investor who will own a 45% interest in the project.
Further the joint venture completed a 99 year ground lease with the Metropolitan Transit Authority from $3 43, Madison Avenue site.
Under the terms of the lease the joint venture is required to construct a direct entrance into the long Island Railroad East side access project known as Grand Central Madison.
The joint venture can terminate the ground lease and be and be reimbursed for its costs in constructing the access to grand Central Madison.
With direct access to transit and the relatively tight Grand Central Submarket $3 43, Madison is a unique offering and preliminary discussions with potential anchor clients have been constructive.
Yes.
DXP continues to execute a significant development pipeline with 13 office lab retail and residential projects underway. These projects aggregate approximately $3 1 million square feet and $2 6 billion of DXP investment with $1 6 billion remaining to be funded and are projected to generate attractive yields upon.
Delivery.
On a personnel matter after a 25 year distinguished career running DXP, San Francisco region, Bob Peter has elected to retire early next year.
We have asked Rod, who currently runs leasing and DXP, San Francisco region to succeed Bob.
Rod and 18 year DXP veteran is an accomplished leader with a strong track record of commercial success with Dxp's clients.
With this change we are also adjusting our organizational structure DXP has and will continue to execute its business and three regions on the west coast. However, given that L. A and Seattle are relatively new regions for <unk> XP and currently under scaled we will manage these three regions with a unified organizational.
Sure under Rod sharing resources across the regions to the benefit of Dxp's clients and shareholders.
Alex Cameron and Melissa Cohen will continue to be our senior representatives in the La region, and Kelly <unk>, our senior representative in the Seattle region.
So in summary, despite strong negative market sentiment DXP had another productive quarter with financial performance and leasing above expectations at a stable dividend.
DXP is well positioned to weather the current economic slowdown given our leadership position in the premier workplace market segment.
Our strong and liquid balance sheet with access to multiple capital sources.
Our significant development pipeline, providing growth and our potential to gain market share in both assets and clients due to the current market dislocation, let me turn it over to Doug. Thanks Alan.
So during our June NAREIT meetings, the most frequent topic of conversation with our leasing activity since they're obviously drives occupancy topline revenue and net operating income so I am going to focus my remarks here. This morning, Owen highlighted the volume of signed leases during the second quarter.
Just to remind everybody during the last nine months, we've been providing the leasing expectations embedded into our 2023 earnings guidance between $5 million and 1 million square feet per quarter, correct, which translates to 750 square thousands square feet on average four 3 million square feet for year 2023, So during the first quarter, we signed six.
60.
As of the end of the first half of 'twenty. Three we've completed 1.5 dollars 6 million square feet pretty much on target.
This quarter, the 938000 square feet of signed leases included 63 transactions.
37 renewals 26, new tenants there were seven contractions and five expansions.
Three of the expansions where law firms. Although we also had two law firm contractions, along with a nonprofit and government agency <unk>.
Breaking the volume down by market 320000 square feet in Boston 280000 square feet in New York 235000 square feet in DC, and 100000 square feet in San Francisco.
We ended the second quarter with an in service occupancy of $88 three compared to $88 six last quarter, but as Owen said, we added 2100, Pennsylvania Avenue to the in service portfolio. The building is 91% leased but only 61% occupied for purposes of revenue recognition, which is how we calculate our occupancy statistics.
So if you exclude the additional property our occupancy actually remained flat for that quarter.
As we sit here today, we have signed leases that have yet to commence on our in service vacancy totaling approximately 1 million square feet with 800000 square feet anticipated to commence in 2023 that does not include the development portfolio, which is $3 1 million square feet and 54% leased.
We currently have 44 leases in negotiation totaling 117 million square feet as compared to about 900000 square feet as we entered the second quarter, so a slight acceleration.
The one difference in this pool of transactions is that there was one large renewal over 300000 square feet versus the largest active negotiation last quarter also earned ROE was just over 100000 square feet.
We also have a current pipeline of additional active proposals totaling over $1 7 million square feet. So if we complete 95% of the leases in negotiation and a third of the $1 7 million square feet of proposals. We currently would have about one 7 million square feet of additional leases, we hope to execute during the second.
Half of 'twenty, three which will bring our total leasing for 2023 to just over 3 million square feet again going back to our original embedded expectations right on target.
Our remaining 2023 exploration are one 3 million square feet.
We have 800000 square feet of signed leases with an anticipated 2023 commencement will be delivering 140, Kendrick Street 104000 square feet.
In service portfolio in the third quarter, and 751 gateway, 100% leased 231000 square feet in the fourth quarter.
We will have additional 2023 activity across the portfolio, which will get our occupancy up slightly by year end.
But as we get further into calendar year 2023, additional lease executions will impact occupancy after 2023.
The Newark regions. The second generation leasing statistics jumped out this quarter I need a little bit of explanation. The deals commencing included a floor that was previously leased to an existing tenant at a below market rent as they were rebuilding their space elsewhere in the building. We subsequently re let the space under a long term lease to a new tenant and the impact is hitting.
Quarter, if you strip out that transaction, New York would be down nine 2% on a gross basis and 15% on a net basis.
As I said before in general we continue to have roll ups in Boston and San Francisco Roll Downs in D C and Northern Virginia, While New York is very building and lease specific.
The leases we signed this quarter on second generation space were up 8% in Boston, 10% in San Francisco down, 11% in New York and down 13, 5% in D C and New York leases signed this quarter included 120000 square foot renewal in Princeton that was down 28% on a cash basis.
The sentiment around office is worse than the reality as Owen said.
Illustrate the point that our portfolio, we continue to see an incremental pickup in daily activity as we look at the month to month trend lines.
We measure the unique client employees coming into our building every day against the number of workstations Slacks office depth in our CBD buildings today using this methodology, we are seeing weekly usage.
80% in New York City, 75% in Boston, and 70% in San Francisco and this excludes Salesforce dot com and we work because they don't use our access card system. When we look at individual firms. There is wide discrepancy in utilization we have clients that are close to 90% of their daily Hi.
They had pre pandemic, while we have a few insurance companies back office that are as low as 35% sort of making Owens point on the type of work that's being done.
The frequency of work in the office is about three days per week across our markets, where we track the data and this includes San Francisco. So that people are coming back to work. The <unk> days a week Friday's continues to be a real outlier for our clients.
Contrary to popular sentiment our clients are using their space.
From a broad perspective.
The supply picture it didn't improve in the second quarter and the third party industry reports all noted negative modest absorption across all of the major markets in the United States all of them and Youll clearly read about high headline availability.
Scintillating in every market.
In the U S for some time, however, continuing the theme that the stat the minutes worse than the reality, the New York City Brokers' reports also indicate that the class a inventory in the Park Avenue Submarket has an availability rate of 11% and net effective rents are rising rising with higher fee rates and <unk>.
<unk> or lower concessions.
And while it's not reported the availability and the premier buildings is even tighter.
Away from the Midtown market and the DXP portfolio. We are now in negotiations with our first multi floor client at 360 Park Avenue South.
Tenant demand in the San Francisco CBD has increased more than 50% since the fourth quarter of 2022 with new technology demand responsible for much of the increase.
And there are a significant number of AI companies actively considering space and the requirements will all create net absorption.
Given their potential growth at these organizations, we would expect this demand to center on the Welbilt Tech sublet space that is readily available in the market not direct vacancy.
Global investment in the AI field is rapidly increasing and it's going to result in job growth San Francisco is the leading labor market for AI jobs, followed by Seattle, and New York and New venture capital investment in AI is concentrated in San Francisco CBD New York.
Boston with CBRE research reporting at San Francisco has received more than 50% of the total invested money during the third quarter. These are encouraging facts that can only be constructive in the eventual recovery of the San Francisco CBD office market.
The concentration of user demand strength will grow up with growth.
<unk> is broadly speaking turning to the asset managers private equity venture hedge funds specialized fund managers. These companies are growing their teams and capital under management.
This pool of clients typically wants to occupy premier workplaces.
Illustrate this point during the quarter, we did a multi floor 10 year renewal with a private equity firm in Boston and a 15 year renewal with them for a full floor within investment manager in New York City in General.
Our strongest activity as at the General Motors building in Manhattan, 200, Clarendon and the Prudential Center properties in Boston, 2200, 2100, Pennsylvania Avenue in D. C. The urban core of Reston Town Center in Northern Virginia, and our Embarcadero Center asset in San Francisco, We don't have availability at Salesforce tower ourselves directly.
The law firms are also active in our portfolio and important clients or be XP <unk>.
This quarter, we completed three law firm leases in New York, one in Boston and three in our D. C portfolio. We also have a number of active locked firm transactions in the proposal stage at Embarcadero Center in general However outside of Manhattan, The law firms are reducing their footprint.
During the quarter, we completed three life science leases at 55000 square foot extension in Lexington, Massachusetts, We relax re let the 12000 square foot suite at AAD Winter Street, where we had a forum biotech companies shut down its operations in March we did it on an as is basis at a rate that was 9% higher than the prior rent.
We completed our second full floor lease at 651 Gateway in South San Francisco. We are also negotiating a third full floor lease at 651 gateway and we intend to complete a speculative turnkey installation on an additional floor. The property will open in 'twenty four and to date each lease at 651 gateway.
Acquired our partnership to complete turnkey build outs.
Pivoting in the life science market continues to be moderate across both Boston and South San Francisco and there is new unleash spot supply being added to the markets. There are a few larger requirements that are touring but as I have previously said the bulk of the demand is from small private companies theyre looking for fully built space.
Our new client client at 80 winter fits this profile.
Also wanted to note that we are seeing cost decreasing this inflation on our tenant improvement work relative to jobs completed in 2022, largely due to the falloff in transactions in our markets. The numbers are slightly different by market by market, but we are seeing a reduction in <unk> that we are budgeting.
<unk>.
Dxp's portfolio is going to gain occupancy we will continue to lease available space because our portfolio is fundamentally provider comp.
Emprise, a premier workplaces, the majority of the demand new and existing clients in the market wants to be in these types of properties and we are investing capital in our building infrastructure amenities and tenant spaces. We.
We are all seeing the stress that many buildings are feeling due to their current capital structure the transition or recapitalization of these buildings is going to take an extended time.
While this is happening many of these assets are not in a position to commit capital to existing or new tenants, which greatly impacts the leasing brokers interest in considering them for their clients and so returning to the theme of the sentiment is worse than the reality for DXP much of the available space in our markets is not competitive.
With our assets and some buildings are not in a position to compete due to their owners and willingness to invest capital while their capitalization is and the restructure mode.
Our clients are using our space medium and small financial and professional service clients will make up the bulk of the leasing we completed in 2023, we completed 57 leases during the first quarter 63. During the second we have had only two leases above 100000 square feet. This year and each was a renewal occupancy.
Occupancy gains will be captured slowly through with lots of small and medium sized new leases and renewals I'll stop here and turn the call over to Mike.
Thanks, Doug.
Good morning, everybody.
Im going to start with a few comments on our balance sheet and then I plan to cover the details of our second quarter performance and the changes to our 2023 earnings guidance, we had a busy quarter in the debt markets and we continue to bolster our liquidity and opportunistically manage our interest rate risk in the bond market, we issued 700.
$50 million of six 5% 10 year unsecured green bonds with strong support from our fixed income investors and our deal was well oversubscribed, allowing us to upsize the transaction and reduced the pricing from initial guidance.
When we assumed the notes in May the underlying treasury was 334% and our credit spread was 320 basis points are credit spreads have rallied significantly to under 250 basis points today, while the 10 year has increased to over 4%. So despite all the volatility if.
We issued another 10 year today, it would be at a similar coupon.
In the mortgage market, we refinanced our $105 million expiring mortgage on 500, North Capitol Street in Washington D C.
We also exercised one year extensions for our mortgage loans on the Marriott headquarters in Bethesda, and the hub on Causeway office tower in Boston.
Our remaining 2023 loan maturities are limited to a $500 million bond maturity that we expect to repay with cash as well as our mortgage loan on our mixed use hub on causeway podium building.
Hub on Causeway is held in a joint venture and our share of the loan is only $87 million were finalizing terms and expect to refinance the loan in the third quarter for two additional years plus a one year extension option.
This quarter, we also entered into interest rate swaps to fix the rate on our $1 $2 billion unsecured term loan through may of 2024, we fixed the term silver rate at 464%, that's approximately 70 basis points lower than where term sofa sits today.
Our liquidity is strong at $3 1 billion at.
It consists of $1 6 billion in cash and full availability under our $1 5 billion in credit.
Our liquidity needs through the end of 2024 include $1 $1 billion of projected spend on our development pipeline.
$1 $2 billion of bond maturities and $190 million of mortgages with final maturities by 2024.
We do have another $390 million of mortgages and our $1 $2 billion term loan that mature in 2024 and have extension rates into 2025 or 2026.
So our financing plan is to pay off the $500 million bond expiring in September with cash refinance our $700 million bond prior to its maturity in February 2024, even through the secured or the unsecured market.
Refinance our mortgage maturities and continue to maintain ample liquidity.
Now turning to our earnings results for the second quarter, we reported funds from operations of $1 86 per share our results exceeded the midpoint of our guidance range by <unk> <unk> per share. The outperformance was due to <unk> of better than expected revenues in the portfolio combined with <unk> <unk> of lower than expected.
Operating expenses.
With stronger revenues were spread across the portfolio. It included earlier than projected lease commencements higher service and parking revenues and outperformance at our hotel on.
On the operating expense side of the ledger the savings were split between lower energy costs from both lower consumption and rates and.
And the deferral of repair and maintenance expenses.
We project that most of the benefit from lower maintenance expenses will be lost as the projects get deferred to later in the year.
So for the full year 2023, we're raising our <unk> guidance to $7 24 to $7 29 per share.
And our same property portfolio, we expect most of the second quarter performance to flow through to the full year, we're raising our assumptions for our same property NOI growth by increasing the bottom end of our range by 50 basis points. So we're now assuming same property NOI growth from 2022 of zero to <unk>, 5%.
We're also increasing our assumption for same property cash NOI growth to one five to two 5%.
The other area. We are seeing improvement is in net interest expense by swapping to floating rate on our $1 $2 billion term loan to a fixed rate we've locked in interest savings and while we issued new bonds to refinance our September maturity earlier than we had projected the interest rate was lower than our assumption from last quarter plus.
We're seeing better deposit rates and are carrying higher cash balances. So we're earning more on our liquidity.
In conclusion, we are increasing our 2023 <unk> guidance range by <unk> 10 per share at the midpoint. The changes are primarily from five per share or better same property portfolio NOI and <unk> per share of lower net interest expense.
Overall, we had a strong quarter with topline revenue growth earnings outperformance improved leasing volumes positive mark to market on our commenced leases and timely capital raising activity our balance sheet is in excellent shape and we are well positioned in an uncertain environment for any economic outcome.
Looking further forward, we do expect the high interest rate environment to continue to be a headwind as we refinance low cost expiring debt and anticipated higher rates.
For example, we have a $700 million of three 8% fixed rate unsecured notes that expire in early 2024, and we expect the refinancing rate of approximately six 5%.
In addition, we have $1 9 billion of floating rate debt is impacted by changes in sulfur rates. Our floating rate debt does include our $1 $2 billion term loan that has been swapped to a fixed rate through may of 2024.
We expect that our same property portfolio.
With stable with occupancy improving over time, and we will continue to add to our income through placing developments into service over the next few years.
Okay that completes all of our formal remarks, operator can you open up the lines for questions.
Thank you Sir.
As a reminder to ask a question you will need to press star one one on your telephone.
Your question. Please press star one again.
We ask that you keep your questions to no more than one but please feel free to go back into the queue and if time permits we'll be more than happy to take your follow up questions at that time.
Please standby, while we compile the Q&A roster.
Okay.
I show. Our first question comes from the line of John Kim from BMO Capital markets. Please go ahead.
Good morning, I think I'll try to ask a multipart question on 343 Madison.
Any additional commentary you can provide on the total costs of both the east side access and the building itself.
Development yields that you expect.
With a partner is or at least what regions or September style then.
And what level of pre leasing you need to move forward with the project.
So EMEA, let me answer the first three parts of your question and will let Hillary answer the fourth so.
We are designing the building the building isn't been design yet we are not in a position to discuss the economics of the development or the returns clearly the capital markets are different than they were so the return thresholds necessary to rationalize putting capital into building are going to be higher than they would have been in 2019 year 2020.
I will let Hillary talk about.
The demand side.
Thanks, Doug the demand side for this building has been interesting in the sense that as Doug pointed out the building is still being designed and yet we are receiving inbound calls from clients, who are interested and anchoring the development. Even in spite of the fact that it would take several years to build the building.
This has to do as Owen mentioned with the tightness and the Park Avenue District, and the Plaza Submarket more generally in the sense that there is very little class a premier workplace available for folks to occupy and as businesses are expanding and that districts are finding themselves.
Popped out of.
Larger space options, and so I would say, particularly given the fact that we have not had a very active marketing program in place for 343. The interest in the building has been has been very very robust with multiple clients ranging from call. It 200 to 300000 square feet seeking information on the building.
And John It's <unk> and lastly, we.
Our honoring our partner's request for confidentiality.
Thank you.
And our next question comes from the line of Michael Griffin from Citi. Please go ahead.
Great. Thanks, Alan I appreciate your comments kind of about the transaction activity and potential acquisition opportunities out. There I was wondering if you can get some color on kind of what the IRR is on those potential opportunities could be in kind of how you weigh that relative to maybe potential share buybacks.
Well.
Michael I think on IRR is as I mentioned in my remarks, Theres, just not very many deals out there that are happening.
On this call every quarter I tried to give up.
Spectrum of the deals that got completed in and frankly, it's really hard to find things right. Now so look I think in the premier workplace segment.
Overall, the IRR is where transactions were occurring before interest rates went up was probably in the sixes and.
Today, even though theres not many data points given the capitals.
More expensive they have clearly gone up.
100 basis points or more I would say, but again that's conjecture.
As it relates to buybacks as we have been saying, we think our stock represents a tremendous value opportunity.
But we also have uses for the capital.
Our development pipeline and opportunities that may present themselves.
So.
We have elected not to pursue a buyback program at.
At this time.
Thank you.
And our next question comes from the line of Blaine Heck from Wells Fargo. Please go ahead.
Great. Thanks, Owen I think you mentioned considering capital raising through dispositions and joint ventures can you just expand on whether the dispositions would be concentrated in noncore assets are higher quality properties and then on the JV side can you give some color on what potential investors are looking for in an ideal investment and.
Sort of returns they are targeting in this environment given the high capital cost that you just referenced.
Yes.
Well I mentioned in my remarks that we're looking at dispositions and joint ventures with our residential assets and also our least development properties.
Those.
Two asset categories would probably represent the least impacted in our portfolio in terms of increasing cost of capital and cap rates.
So I think the residential.
Asset segment today is more liquid than <unk>.
There are no premier workplaces, selling, but it's certainly more liquid and office. So we're going to evaluate those opportunities and we're also evaluating evaluating opportunities on our leased development pipeline.
And Blaine I would just.
Just to make the following.
Analytic comment and.
And the IRR is dependent upon obviously with the cash flow looks like but they are still very dependent upon what your expectations are for the future and so we are not smart enough.
To be able to read the minds of our potential partners and how they are thinking about what they view as the capitalization rates in 10 years eight years 15 years, how much growth there viewing there is going to be in the underlying rents of the buildings that we might be operating to them. So it's really hard.
To sort of get into their minds as Owen said, it's a lot higher than it was in 2019.
But but we don't know if its higher because they've lowered their expectations for those residual cap rates they've lowered their growth rates on their rents or some combination, but it's it's not an easy question to answer.
Thank you.
And I show. Our next question comes from the line of Steve <unk> from Evercore ISI. Please go ahead.
Yeah. Thanks, So I wanted to just maybe circle up on platform 16 and.
Oh, and I realize you've kind of gone through this before with 250 west 55th in the past.
But does the does the building have maybe other uses if office for that building just doesn't come back in the near term can you switch to residential or.
I guess, how long are you prepared to hold us.
So Steve this is Doug so the answer at the moment is we haven't focused on not building. The project that we currently have and the project. We currently have is three commercial.
Premier workplace buildings.
Clearly, we have a platform and a parking structure that is.
Going to be able to hold three large suburban office buildings on it so the platform would allow for something other than that but at this point, we believe in the location that we believe in the <unk>.
Rationalization of transportation through the Couch ran which is why we picked this location in the first place we believe and what eventually.
User who owns most of the land around there will build and so we're not pushing towards doing something different at this moment, but fundamentally we looked at the market and said.
2024 is pretty quickly coming and owning a building thats going to deliver in that marketplace, probably given the availability of other buildings around there is not going to be the best use of our capital today. So we're just going to hold off and let the market recover some more and deliver at the appropriate time and that's the.
Button mentally that decision that we made today rod or Bob I don't know if you'd like to add into that.
Yes, I don't have anything to add at this point.
Thank you.
And I show. Our next question comes from the line of Michael Goldsmith from UBS. Please go ahead.
Good morning, Thanks, a lot for taking my question, we recognized one of the key tenants of the DXP investment cases, this long development pipeline and so now Youre pausing. This one building like how should we think about what is your confidence level in the expected yields of some of your <unk>.
<unk> projects are they at risk of also being delayed.
Just your overall thoughts about.
When your development pipeline can be monetized and whether that is in the near term or kind of on the shelf for now so.
Most of the balance of what we have is leased so.
The big projects are the ones that we have in east, Cambridge, and one is fully leased faster than the other is fully leased by borrowed.
360 Park Avenue, South and the other one we are actually having some very constructive dialogues on that property and have a letter of intent with a client for part of the building so.
The platform 16, with rather unique circumstances given.
The amount of sublease space Thats been been put on the market in the Silicon Valley Slash San Jose area made us feel that and it was.
Lately speculative project with no pre leasing.
<unk> brought us to the decision that Doug described and again everything that we currently have on that development pipeline that is not yet leased is almost finished so there isn't there is no such thing as a delay of these projects relative to our future development.
Again, $3 43, Madison is future development and as I said, where our return expectations is higher than it would have been in 2019 or 2020. So if we if and when we start those buildings, we would hope that we're going to have an economic.
<unk>.
<unk> two <unk>.
See the kind of returns that are necessary to rationalize.
Incremental amount of capital going into those new assets.
Thank you.
And our next question comes from the line of Caitlin Burrows from Goldman Sachs. Please go ahead.
Hi, Good morning, I think you mentioned earlier about how the top question at NAREIT with on leasing because that's so relevant to your company. So following up on that and leasing velocity was up significantly in the quarter, but down year over year I guess it can be volatile. So what are your conversations like now and do you.
That pace of signings from QQ can be maintained or like to pick up that you saw in the second quarter was there something in particular that drove that or could it be.
<unk> continued thanks, yes, so welcome back Caitlin so the when we had our call during the first quarter, we had about 900000 square feet of what I referred to as our leases in negotiation and so as we enter the third quarter that number was over $1 1 million square feet. So I'd say as I said, a modest acceleration in that.
And we are comfortable with our embedded expectations are somewhere just over 3 million square feet for the year, So I would say quarter to quarter to quarter, it's going to be really what we anticipated and I'm guessing the third quarter will be slightly better than the second quarter and the fourth quarter. It will depend upon how many early renewals with <unk>.
Compensation occur for 2020 for 2025.
Explorations because as.
As we get closer and closer to the end of the year. The leasing activity has generated from those types of.
Conversations with our clients so.
We're constructive I mean as Owen said.
The tech demand.
Particularly on the West Coast has not really started to materialize and so and that was a big volume generator for all of the companies that are in our product mix.
Don't anticipate that changing in 2023, probably not in 2024, so our comparisons to the prior year as we think will be muted because as Owen said, we are we believe we are in an office recession relative to our clients and so there's not likely to be.
Mass of acceleration in leasing activity.
We're going to capture market share because of our asset quality and our teams and their propensity to be creative about figuring out how to solve client problems, which will add to our occupancy, but general market is not going to be what it was in 2022.
Doug one additional comment on the activity is that we are seeing some.
This increase in the amount of not only access but time that we're spending directly with clients.
Most of them are focusing on what is the workplace strategy for them going forward and we're even seeing title changes, where you have director of workplace.
Strategy versus facilities people and these.
These conversations are increasing weekly and it has to do with the whole strategy and specifically on what Premier workspace is going to be needed versus the other bifurcation of space that they had that you mentioned earlier, so I think theres going to be an activity jump here in the future that's coming because it's been pent up because people have been <unk>.
Mccann.
Thank you.
And I show. Our next question comes from the line of Alexander Goldfarb from Piper Sandler. Please go ahead.
Hey, Good morning, first got Bob Congrats on your retirement.
Or I don't know if we're allowed to use award retirement, maybe going to part time, but congrats there.
So.
So question for you just continuing on the West Coast theme.
What do you guys need to see to happen like what's going on with the tech companies. If we if we think back to the credit crisis like here in New York.
Wall Street was down and out for quite a long time it took.
Many many years before it came back for the Tech companies is it they over hired not sure what's going on with with work from home I mean, they certainly seem to be profitable. They always come up with new innovations that they seem to need to hire in need space for so what is what are the things that you need to see for the tech industry on the <unk>.
West coast to sort of Reengage proactively on the office front.
I think.
Alex I'll take a shot at that I'd say first of all.
The tech companies.
<unk> of income growth has flattened out so I think there is more focus on cost, which has an impact on space demand.
And as new technologies are created in the advertising cycle changes and the growth continues then I think there'll be more space demand I think thats part of it I think there definitely could have been an overinvestment period.
Where.
There were.
Lots of employees hired and also space that was taken in anticipation of growth that hasn't materialized. So I think there's a digestion aspect of this.
And lastly, I think the tech.
Technology companies as well as the federal government by the way have been.
Behind the rest of corporate America, and return to office and I think as those policies are rolled out with the tech companies and we're seeing it happen Amazon came back to the office on May one.
There are other technology companies that have come back to the office others are suggesting things like I said in my remarks about evaluating performance and paying people based on their office attendance. These policies are rolling out now and I think that will also increase the demand for space and it's going to take some time.
Thank you Doug.
Rod anybody else have other views on this.
Okay. Thank you rod.
Just comment real quickly Alex I, just would add and I think.
<unk> addressed this point, which is one of the positive drivers now that we're seeing is the.
The AI demand, it's real we've seen those deals in the market a few of them got signed and it's not.
Still by any stretch the majority of.
Deals in the market, but it's happening so it's that opportunity of a new technology that is pulled aside of other downturns and so this is getting a lot of attention I think rightfully so.
Thank you and our next question comes from the line of Nick <unk> from Scotia Bank. Please go ahead.
Thanks, Good morning, I, just want I just wanted to follow up on all the commentary Doug you gave on leasing in the pipeline and activity.
Want to make sure we're clear on this so if you look at your leased rate. It was down year to date about 100 basis points are you, suggesting that in the back half of the year based on the visibility you have right now is actually going to be improvement in the leased rate and then second part of that is you also mentioned it numerous times.
Occupancy gains for the portfolio and so I just wanted to be clear that are you, saying that occupancy. This year is going to be at a bottom and at this point you think next year is actually a growing occupancy here for the portfolio.
So I'll answer the second question first yes, it's going to be modest, but it's a yes.
I'm not sure what you mean by leased rate.
If youre talking about the amount of leasing that we're doing on a on a quarter by quarter basis compared to the previous years. It is going to be down for every quarter in 2023 relative to 2022, and that's why we I mean again, we did build to suits in 2022 that we're not doing in 2023, including almost 1 billion square.
Feet, just in Cambridge, with Astrazeneca and the broker so so again.
So we're doing a lot more leases in terms of numerical number of transactions, but.
The check sizes, obviously smaller because of the nature of what the demand is coming from it which is small professional services and law firms and the financial services firms that I described before so.
We feel good about our pipeline of activity on a relative basis first quarter second quarter to third quarter to fourth quarter of 2023 and.
And again, it's going to be within the construct of the embedded earnings projections that we provided which is going to have somewhere in the neighborhood of three plus million square feet of space.
Thank you.
And I show. Our next question comes from the line of Vikram Malhotra from Mizuho. Please go ahead.
Thanks for taking the question. So just maybe building on uses of capital you talked about the balance sheet your ability to fund what you have so far but I'm just wondering stepping back.
Given what we know about the transaction market our thoughts today, how do you view sort of your implied value given the run up in office or the little run up in office, we've seen relative to perceived nev.
And related to that just uses of capital as the Premier workspace trend is sustainable over say a five seven and 10 year period is this a unique opportunity for you to do something more strategic in the Premier space.
So vikram I'll answer it this way.
These are hard they are based on a lot of judgments that Doug talked about earlier, which are what's your assumption on rent growth in residual cap rate and all of these things. So I think the simplest way to think about it is what is the what is be xps look through cap rate and today that is around eight.
And a quarter percent.
I did highlight one premier workplace that sold in the Silicon Valley and its cap rate was six 1%.
I can't tell you what the proper look through cap rate is for Dxp's assets, but I don't think its the 8.25% and so I think it does represent.
A significant value.
Look I think we are always going to be interested in looking at <unk>.
Expanding in the Premier workplace segment in the life Science segment and in the residential development segment in.
That's one of the reasons why we have the liquidity that we have and we're so focused on our balance sheet, because we want to have capital available.
During this time of distillate.
Available to make these kinds of investments and we're going to stay actively involved in our market looking for them.
Thank you.
And our next question comes from the line of <unk> <unk> from Bank of America. Please go ahead.
Good morning, <unk> had a lot of leasing activity over the past year and your Boston CBD portfolio, which is well leased so could you speak to how tenant demand is trading for your sub urban markets and more generally any comments on how your leasing pipeline breaks down between life Sciences and more traditional office users would be great.
Yeah.
So with regards to the Boston suburban market.
Depending upon how you define things, we have Cambridge, which is where the bulk of our value is and we have no available space there either including.
With new developments that we're doing which are 100% lease and then we have this this group of assets that were.
Once the sort of.
The perfect solution for a growing technology company on 128, which was called technologies Highway that were created in the <unk> <unk> 2000, and those locations are fabulous locations still and what we've been doing over time as we've been converting some.
Those buildings from office locations to like site locations.
And so if you look at our development pipeline the bulk of our available opportunity set is.
As in Waltham, Massachusetts in life Science.
And that that is I would say our focus for growth because we see more likely growth over time with life science demand in the greater Boston market than we necessarily do with traditional technology office demand. It doesn't mean, there isn't isn't demand out there because we are actually doing leases, both renewals and new deals.
And the greater Waltham Lexington market on the office side, but I will tell you that in general the suburban Boston office demand market is slower than than the CBD market by a material.
<unk> right now.
And so we are we are well positioned to capture incremental demand as the life science market recovers and as we've said time and time again, we're not going to simply build for the sake of building, we're going to wait for the demand to come to us and for the market to tightened to the point, where it makes economic sense to do this and we have such a low.
Basis in these buildings, because we have effectively free land or buildings that were purchased for 150 or $250 a square foot, where we can rationalize incremental investment and get a strong return when the market is a quote unquote stable market from a life science perspective, so so I would say that the demand in general.
Traditional office space in the greater Boston suburban market is light.
But there is some there and we are capturing it because we happen to have the best absolutely the best properties in the best locations and what Brian has had.
Sort of term or urban edge locations. It is not no longer viewed as suburban and Brian If you want to make any comments yet too early things that I could point to that may lead to a trend as we have already completed one transaction with a downtown tenants, who has put a spoke into the urban edge and one of our assets we're talking with.
Two more about that strategy, which gets back to this workplace strategy in the future for these companies that are really focused on their knowledge workers and then we're seeing let's say early trend Doug in what some people are calling top tech, which is some portion of this space needs bigger clear heights for Workbenches et cetera, maybe.
Displays for.
Sales, but that uses picked up over the last six months for certain.
Thank you.
And I show. Our next question comes from the line of Ronald Camden from Morgan Stanley . Please go ahead.
Hey, just staying on the life science team.
We've sort of heard about sort of funding out of the smaller companies having to come back for funding and could impact leasing. So we just would love to hear just both in.
On the demand side, what your expectations are in terms of activity over the next 12 to 24, how you guys are thinking about it and then also hear your thoughts on the supply side I mean, he felt a lot of the brokers have a lot of supply in the pipeline, but maybe if you could talk about what youre seeing and which is competitive.
To your portfolio. Thanks.
So I'm going to I'm going to try and truncate the my answer to this.
Not going to talk about all the things that <unk> talked about on their calls relative to sort of overall large scale demand in <unk>.
Life science in particularly.
Biotech relative to gene therapy in all sorts of new discoveries that are going on if you. If you simply look at where the money is going.
It was the amount of capital that was put into the life science market from a VC perspective.
<unk> had an enormous spike in 2019, 2020, one and it was a way outsized and if you look at what's going on in 2023, it's pretty normalized.
Slightly higher than where it was in call. It 2014 to 2019, and so I would say that there is lots of available capital, but the capital is being very thoughtful and it's taking advantage quite frankly of dramatic drops in valuations for companies that were funded by people, who probably shouldn't have.
Even them capital and gave gave it to them at valuations that were not appropriate for whatever the the discovery was in the stage of those businesses. So we believe and we will we believe we will see this what I refer to as sort of small life science demand continue in the marketplace. The issue is that there are not a lot of big demand.
Drivers other than some one or two consolidations that are occurring with some pharma companies that have acquired some additional biotech companies or last few years I'm just trying to put those requirements together in both San Fran South San Francisco in an integrated Boston marketplaces.
But you hit on the sort of the issue, which is there's more there's more supply and when that money was going into the sector lots and lots of people who had property said Aha. This is <unk>.
Perfect way for me to solve the problem of lack of demand in the office side I'm going to take this building and convert it or I'm going to take this land and build a new building and we're going to have to deal with the rather large amount of supply that's going to be in the marketplace for the next couple of years.
And it is clear that there are winter locations and there are a loser locations in these ecosystems of matter a lot.
And so we think that we are really well positioned with our particular assets in terms of their locations both in south San Francisco at $6 51 gateway as well as the two Walter and properties that we have under development.
And PON road interchange, which is where they sort of cluster over the large large larger life science requirements.
<unk> have gone to over the past three or four years and so we believe we will lease these things up or the economics is going to be what we had hoped they are not and I've said this before we're going to have to do more.
Turn key installations for these companies as opposed to give them an allowance and then putting their own money in.
But we will deal with that and we have the capital to do that which again many of our I believe our competitors with product may or may not have the desire or the capability of doing so we're going to get these buildings leased as the demand comes the demand is going to get better not worse.
We just it's going to.
Take a little bit of time I can't give you a projection of whether it's 12 months to 24 months, but that's the way we're thinking about.
Thank you.
And I show. Our next question comes from the line of Bill and Brzezinski from Green Street. Please go ahead.
Thanks for taking the question guys I guess, just looking at <unk> portfolio in terms of office concentration are there certain markets, where you see you guys, adding incremental capital to or possibly even reducing your concentration to overtime.
Our the way we operate is strict.
Strategically we set a parameter which are the six markets that we're in and the way the capital gets allocated is bottoms up so what deals arise in those locations that make the most sense for our shareholders and we execute on them. So we pay attention to the top line, what's the contra.
<unk> from the different markets, but we think it's very important to be nimble and opportunistic as we think about allocating capital across those regions. There have been shifts over time.
Look at the last five years, there has clearly been a shift of capital and allocation out of the CBD of Washington.
That would be a change that I would point out so that's the way we operate the business from a capital allocation standpoint.
Thank you.
And I'm sure. Our last question in the queue comes from Anthony Powell from Barclays. Please go ahead.
Hi, Good morning, and thank you mentioned that variable revenues, including parking was a source of upside in the quarter could you remind us where you are in parking revenues on a same property basis versus pre COVID-19 levels.
How how utilization trended in could you push parking rates as more people come back to the office going forward.
I mean, I think we're doing pretty well on parking.
We are overall I would say parking if you kind of exclude the fact that we removed a parking garage in Cambridge from service.
Earlier this year, we're actually where we were before.
I do think there is still opportunity to grow that because we're better than where we were before because we have increased rents.
We have had occupancy come back into these buildings into these cities. So.
So I do think there's still room there but.
But for parking we're already there.
Increase that we had in this quarter for parking was modest as I said, the kind of the revenue beat was a little bit across the board. It was a little bit in a bunch of different places.
On the retail side.
I'd say every place, but San Francisco, we're back the San Francisco retail contribution before the pandemic was a few million dollars. So hopefully that will come back at some point.
But at this point I'd say, it's still difficult and we're helping our retailers along.
We do have some retail.
Still returning for example in Boston, where we closed down the Lord <unk> Taylor and we're putting in a Dick's sporting goods, that's going to open next year, I mean, thats going to be additive.
To us from a retail perspective.
And then the hotel.
Still a couple of million dollars below where it was.
So I don't know where thats going to stabilize out I mean, it's doing pretty well.
But hopefully it will continue to improve over time and get back to where it was in above where it was.
Thank you.
Im showing no further questions in the queue at this time I would like to turn the conference back to Owen Thomas Chairman and CEO for closing remarks.
That concludes our remarks. Thank you all for your interest and attention for DXP. Thank you.
Thank you. This concludes today's conference call. Thank you for participating you may now disconnect.
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