Boston Properties: A Contrarian To The Work-From-Home Trend – Seeking Alpha

Investment Thesis

Anti-office technology stocks have rallied to all-time highs week after week, while office REITs remain flat at rock-bottom prices after the march sell-off. Work-from-home policies and social distancing measures have clearly contributed to the rally of anti-office stocks. On the other hand, there’s no sight of light at the end of the tunnel for office REITs as the work-from-home trend remains and the return-to-office trend largely discouraged. However, I believe there will be a reversal to both these trends as a vaccine development is soon approaching. While work-from-home trends will remain in place after the pandemic ends, the hybrid office format is likely to be adopted by many corporations. Thus, the office will still remain relevant in the post-pandemic era.

Boston Properties is the largest office REIT with top-of-the-line office properties and has the only “A” credit rating in the office REIT sub-industry. Yet, share prices are 40% down from pre-pandemic levels, a huge bargain for patient value investors.The entire story of The Office finally explained

(Source: Google Images)

An Opportunity Amid the Crisis

The past few months have seen crazy rallies in the markets, particularly in the technology sector where it’s not uncommon to find stocks that are 2x, 5x, or even 10x their pre-COVID-19 prices. While the technology sector has enjoyed massive capital appreciation, some sectors and industries are still lagging behind. Being the value investor that I am, I turn to the best-performing technology stocks to look for potential long ideas – when these technology stocks outperform, there should be a group of stocks that consequently underperform.

One great example would be Zoom Video Communications (ZM). With COVID-19 sending global economies into a shutdown, the majority of the global workforce was forced to work remotely, which became a positive catalyst for ZM as employees turn to video conferencing tools to conduct meetings safely online. As a result, ZM’s stock zoomed past its previous highs and rallied as if the whole world will work-from-home for the rest of eternity. For me, this presents an investment opportunity, not in ZM, but in its counterpart – office properties (I can already sense readers cringing at this idea). Prices of office REITs such as Boston Properties (BXP) were beaten down to valuations only seen during the Great Financial Crisis. The chart below shows the year-to-date returns for ZM and BXP. As you can see, the valuation gap gets bigger and bigger by the month.

(Source: TradingView)

In this article, I will discuss why there is a pricing disconnect between these two stocks and why BXP is a great potential buy.

COVID-19 As An Accelerator Of The Work-From-Home Trend

The pandemic has accelerated the work-from-home trend due to multiple factors. Safety is the first factor. As a response to the outbreak, states nationwide have issued stay-at-home orders as a means to keep citizens safe and slow down the spread of the virus. As a result, working remotely became the most obvious solution, and a return to the office a no-no. In addition, employees do not feel safe and comfortable returning to the office anytime soon. A recent PwC Workforce Pulse Survey shows some of the measures that need to be taken in order for workers to feel more comfortable going back to the office:

(Source: PwC)

The second factor is convenience, both from the employee’s and employer’s standpoint. Employees can work at the comfort of their homes without sparing commute time. Not only does working from home save time for employees to work on more meaningful tasks, but it also eliminates the risk of catching the virus on public transportation. From the employers’ perspective, it is convenient in a sense that they do not have to spend extra dollars on additional office spaces and maintaining them. The introduction of video conferencing tools like Zoom opens the possibilities of conducting the majority of business remotely, and thus, allows employers to enjoy lower operating expenses and improve their margins. Furthermore, on top of leasing an office space, employers may be reluctant to spend more to “COVID-19-proof” their buildings by investing in touchless entry systems and desk dividers. Why spend more when you can save more? Why rent office spaces when you can work anywhere in the world?

The third factor is flexibility. With rising health concerns due to the pandemic, employers have the fiduciary duties to keep their employees safe and therefore, are more flexible in terms of allowing their employees to work-from-home. Absent of the pandemic even, employers were already flexible in terms of their employees’ presentism or absenteeism in the office, just as long as they get their work done and on time. The pandemic has also caused employees to demand the ability to work-from-home for at least a few days of the workweek, even after work-from-home measures have ended.

(Source: Morning Consult)

The fourth and final factor is the reversal of densification, which for the past few years saw more people crammed into smaller spaces. Unsurprisingly, the pandemic is sure to put an end on this trend as social distancing measures remain in place. There is also the potential that some workers may not ever feel comfortable getting close with their colleagues even if a vaccine is already introduced. In addition, the reversal of densification has triggered an urban exodus out of major cities, threatening commercial real estate properties in these cities.

All these factors may support the thesis that the majority of work can and will be conducted virtually, and that the use of office spaces is redundant. Without a doubt, COVID-19 is an accelerator of the work-from-home trend – however, it is not an exterminator of traditional offices.

The Office Will Remain Relevant

While the bullish thesis for work-from-home stocks like ZM remains, I don’t think working from home is a long-term solution. In fact, I think the whole notion of “the end of the office” is overblown. Rather, I believe that corporations will adapt to a hybrid working format where employees split their time between the office and home (e.g. 3 days in the office and 2 days at home). Why not shift entirely to remote working? Because there are aspects of in-person interactions that cannot be replaced by Zoom. Some examples include onboarding, mentoring, team collaboration, creativity, and culture building. During the Q1 earnings call, when asked about the office environment being permanently changed, here’s what BXP CEO Owen Thomas responded with:

And look, I agree with you, I think that we’ve all gotten better at it, we understand the power of the tool. And I think we also understand what’s not great about it in terms of being with colleague? Can you really manage and lead an organization or a group remotely over the long term? Can a company build culture by not being in person over the long-term? Is it really more efficient for everyone to be working remotely? I think these are the questions that business leaders are going to have to answer for themselves as they work through the question that you postulate.

So I’m not saying things aren’t going to change, things always change in real estate and in the use of office buildings. But again, I think the viability of the office is not questioned, by what we’re experiencing.

There’s no question that leasing activity has plummeted due to the pandemic, but there are still signs of transaction activities in the office market. For example, in Q2, BXP completed 942,000 square feet of leases and renewals, including a new 12-year lease with Microsoft Corporation (MSFT). Furthermore, there may even be more demand for office spaces in the future. Yes, you read that right. Here’s what management has to say about demand:

We’ve had conversations with some of our technology tenants, and there is no question that the technology tenants are looking to increase the amount of space per employee. And they’re clearly thinking about reducing the “areas of collaboration” and increasing what you would refer to as personal space.

As such, there is enough evidence that offices will remain relevant. While tenants in the professional services industry (legal, financial, and consulting) struggle with interacting with clients, the growth of the technology, life sciences, and healthcare sectors should drive demand for office spaces. I agree that office properties will experience very tough, near-term headwinds, but they will always be a critical component of the corporate culture. Even some of the most respected executives think so:

(Source: BXP Q2 2020 Investor Materials)

Boston Properties Is Well-Positioned To Emerge As A Winner

(Source: BXP Q2 2020 Investor Materials)

As of year-end 2019, BXP develops, owns, and manages a portfolio of Class A properties, which includes 177 office properties, 12 retail properties, 6 residential properties, and 1 hotel. BXP properties are concentrated in five major urban markets, namely Boston, Los Angeles, New York, San Francisco, and Washington, DC. These are gateway regions with a growing job market as a result of the growing number of tech companies.

In addition, some of the largest companies have their headquarters situated in these markets, which is why BXP is able to secure top-quality tenants – Google (GOOG), Salesforce (CRM), and Bank of America (BAC) to name a few. Top-tier tenants are more inclined to lease one of BXP’s Class A offices as a means to show off their statuses and reputations as well as to attract top talents in the job market.

(Source: BXP Q2 2020 Investor Materials)

Part of the reason why BXP’s share price remains in depressed levels is due to the uncertainty of the virus’s impact on the cities where its properties are located at. The pandemic, combined with high crime rates, political unrest, and trends of urban exodus, threaten the longevity of office properties in these markets. However, BXP’s strong tenant base, coupled with its investment-grade balance sheet, will protect the company from major headwinds down the road. This is shown by BXP’s high occupancy rate and rent collection for its office properties in Q2, at 92% and 98%, respectively. On the other hand, its retail properties and hotel have underperformed during the quarter.

(Source: BXP Q2 2020 Supplemental)

In its Q2 update, BXP management affirms the company’s liquidity position totaling to about $3.4 billion, which includes $1.9 billion of cash and $1.5 billion line of credit available. To put that into perspective, $3.4 billion will be enough to pay off the company’s debt maturities in the next three years. This level of liquidity should be enough to help the company see through the pandemic.

(Source: BXP Q2 2020 Investor Materials)

Conclusions

I understand why anti-office stocks like ZM have exploded in the past few months – work-from-home trends, safety measures, convenience, technological adaptation in the work environment, and so on. But the markets have priced the stock as if we will never return to the office. I completely agree with the fact that the work environment may never be the same again; I don’t know what it will look like in the future, but I’m confident to say that workers will return to the office. Therefore, I do not believe in the narrative that the office is dead.

(Source: BXP Q2 2020 Investor Materials)

I think this pricing disconnect between ZM and BXP is short term – no vaccine is a tailwind for ZM, but a headwind for BXP. Eventually, a vaccine will be introduced. When? I don’t know. I don’t have a crystal ball. In the meantime, BXP will experience more pain in the next few quarters including the loss of pricing power, higher vacancy rates, additional expenses to COVID-19-proof buildings, urban exodus, and even delayed vaccine development. However, BXP’s premium portfolio of office properties and strong balance sheet should protect the company from near-term temporary disruptions.

Densification and work-from-home policies are two major risks to BXP, which could depress demand for office spaces in the near future. However, such policies may also present an opportunity as tenants seek additional space to compensate for social distancing measures. In the long run, workers are expected to return to their offices, albeit in a less frequent manner – part-time work-from-home, part-time work in the office. Additionally, there are aspects of corporate offices that cannot be replaced by work-from-home technology, such as mentoring, onboarding, culture building, collaboration, and so on. Thus, office demand should remain in place in the long run, and BXP should benefit from growing demand from the life sciences and technology sectors where BXP properties are located.

Soon enough, a vaccine will be developed and work-from-home fatigue will set in – only time will tell. For now, ZM’s share price reflects maximum optimism while BXP’s share price reflects maximum pessimism. There’s the saying by Mr. Warren Buffett: “Be fearful when others are greedy and be greedy when others are fearful.” Value investors who believe in the eventual deceleration of the work-from-home trend and the acceleration of the return-to-office trend should consider accumulating shares of BXP at current prices. Here’s a portion of an FT article to close out today’s article:

And whilst a certain amount of time can usefully be spent working from home in say report writing and document reading, do we really want to LAW (Live At Work) for the rest of our lives? Full-time WFH was a short-term necessity but not a long-term solution to anything.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BXP over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Author: HOCAdmin