Office real estate investment trusts (REITs) made a huge comeback in 2021 after being crushed in 2020 with the onset of the pandemic. However, the newest variant of the coronavirus, omicron, is fueling further uncertainty in the market and disrupting the positive sentiment for the future of office space. This is precisely why I'm waiting to buy Boston Properties (BXP -0.05%).
Leading office provider in top tier markets
Boston Properties leases high-end office space in six of the largest metropolitan markets in the U.S. -- Boston, Los Angeles, San Francisco, Seattle, New York, and the greater Washington, D.C. area. In total, the company owns 202 properties, leasing the space to a diverse range of tenants, including tech companies like Salesforce, Google, Microsoft, life science businesses, and co-working office operator WeWork, among many others.
The company is nearing pre-pandemic performance in terms of its funds from operations (FFO), with a gain of 5.4% in Q3 2021 from Q3 2019. However revenue was down 1.8% from Q3 2019, and net income per share was little changed at $0.69 per share, versus $0.70 in the 2019 period.
Given its steady recovery, it may seem counterintuitive to wait to invest in Boston Properties, given that its share price is down 20% from pre-pandemic levels. But I still have concerns over the future of the market for office space, particularly as omicron wages on and financial markets waver in the face of anticipated central bank interest increases.
I'm not one of the naysayers who believes the office is dead. I very much believe there is still a need for office space. However, I think there is excess office space in the market today, particularly in the large cities where Boston Properties operates.
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The future of office space is unclear
As of Q3 2021, the company's portfolio was 87.8% leased on average. Before the pandemic, it was 92.6%. The company also has 4.3 million square feet of development in its pipeline, with office space in these buildings 87% preleased.
However, I think a lot of tenants have been playing a waiting game. Expectations for a return to normal in a post-pandemic world were high after the advent of COVID vaccines in early 2021, which caused a number of businesses to enter new leases for office space or re-lease existing space. But new variants and the spread of the coronavirus even among those who are fully vaccinated is complicating matters.
Employees are also demanding more flexibility in their working conditions, while more than 3.9 million workers were quitting their jobs on average each month last year. I think this new variant and likely others to follow will force many employers who have been patiently waiting to return to the office to reconsider and possibly lease less space in the future.
There's a lot of volatility in the marketplace amid the likelihood of several interest rate increases to combat mounting inflation. The impact of these forces could spill over to businesses. Many of Boston Properties' tenants haven't fully recovered from the pandemic, and a recession certainly wouldn't do the office sector any good.
Boston Properties has a superb portfolio of assets. It is one of the premier office REITs, with some of the highest-quality office buildings in its various markets. I simply think office space is a vulnerable asset class right now. It can recover quickly if we find a way to effectively contain the pandemic or, conversely, have a tough few years if the pandemic wears on.
The company could benefit from improving its debt exposure, considering its debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio is more than 7.7-to-1, well above the target ratio of 5 for REITs. I hope Boston Properties will continue to recover and eventually return to being one of the leading REITs for long-term investors, but right now, the risk for me is just too high.
