In his words before Congress, Federal Reserve Chief Jerome Powell addressed an issue many real estate investors have been worried about for years: the ongoing fallout from commercial real estate. Powell defined the situation as "a risk that has been with us and will be with us for some time, probably for years." He emphasized that large banks recently passed their stress tests and that some stress tests focused on commercial real estate exposure.
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While most investors believe that large banks are too big to fail, much of the commercial real estate risk lies with smaller banks. For investors in office real estate investment trusts (REITs), finding out where the debt is situated and looking at the terms of that debt is essential. We expect REITs to carry debt, often more debt than other publicly traded companies, because of the rules for REITs that require them to distribute the bulk of their income in the form of dividends.
While interest rates may drop in the future, much of the commercial real estate debt that exists was established before the pandemic when capital was still relatively cheap. To add fuel to the fire, much of that debt is due this year. Earlier this year, the Mortgage Bankers Association reported that $939 billion of the $4.7 trillion outstanding commercial mortgages was coming due this year. That works out to around 20%. Some of that may be refinanced, but when looking at REITs, a wide breadth of debt maturities is a reassuring sign that the company won't suddenly have to scramble to handle a looming debt issue.
Can This Office REIT Rally?
Boston Properties BXP is a REIT with 187 properties, mostly offices but some life science facilities. As you might expect with a name like Boston Properties, much of its real estate is in the Boston market, but it also has exposure to New York, Seattle, San Francisco, Washington D.C., and Los Angeles.
While its leased property rate is below what we'd like to see at 89.9%, that number has been dragged down by weakness in the Seattle, San Francisco, and Los Angeles markets. As of the first quarter, there are signs that the company can keep leasing new property. One encouraging note is that it has $1.2 billion worth of life science developments and redevelopment, 64% of which is preleased.
Looking at its balance sheet, one point worth highlighting is that funds from operations (FFO) growth is anticipated to be in negative territory for the year, down to -3.3%, partly because of higher interest expense. When we dive deeper, we see that its net debt to EBITDA is rising, another sign of concern. Its debt-to-market capitalization has also been elevated in recent quarters. As of the first quarter, it was $15.4 billion, and the bulk (71.5%) was unsecured.
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Since the pandemic, Boston Properties hasn't raised its dividend, but it hasn't lowered it either, keeping it at a steady $0.98 per quarter or an annual dividend of $3.92. It has a forward dividend yield of 6.4%. While the stock price has dropped by over 53% during the past five years, what's interesting is that there is a wide variance in how analysts consider its prospects. The consensus price target is $81.14, but that takes into account target prices ranging from $52 to $132. Most recently, Morgan Stanley maintained its equal-weight rating.
Jerome Powell's statement on Capitol Hill reminds all REIT investors that prudent debt management will be the key to success. Boston Properties has significant debt and a tough road ahead. Much will depend on whether its move into more life science properties attracts greater leasing volume. Investors may want to keep a close eye on its development pipeline to ensure it hits its leasing targets.
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