Stagnating Occupancy, Rising Interest Rates and Growth Ambitions Cloud BXP's Dividend Outlook

Boston Properties, the class-A office REIT with buildings in premier cities such as Boston (35% of rent), New York (33%), and San Francisco (18%), has struggled to bounce back from pandemic lows.

As remote work remains a formidable force, Boston Properties' occupancy rate has stagnated at around 88% compared to 92% in 2019. And management forecasts only modest vacancy improvements over the next year as leasing activity has slowed and some tenants require less space as they adapt to a hybrid workforce.

The slow recovery has given tenants more leverage in negotiations, resulting in favorable concessions such as free rent and property improvements funded by Boston Properties.

As these forces pressure profits, which management projects will fall by 3% to 5% in 2023, the REIT is also contending with rising rates expected to increase the firm's interest expense by $100 million next year.
 
For perspective, Boston Properties will generate around $700 million of cash flow this year and pay just over $600 million in dividends.

While stagnant occupancy and rising interest rates stand to pressure income in the year ahead, Boston Properties has historically maintained a comfortable payout ratio, providing a stable dividend through these last few challenging years.

Even so, Boston Properties, one of the country's most prominent office space developers, has intentionally kept the dividend low to help finance construction projects with retained earnings.

Prioritizing growth over shareholder income has helped Boston Properties build a world-class portfolio in some of the nation's most sought-after locations. 

But this strategy could pose a more significant threat to the payout as higher interest rates make self-financing of development projects and acquisitions even more attractive.

With the convergence of sluggish occupancy and rising interest rates dampening the REIT's outlook, we are downgrading Boston Properties Dividend Safety Score from Safe to Borderline Safe.

While this downgrade does not signal an imminent dividend cut, it does reflect the overall deteriorating environment for office REITs and the reduced financial flexibility of Boston Properties as interest rates rise.

If the payout was eventually reduced in response to these pressures, we would not expect a big cut.

Boston Properties has kept its payout near the 90% of taxable income threshold REITs are required to distribute, so a dividend reduction of no more than 20% could be a worst-case scenario.

To consider returning Boston Properties to a Safe rating, we would like to see the REIT's occupancy improve, dividend coverage stabilize at a healthy level, and leverage come down as several development projects start generating cash flow over the next couple of years.

Overall, Boston Properties has one of the highest-quality portfolios in the office REIT industry. The stock also looks cheap by historical standards, but investors considering BXP need to have confidence in the long-term outlook for office demand, which remains murky. 

We will continue to monitor the office REIT and provide additional updates as needed.