Boston Properties Inc. Q2 2009 Earnings Call Transcript

Jul.22.09 | About: Boston Properties, (BXP)

Boston Properties Inc. (NYSE:BXP)

Q2 2009 Earnings Call

July 22, 2009 10:00 am ET

Executives

Arista Joyner - Investor Relations Manager

Douglas T. Linde - President

Michael E. LaBelle - Chief Financial Officer

Mortimer B. Zuckerman – Chairman

Edward H. Linde, Chief Executive Officer

Analysts

Michael Bilerman - Citigroup

Mark Biffert - Oppenheimer & Co.

Jay Haberman - Goldman Sachs

Sloan Bolen - Goldman Sachs

Jordan Sadler - KeyBanc Capital Markets

Ross Nussbaum - UBS Securities

Jacob Strumwasser - BCC

Alexander Goldfarb – Sandler O'Neill

Michael Knott - Green Street Advisors

Jamie Feldman – Bank of America

Nick Pirsos - Macquarie Securities

Operator

Good afternoon and welcome to Boston Properties second quarter earnings call. (Operator Instructions)

At this time, I would like to turn the conference over to [Arista Joyner,] Investor Relations Manager for Boston Properties.

Arista Joyner

Good morning and welcome to Boston Properties second quarter earnings conference call.

The press release and supplemental package were distributed last night as well as furnished on Form 8-K. In the supplemental package the company has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Reg. G requirements. If you did not receive a copy, these documents are available in the Investor Relations section of our Web site at www.bostonproperties.com. An audio webcast of this call will be available for 12 months in the Investor Relations section of our website.

At 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 of 1995. Although Boston Properties 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 Tuesday's press release and from time to time in the company's filings with the SEC. The company does not undertake a duty to update any forward-looking statements.

Having said that, I'd like to welcome: Mort Zuckerman, Chairman of the Board; Ed Linde, Chief Executive Officer; Doug Linde, President; and Mike LaBelle, Chief Financial Officer. Also during the question-and-answer portion of our call, our regional management team will be available to answer questions as well.

I would now like to turn the call over to Doug Linde for his formal remarks.

Douglas T. Linde

Good morning everybody. We really apologize for the delayed start. The conference call company was unable to dial out to us and so for that they should be apologizing. Also, the regional managers that are on the phone, could you please mute your lines because I have a suspected feeling that you are on live and if you rattle or type or do anything like that it's going to get bled through the call.

Thanks for joining us, and I guess we're the first company to report this quarter, which for us is pretty extraordinary because normally we're in the middle to the last portion of the filing. So hopefully we will have some interesting things to tell you and get the REIT season off to a good start.

You've heard us speak about the dependence of the office market, at least in general, on job growth before, and we're going to take you through in a few minutes the importance of looking at the specific markets locations and billing characteristics, in addition to simply the jobs themselves.

Mort put an editorial out there in the Wall Street Journal last week, which I suspect many of you saw and he discussed his views on the state of the overall economy. The employment picture continues to be pretty challenging and as office owners dependent on job growth by knowledge-based companies, primarily in the service sector, we recognize that the employment rate hasn't peaked and that we, broadly speaking, will not see growth in the office business. And by growth, what I'm talking about is growth in rental rates. Until the later stages of a job recovery.

A major contributor to increases in unemployment has been the magnitude and the speed of the cost cutting that has occurred in the businesses across this country. Yet as we enter the second quarter earnings season, what we're reading and hearing is that cost cutting is translating into margin improvements, better than expected results across a broad spectrum of non-financial businesses, and to date Alcoa and IBM and Intel and Family Dollar and Lockheed Martin and Quest Diagnostics and Pepsi Bottling, and a host of others, have all reported higher earnings expectations predicated on only a modest improvement in top line revenues.

The inventory restocking and production balance appears to be gaining some traction as companies like Ocelor, Mattel announce plans to start up dormant field plans. And the financial firms seem to have resurrected at least the revenue side of their businesses. And while the charge-offs from bad loans are going to continue to have a very significant impact on earnings, the mood in the financial sector has clearly changed.

Taken together, this is a pretty positive development if it translates into greater business confidence. As senior management teams become more confident in their recalibrated business models they can become more comfortable making decisions on matters like real estate and will be tempted to explore longer-term commitments, taking advantage of the adjusted rental rate market. And things have adjusted.

At the same time, there is still a whole host of businesses that will continue to face uncertainty and prefer to postpone any real estate decisions, and we're going to do our best to accommodate all of these customers in our portfolio.

It is important to reiterate that leasing transactions originate from events other than national, or even regional, job growth, namely lease expirations, mergers and acquisitions, and new business formation.

Even in an economy with increasing unemployment, there are still tenants that have expansion or growth plans which require incremental real estate. And you're going to hear some evidence of this in my remarks over the course of the morning.

Our strategy has been to own and operate the highest quality assets in our selective markets, to design buildings and tenant spaces suited to customers' needs, and to continue to invest in and upgrade these assets.

In an environment where tenants and landlords are all underwriting counterparty risks now, both ways, tenants will bet on well-capitalized landlords with proven track records who retain and operate assets for the long haul rather than landlords with questionable resources subject to enhanced financing risks.

When we spoke to you at our last call in April we suggested that leasing activities seemed to be picking up and that the spread between landlords' asking rent and tenants' proposed rents had begun to narrow to levels where we felt deals would start to be made. The momentum in activity continues.

We have completed some deals, we are immersed in a series of negotiations through our portfolio on our current vacancies, and we are actively engaged in a whole host of early renewal discussions whether we're going to reduce our roll over exposure in 2010 and 2011.

Transaction activity in the second quarter, defined as signed leases, was 600,000 square feet, versus 250,000 square feet in the first quarter and during the last two weeks we've signed four more leases, totaling 152,000 square feet, which covered 132,000 square feet of vacancy and a 20,000 square foot pending lease expiration in November. So net-net, we're up three times from the first quarter.

Most of the square footage won't hit our revenue in occupancy statistics until late in 2009 and early 2010 but it's a pretty encouraging trend.

Three months ago we discussed the significant change in the level of activity in New York City, primarily mid-town Manhattan. There have been a number of independent articles and analyst pieces sort of confirming our experience of the pick up in Midtown leasing activity.

In the last 30 days we've completed: a 35,000 square foot renewal, which included 9,000 square feet of expansion at 599 Lexington Avenue, we negotiated a lease termination and immediate relet of a floor at 601 Lexington, which is the former Citigroup Center Building, now called 601 and it's the only way we will refer to I hope—a 30,000 square foot lease with no tenant improvements, to a group that was a spin-off from a UBS company twelve months ago; and we leased a final floor of availability at 7 Times Square to a U.K.-based law firm.

Now just to refresh your memory, Heller Erhman vacated 125,000 square feet in 7 Times Square in November 2008 and we collected a termination payment of $7.5 million. We have now leased the entire premises to three separate law firms at rates in excess of Heller's $64 per square foot.

We are incurring some down time, there will be some modest tenant improvements, and yes, we are going to be paying brokers' commissions, but we released the entire space in less than nine months.

Again, it speaks to the desirability of our assets and the advantage that high quality buildings, where tenants have made substantial investments in the installations, have in a weak market.

Lease negotiations are underway on two of the of the Lehman floors at 399 Park Avenue. Those are 100,000 square foot floors. Current tenant interest for the space is coming from a growing niche investment banking firm, two insurance companies, a broker/dealer, and a real estate brokers company. Leases at the base of the building are going to have starting rents in the low 60s, while rents at the top of the building, on some pre-built spaces, are in the high 80s.

Now, not all the news is positive in New York City, as General Motors rejected its lease at 601 Lexington Avenue of 120,000 square feet. We are just simply going to have lease that space again. We are also coming to the end of our stabilization activities at the West 55th Street site and Mike's going to discuss the earnings impacts in his remarks.

Evidence of the increased activity, though not universal, has also appeared in our other markets. In the San Francisco region we completed a 74,000 second quarter lease with Genentech at 601 Gateway, which is going to cover all of our vacant space in the near-term rollover in that building. Rents in south San Francisco are in the mid-30s.

We signed four deals in our Mountain View project, totaling 68,000 square feet and are negotiating leases or in discussions with four additional tenants for another 54,000 square feet.

I would note that the Silicon Valley has probably some of the highest availability rates in the country and has seen very dramatic rental rate declines. While there has been a noticeable fall off in general market activity, the R&D product on the west side of 101, which is really Palo Alto and Mountain View, continues to have pretty good activity and we have a constant of tenants in those properties.

Turning to the city of San Francisco, we signed a four-floor deal on a space that would have been available in November, which I referred to before. We are in lease negotiations on two four-floor renewals, and we're negotiating a two-floor transaction with a law firm that is expanding from one floor elsewhere in the complex.

In an interesting side note, that firm was having a very difficult time consummating a sublease, since they could only offer four-and-a-half years and the firms that were looking at space wanted much longer lease terms. This, by the way, is indicative of why subleased space does not always pose a threat to direct availability from landlords. We responded to two proposals on that space within a week of having a verbal agreement to relocate this tenant. Rents in the Embarcadero Center range from the high 30s to the low 60s.

Activity in Cambridge in the western suburbs of Boston still continues to be pretty okay, where we have seen a consistent flow of small, medium, and larger apartments, with large being over 30,000 square feet. At the risk of being repetitive, there continues to be a handful of expanding technology in biotech tenants that are taking advantage of the recent pullback in the market to upgrade and expand their premises.

This quarter we completed a transaction in Waltham with a technology firm that expanded from 80,000 square feet to 130,000 square feet and extended its lease for five years. Rents in Waltham are in the low 30s for the best spaces.

In addition, we are working on three large early renewals with minimal tenant improvements, in exchange for some short-term rent resets.

In Cambridge we are negotiating with an expanding life sciences company for all of our availability at 3 Cambridge Center, 62,000 square feet, as well as an immediate occupancy in a 20,000 square foot plug-and-play space at 1 Cambridge Center. Cambridge rents are currently in the mid-40s for office space.

The Boston CBD has been less active with limited lease-expiration-driven transactions anticipated over the next few quarters.

Our immediate activity in Washington, D.C. has really been focused on early renewal negotiations. In total, we have over 1.2 million square feet of leases with either the GSA, defense contractors and high tech companies in Reston and in the city that are under negotiation.

If I had to make a generalization about these deals, it would be that they're all being completed with minimal, if any, tenant improvements. In some cases, rents will be lower than contractual rents, and in other cases they're going to be higher. Rents in Reston still range from the low-30s to the low-40s. In the District, where our portfolio is 99% leased, once again our focus is on lease rollover in 2010 and 2011 and we're in advanced stages on renewal discussions with four tenants, including a 76,000 square foot law firm that's considering a 22,000 square foot expansion, along with a 15-year renewal.

Now, there is significant new construction underway, or recently competed, in the D.C. market. These buildings, however, are in secondary locations, near the ballpark and north of Massachusetts, but they can be acceptable locations to meet government user requirements. So they will take the edge off of that type of space requirement.

Overall, the Class A and CBD rents are still in the $45 to $60 triple net range. We continue to have active discussions on the remaining space at 2200 Pennsylvania Avenue but we haven't yet signed any additional leases.

Now, as you review the leasing data we provided in the supplemental, it's pretty clear that the releasing spreads for this quarter were again very healthy. The overall increase of 18% for the portfolio probably seems counter-intuitive, given the perspective that people have on what's happening to market rents.

Now, while these leases will translate into actual rental revenue, they have less predictive value when the market changes as rapidly as we have seen. We tried to separate the deal into leases that were signed before and after December 2008, must to give you a perspective where on rents are. Looking at the data in this way, the overall increase for the earlier deals is over 26% and includes about 650,000 square feet of that space, while the more recent deals on the balance of the space actually have a net decline of about 2%. So that's probably certainly much more consistent with what your intuition would have been.

When we recalculated our mark to market last quarter, we had a much better picture on the current level of rents in our portfolios because we really were in the midst of a number of live transactions, particularly in New York City. And we just don't see any data out there to suggest any further downturn in revisions this quarter.

While we may not have hit bottom, particularly in some of our markets, rents have reached a level where the bid/ask spread is close enough for transactions to be happening in a pretty consistent manner.

Now once again, when you're thinking about our mark to market, you have to remember it's a point-in-time comparison on our lease spaces. It includes currently leased space that won't vacate in the near term, as well as leases that don't expire until times like 2019, with very high rents in them, as well as rents like the deal we did in New York City last year at $140 a square foot, where the spot rent might be $85 today, but we don't have any impact for another ten years. It does not include any currently vacant space.

So changes in our portfolio vacancy will have a very significant impact on our income. At an average portfolio rent, adjusted for our JVs, of about $49 a square foot, each 1% of occupancy translates into about $16.0 million.

Now, currently the overall portfolio mark to market is pretty flat. It's about $0.10 positive. And I guess the real point is what's going on in the next few years. The mark to market for space coming available in 2010 is positive $1.88 and that same calculation for 2011 is negative $2.47. The reason for the 2011 rent rolldown is that we have about 200,000 square feet of space in Embarcadero Center Four, where the current rent is over $62 a square foot and the actual rents probably today are closer to $92 a square foot and the actual rent is closer to probably $60 to $65 a square foot, so a pretty big rolldown.

We are still in the midst of the deleveraging process that is occurring across the financial sector and in the real estate industry. Since the end of 2008 we have taken significant actions to add to our liquidity and/or reduce our capital commitments.

Just to review: we've halted construction on 250 West 55th Street, which resulted in a $500.0 million reduction of capital commitment; we formally established a dividend level of $0.50 per share, increasing our retained capital by $17.0 million per quarter; and most recently, we raised equity through a secondary offering of 17.25 million shares, netting $842.0 million after transaction costs.

We have retired some near-term secure maturities but we retain a very significant cash balance. And while the leasing markets have achieved this level of equilibrium, where deals can be completed, the same really can't be said of the sales market.

The secured debt markets continue to be in a state of disarray, with previously considered conventional leverage level simply unobtainable today. And while there may be life insurance company bids available at levels of up to $150.0 million and at rates between 7% and 8%, reasonable rates, the level of equity required for any new acquisition is probably 50% or more of a purchase price. The daily headlines of commercial real estate debt troubles are only going to increase the caution of potential lenders.

The unsecured markets are functioning relatively normally and Mike's going to touch on that in his remarks in a few minutes. Given these economics, bidders are making offers at levels that are considered lower than the levels which where sellers, at the moment, are prepared to transact. If an owner does not have to do something today, they are hoping for a better tomorrow.

Now at some point this state of affairs is going to change. While maturities are certainly an obvious friction point, leasing transactions may force earlier action. As I suggested earlier, tenants are starting to consider long-term commitments and in many cases these decisions require action on the part of landlords in the form of either rent concessions or capital investments.

Until there is recognition of current valuations by all parties in a particular building's capital structure, the owners of over-leveraged assets are going to be paralyzed to act. In the meantime, we are working to differentiate ourselves in the way we operate, the way we invest, and the way we lease our buildings and we are taking the appropriate actions to put ourselves in the best position to participate in the recapitalization of assets in our core markets.

And with that I'll turn the call over to Mike to talk about our results this quarter.

Michael E. LaBelle

I just want to add a couple of comments to Doug's discussion on the leasing. We are very encouraged with the increased level of activity, as is evidenced in our statistics and also in tour traffic on our available space. While we are completing a number of deals with minimal tenant improvements, in some cases the concessions have increased and depending upon the quarter, we may see large variability in our concession costs.

This quarter our average transaction costs were approximately $38 a foot. And to give you a little more detail, our activity included a handful of larger new and expansion leases with average transaction costs of close to $60 a foot, while the remaining leasing was a diverse pool of both new and renewals that were under $20 a foot on average.

Looking forward, we will actively pursue the use of prebuilt spaces and use our construction management capabilities to manage installation costs by offering turnkey build out services where appropriate to best meet market demand. On larger deals, the tenants who have options are pressing for larger contributions.

That said, we continue to see a high level of renewals and shorter-term deals with low transaction costs. Overall, we expect our leasing strategies will result in increasing our hit ratio but new transactions will be evidenced by higher than historical transaction costs.

Getting to our first quarter results, last night we reported FFO of $1.32 per share. Excluding the impact of the additional share count from our equity offering, we exceeded the midpoint of our guidance for the quarter by approximately $12.0 million, or $0.08 per share. If you pull out a couple of significant one-time items, such as termination income and an impairment charge, we still exceeded our guidance by about $0.04 per share.

The first major one-time item was termination income of $14.9 million. The vast majority of this came from two tenants in New York City. One is a 30,000 square foot tenant at 601 Lexington Avenue that Doug mentioned, where we've already back-filled the space. Although the rent from the new tenant is lower than the prior deal, inclusive of the termination payment, it was a good economic deal for us.

We have also terminated a 15,000 square foot lease at our 2 Grand Central asset and we have activity and a proposal out where we could see a rent roll up of roughly $5 a foot, or 10%.

$5.2 million of our termination income is non-cash and consists of the value of furniture and fixtures that two of our tenants have agreed to leave behind, plus the acceleration of $1.5 million of FASE141 income.

On the negative side, we are taking a $7.4 million non-cash impairment charge related to our joint venture interest in our value fund. This is solely related to three properties located in the Silicon Valley where we have written this downward pressure on rent to the tune of 20%+ in the last quarter. Our ownership position in these buildings ranges from 25% to 40%. Because they are held in an unconsolidated joint venture, GAAP requires quarterly impairment testing to fair market value. The rent decline is reflected in our leasing assumptions in the discounted cash-flow driven valuation resulting in a lower fair market value this quarter.

Our interest expense came in about $2.0 million below budget due to the combination of the early repayment of a couple of loans and the decision to postpone a few other financings. The remaining $4.0 million variance from our guidance was due to portfolio performance, including about $2.5 million of operating cost savings. These savings related to the deferral of repairs and maintenance items, savings in utilities due to cool spring, and also to some more permanent cost-cutting measures that we have been implementing.

We are focused on the expense side of the ledger, and as we discussed last quarter, we reduced our G&A projections last quarter for the full year 2009. We have also undertaken an extensive review of our property operating expenses. We are holding discussions with many of our key vendors from cleaning to security to elevator maintenance to utilities providers and expect to achieve meaningful savings in the rebidding of contracts.

We are also analyzing our staffing needs and have made adjustments where appropriate. Overall we anticipate that we can reduce our expenses by between $10.0 million and $15.0 million per year. Now most of this does not drop to the bottom line, due to the fact that the majority of our tenants have base years but over time it should manifest itself in improved operating margins.

Looking at the rest of 2009 we continue to be very cautious about the leasing markets. As Doug discussed, we are seeing an uptick in activity on much of our space but we don't expect it to have an impact on 2009 due to the lease commencements that would not occur until late in the year, or even in 2010.

As we forecasted last quarter, our occupancy decline by 200 basis points this quarter, with Lehman Brothers vacating 399 Park Avenue, General Motors failing to perform on its lease obligation at 601 Lexington Avenue, and 1 Preserve Parkway coming on line in suburban Maryland at just 20% occupancy.

At 1 Preserve we are in negotiation on another 50,000 square feet that may grow to 75,000 square feet, which would increase the occupancy to 60%, but with lease-start dates in 2010.

We expect to lose about 100 basis points of additional occupancy by the end of 2009, mostly due to uncovered roll over primarily in suburban Boston.

The vast majority of our vacancy is high quality and well positioned space that is attracting the current market's demand. In the current environment deals are simply taking longer to complete.

We consider approximately 675,000 square feet of our vacancy, just 2% of the total portfolio, to be space that is much tougher to lease, due to being in older buildings, many where we are planning future redevelopments, and therefore will have extended vacancy. This structural vacancy has potential rental income of only about $10 per square foot net so its economic impact to us is really minor.

We project leasing 850,000 square feet for the rest of 2009 and nearly 85% of that number is currently in negotiation. A big part of the remaining leasing is several large renewals where the tenants really have no option but to renew and we are simply negotiating the rate.

We continue to project our same store growth for 2009 to be flat to slightly negative, with cash same store NOI projected to be down 1% to 2% and GAAP same store NOI to be flat to up 1%. We expect straight line revenue, excluding our new development deliveries, of $35.0 million to $36.0 million for the full year, and termination income of $1.0 million per quarter.

Our 2009 development deliveries will have a positive impact with Wisconsin Place, which just delivered this past month at 91% leased, our Democracy Tower Building that is 100% leased delivering in the third quarter, and our build-to-suit for Princeton University also delivering in the third quarter. The FFO yield on these developments is just north of 10%.

We have budgeted and continue to experience tenant bankruptcies. This quarter General Motors, who was expected to commence rent payments on 120,000 square feet at 601 Lexington Avenue in June, rejected its lease. We also had a full-floor tenant in Embarcadero Center file for bankruptcy. For the rest of the year our guidance includes $5.0 million of lost revenue due to defaulting tenants.

We expect our joint venture properties to be fairly stable for the rest of the year with a full year contribution of $135.0 million to $140.0 million. This is down from our guidance last quarter solely due to the $7.4 million non-cash impairment we are recognizing this quarter.

The hotel market nationwide, and also in the Boston area, where we have the Cambridge Marriott, is experiencing continued downward trends, with constant pressure on rates. Our average daily room rates have declined from $237 last year to $196 today. And although our occupancy at 78% remains pretty strong, our RevPAR is off by over 20%.

In response to the worsening conditions, we are reducing the projections for our hotel by $1.5 million and now expect its contribution to be between $5.5 million and $6.0 million in 2009.

We expect our development and management services fee income will run between $30.0 million and $32.0 million for the year.

Last quarter we went through, in detail, our projections for our G&A, including a decline of approximately $5.0 million in cash G&A expenses, and these continue to hold. Our 2009 G&A estimate is $72.0 million to $74.0 million.

Interest expense will come down, as we have elected to postpone several planned financings, including our $225.0 million term financing of Two Embarcadero Center. We project that our interest expense will be between $300.0 million and $305.0 million for the year, including $38.0 million of non-cash interest expense associated with our exchangeable debt in accordance with APD14-1.

Capitalized interest is projected to be between $45.0 million and $50.0 million for 2009 and includes the capitalization of our 250 West 55th Street project. 250 West is responsible for $25.0 million of our 2009 capitalized interest and we expect to stop capitalizing it in the fourth quarter.

As we start to think about 2010, there are several important items to consider that will have an impact on our results. The first is our ability to lease up our vacancy, including the Lehman Brothers space in New York City. We ended 2008 at 94.5% occupancy, and expect to be at roughly 91% by the year end 2009, assuming no additional leasing at 399 Park.

This vacancy creates an opportunity but it also represents between $35.0 million and $40.0 million of rent that we received in 2009 that is not currently on the books for 2010. The Lehman space alone contributed $17.7 million in 2009.

We are seeing activity, but given the overall outlook for the economy, and particularly the job sector, for the next 18 months, we are projecting that our occupancy will hover between 91% and 93% during 2010.

The fact that we have less than 9% of the portfolio subject to natural lease expirations in 2010, with over 40% of it in the fourth quarter, is a positive and mitigates some of our exposure.

We have experienced a substantial amount of termination income in 2009 at $16.0 million through the first half, which we do not expect to recur in 2010.

We also will start to experience the natural burn off of a portion of non-cash FASE141 income as leases expire in our New York City joint ventures. As you recall, FASE141 requires us to recognize non-cash rental income for these buildings as if the entire building were leased at market rents at the time of the acquisition in mid-2008. Market rents have come down significantly in New York City since the acquisitions so as these leases roll, we will be reporting a roll down in GAAP rent, which includes the FASE141 component, even though in actuality many of these leases may experience cash rent rollups.

This is all non-cash, but unfortunately runs through our numbers and our FASE141 income is expected to be $15.0 million lower in 2010.

Also, we have a couple of meaningful development fee assignments that are coming to a close in 2009, including our work on Wisconsin Place and 20 F Street. These two projects are expected to contribute an aggregate of $7.9 million to 2009. We are actively looking for new fee services opportunities.

As I mentioned earlier, we will complete the vast majority of work on 250 West 55th Street in New York City and expect to stop capitalizing interest in the fourth quarter. This project will have $480.0 million invested where we have been capitalizing interest at our average borrowing cost, resulting in capitalized interest of approximately $25.0 million for the full year. Ceasing capitalization on this project will result in an increase in our GAAP interest expense in 2010.

Offsetting this slightly will be an increase in our investment in a remaining development pipeline. We will continue to spend money on Atlantic Wharf, the Biogen headquarters in the Boston market, and our 2200 Pennsylvania project in Washington, D.C., which will partially offset the decline in capitalized interest at 250 West.

We also will see incremental income in 2010 of $20.0 million to $25.0 million from the impact of our 2009 and 2010 development deliveries.

Lastly, there were a couple of one-time expenses incurred in 2009 that should not recur. This includes the $27.0 million charge taken on 250 West 55th Street last quarter and this quarter's $7.4 million impairment charge.

I would like to turn to our balance sheet and capital markets activity. In early June we completed a secondary equity offering, raising net proceeds of $842.0 million and significantly strengthening our liquidity position.

At quarter end we had $820.0 million in cash and virtually our entire billion dollar line of credit available.

On the financing front, we have taken care of all of our 2009 maturities. We have qualified for, and plan to exercise, a one-year extension on our construction loan at South of Market, which has $185.0 million outstanding. We will pay off a small mortgage we have expiring on one of our Washington, D.C. assets next month. And finally, we are completing a $50.0 million financing of one of our suburban Boston buildings that should close later this summer. It's a floating rate, five-year bank loan where we will likely fix the rate in the 7% range, using the swap market.

We are now focusing on our 2010 exposure, where we have some secured mortgages coming due totaling about $800.0 million. Five of these mortgages relate to joint venture properties and our share of the total exposure is just over $500.0 million. We have underwritten the refinancing of each of these mortgages to current market underwriting standards and are comfortable that we can refinance the current debt amount on each, with the exception of two loans, where we project that we will make a paydown of approximately $100.0 million, which represents our share.

As I touched on before, we elected to cancel our financing for Two Embarcadero Center after raising liquidity in the equity market. These impetus for financing Two EC was to raise liquidity to fund our development pipeline at a time when the bond and the equity markets were unattractive. After raising equity, we determined that increasing our leverage with financing, simply to put additional cash on the books, was not necessary.

We are pleased with the return of stability to the bond market. Over the past quarter our bond spreads have traded in a relatively tight 50 basis points band and we believe we could raise unsecured debt in size at 7% to 8% for terms ranging from 5 years to 10 years. Convertible debt investors are also actively looking for investment opportunities, with pricing for us at coupons of 4.5% to 5.0% and a conversion premium of 20% to 25%.

The secured market is more challenged, with tight underwriting standards that is pushing leverage down and instituting structural elements to financings. Pricing for 10-year mortgages is stable in the mid-7% area but our discussions with lenders find that they are not investing their full allocations due to a lack of quality product at their targeted leverage points.

Lenders are proving to be very selective about the assets and sponsors they intend to finance, even if it means they do not meet their new production volume goals. The good news for us is that the insurance companies remain active and are seeking opportunities to put out capital for high quality assets such as ours.

Our objective is to maintain consistent access to all of the debt markets, providing us with the flexibility to pick and choose the most attractive market to raise capital. Access to the public debt markets provides us with a competitive advantage in the marketplace and as a large, well capitalized company, we can quickly raise capital in meaningful size to fund investment opportunities.

I would like to conclude by updating our 2009 guidance. Our guidance is affected by the additional shares in our share count from our equity offering and FFO is projected to be $4.55 to $4.63 per share for 2009. The increase in our average share count has resulted in a $0.31 reduction in our guidance range. By simply removing the impact of the equity offering, the midpoint of our range would have increased by $0.18 per share.

This is primarily due to our second quarter outperformance of reduction in our tenant default projection to $5.0 million and our expectation for lower interest expense during the second half of the year.

For the third quarter, we are projecting FFO of between $1.08 and $1.11 per share, which is calculated using our new diluted total of 160.7 million shares outstanding.

I would now like to turn the call over to Mort for his comments.

Mortimer B. Zuckerman

What I think we are, a transitional period and the interesting thing is going to be, of course, which way the economy goes. I did write this article in the Wall Street Journal last week and it really got a remarkable reaction. I think because it sort of expressed in some detail what a lot of people were concerned about with respect to the economy and if you saw Bernanke's testimony to Congress just yesterday, what he was talking about was pretty much the same thing, which was his concern with the unemployment numbers and what that might do to the economy in terms of additional foreclosures, additional savings that would reduce consumption, additional, not just home foreclosures but defaults on credit cards and what that would to bank lending, etc.

And that is one of the key issues that we face. I think what has happened in terms of the world of finance, which is a part of the world that feeds a good part of our own office activities, is that the world of finance is, in a part, reflecting what's happening in corporate America.

Corporate America is cutting costs dramatically and widening profit margins and therefore their earnings are doing a little better than a lot of people anticipated and the stock market is having a very nice rise to reflect that. It was oversold at some point and it's not perhaps being over bought, but it's certainly heading in the right direction, in part because of the fact that the earnings, I think, are going to be better than a lot of people expected.

That, frankly, is going to have a fairly good impact on the kind of space that we have, because what has always been the case, not just in this downturn but in several other downturns that we and I have been through, is that when you have buildings that are the sort of the best buildings in a particular market, which are the only buildings that we have, basically, what happens when rents go down in a downturn is tenants who wanted to be in the first-rate buildings and the top buildings of a city or a market, they now feel they can afford to go into that building, and so we generally tend to fill up whatever vacant space we have and I think we're going to have that same experience.

There is a lot of activity up for this space, for example, that we have in New York and I suspect that within the next several months a good chunk of it, and perhaps the vast bulk of it, will be off the market because of tenant commitments.

The real question, it seems to me, is just what is going to happen now in terms of the downward pressures on the overall economy and on that count, everybody has their own view. Nobody's view is totally 100% because we are in an unprecedented kind of economic downturn and therefore, it being unprecedented, it's still unpredictable.

The unprecedented part comes from the fact that we're trying to work through just a mountain of debt on households, on businesses, on the financial world, on state and local governments.

And just to look at state and local governments, the estimate is that the 50 states will have, in the next year, in the year 2010, a combined cumulative deficit of $166.0 billion and another $190.0 billion in 2011. This is bound to have an effect on the economy in those individual states. And you saw what happened in California which just reached an agreement.

There's going to be a substantial cutback in a lot of programs. There will be a reduction in the number of state workers and the estimate is that as many as 50,000 or 60,000 workers will have to be let go, who are presently employed by the state.

Frankly, I think the Obama administration stimulus program was a whimper, compared to the shout that it needed to be because of the way it was structured and put together by the Congress. Turning it over to the Congress, in my judgment, was a fundamental strategic political mistake of the administration. And they got a very, very limited program which they're now saying, after saying it was going to really change things around immediately, they're now saying it's a two-year program.

Well, if it's a two-year program, by the time they get through the depth of the first year, they're going to have a much tougher situation to come out of than I think they should have had.

But the natural animal spirits and optimism of the American market is, I think, going to come through and I think the one thing that worries me about is the unemployment numbers. Those unemployment numbers have always been considered to be lagging numbers and therefore they represent decisions that were made a while ago.

Nevertheless, they also are, I think, coincident numbers and may even be predictive numbers because I think it's happened so fast. And it's continuing to happen so fast.

And it's not just a 9.5% unemployment number. That unemployment really understates the real condition of the market. There is both unemployment and under-employment. People are working part time who want to work full time. Or if you add to that people who have left the labor force because they haven't been in it for a year. The people who have been in it for a year but who haven't applied for a job in the last four weeks are not considered in the unemployment number. That's 1.4 million people.

So the numbers really understate the real problem. If you take the unemployment and under-employment number, it comes to a total of 16.8%, if my memory serves, and there's at least another million people who should be on the unemployment number.

We have to work through that and it's really going to be an unprecedented downturn in that sense, but we also have unprecedented amounts of monetary stimulus. And I think that Bernanke has made it clear that the low interest rates are going to be sustained now for quite a period of time.

So we've had, in a sense by and large we've avoided the kind of possibility of a real financial collapse. I think the financial world is slowly beginning to revive itself. Certainly there is much more optimism in the financial world about the profitability of American business.

That profitability, as I mentioned, is because they've really got their costs under control. They've really slashed their costs in many, many ways so their margins are up. Even if the volume is not as high as everybody expected.

And therefore, I think within the next couple of years we have a very good change to turn it around. We are in a basically a long-term business, not a short-term business. We do have some roll over, as has been indicated. But basically what we look for is long-term values and I think the kind of real estate that we have and the kind of markets we are in will continue to reflect that.

I think we will do better than a lot of people expected, in terms of leasing up the space and getting it done. Yes, the rates will be down from where they were but we'll still do well at those rates.

Doug made reference to the Heller Erhman space in our building in Times Square. We were able not only to lease it but we were able to lease it at above the rental rates that we had with Heller Erhman. I mean, a lot of the leases, when you have problems with some of these leases, these leases were done five, six, seven, eight, nine, ten years ago when rents were considerably lower.

So even though we're not going to be able to get the amount of appreciation that we had once thought we were going to have, we will still get appreciation in many of these cases.

So by and large I think we're in a strong position. We're certainly in a strong position financially. We're in a strong position in terms of our credibility in the individual market. We do have the opportunity now, I think, to be opportunistic, in terms of looking for additional acquisitions or additional sites for longer-term development, because of the strength of our finances. And frankly, we will continue to look for ways to further enhance our liquidity and the opportunities for taking advantage of what we think will be further opportunities.

So, that's sort of where we are. This is not a bullish market, by any means. But I do think we have a unique position in the markets we are in, which are all supply-constrained markets. We have the unique position in that we are exclusively at the upper end of those markets and I think we are still in a position, there always tenants that are moving and growing and I think we're in a position to be credible with those tenants and if necessary to do a lot of the financing from our own internal resources.

So I think the downward sort of concerns for a company like ours should be mitigated by the fundamental facts and I think we're just going to get through this next period of a year or two and we'll be back, I think, in a much stronger market than the market we are in.

That's about all I have to say.

Douglas T. Linde

We will now open up for questions and answers.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Bilerman – Citigroup.

Michael Bilerman - Citigroup

Mort, you obviously painted a little bit more of a bleaker picture for the economy on the employment side, and from Boston Properties point of view things appear to be probably a little bit better than expectations. While they are difficult, there seems to be momentum.

How do you factor in some of the positives you're seeing in this business relative to your views on the broader economy and whether there are things that you're seeing on the ground, within Boston Properties, that potentially could paint a maybe brighter picture for the economy and the employment situation.

Mortimer B. Zuckerman

That's a very good question. That's a very difficult thing to correlate, I have to confess, because I do think that the broader economy and the consumer economy is going to be much tougher than the government is portraying. I do think there is a sense of they are focusing in on confidence and the attempt to retain and even to build confidence. I think they're going to, in some ways, lose their credibility as a result of that, because I think it's going to be worse than they have expected. In fact, it is worse than they expected.

I mean, it's not only that they predicted that there would be an 8% unemployment rate, but now they're saying it's going to above 10%. And I think it's going to be closer to 11%. Nobody knows what these exact numbers are. As I said, it's unprecedented.

But again, let me just say to you, we have always in these situations, when you invest and develop for the long-term, you have to anticipate that there are going to be downturns. And in terms of sort of developing a business strategy, we try to come in to sort of a construct that in a sense where we think we're going to do fairly well.

Anybody who has heard me on these talks in the past will remember that I keep on saying we do better in downturns, relatively, because of the fact—a) we're in a supply-constrained market, b) we're in the upper end of the office building market so that when there is a decline in rental a lot of tenants who want to be in the higher quality buildings now feel they can afford the space and will move in, it may be a little more expensive but they are prepared to move in. And that's exactly what we're seeing now.

And we're also in markets where, frankly, the availability of supply, taken in Washington, D.C. We're building a building there, 520,000 square foot building. This is the last site on Pennsylvania Avenue that is available and it's a great site, and we're very comfortable with that market.

Again, I'm not saying that the market is going to be as ebullient as it has been, but I'm saying in the markets that we are in and in the portion of the markets we're in where there is a supply constraint in Washington, the supply constraint is caused by the height limitations on the buildings so you have to grow out horizontally, you can't go up vertically. And that's a very difficult thing to do in Washington. It's very difficult to find sites in the central business district, for example.

The same thing is true in New York. Now, in New York we are, again, if you look at the buildings that we own or have purchased, they are really the highest quality buildings in this market. Not everyone is the absolute peak but—and we continue to improve these buildings. Citigroup Center, for example, where we have done some very good leasing, has spent close to $20.0 million. We completely redid the lobby and the entrance. We opened up a completely new entrance. It separates out the retail area from the office area. It helps the office area and the retail area, we've just managed to put together a great sports facility, an athletic facility that is great for the entire building, etc., etc.

And this really makes a difference over time in the sense that when tenants, and there's always movement in the market, no matter what. I mean, there are always leases coming up in other buildings, as there are in ours, but we generally tend to have the longest sort of average lease.

But we, I think, will always do better in the down markets compared to the overall market, simply because of the quality of our buildings and the supply constraints in the market we are in.

Now, I have to tell you, what we are in now, I think in a way is unprecedented. I don't anybody has ever lived through, certainly I haven't, this kind of—the accelerated which everything happened. The way it spread, not just across this country's financial world and economy, but around the world. It's unprecedented. Nobody's ever seen anything like that. And it's all because there was so much of the world of finance was interconnected.

Now they have at least, I think, staunched the major problems there. There is going to be a slow build up and you're going to see a number of these financial institutions are beginning to do very well in this world. They have gotten their costs under control, to a large degree, but I think some of them are going to begin to grow again and there are going to be—well, look in New York.

In New York, where you had the dissolution for a number of major firms, but a lot of the talent in those firms have spun out and they're forming smaller investment banks or boutique financial firms or what have you, and they're beginning to take space. Some of them are going to do well and some of them won't do well.

But that will be the seeds of growth in this market. I do think New York, as I've said before, will be the first financial center to recover. The world of global finance is not going to go to London, in my judgment, after the debacle in London, which was much worse than what happened in the United States and in New York. They're going to come back to the United States and particularly to New York and Washington.

So I do think we're going to recover in that particular phase of the real estate economy will recover more quickly and will do relatively well. I don't want to make any predictions because the part that I really, I just can't give you a handle on—if we get—I'll put it this way. The major financial institutions have huge amounts of credit card debt on their books. And both for the small businesses and individuals.

And that credit card debt is in terrible shape. The default rate, I think, is going to go through the roof. You've already seen that in the various reports of some of the banks. And I think that's just inevitable. I don't know what means. One of the things it does mean, is I think there is going to be a continued constraint on credit. So if you have higher unemployment, you have continued decline in housing prices, and you have a continued constraint on credit in general, I am not optimistic about the economy. I'm not as optimistic as most.

But I don't think our particular business, here—I'm in another business, I'm in the publishing business. The publishing business is much worse than the general economy. They are being dramatically affected by the decline of advertising. So when you ask me how do I reconcile the two with our real estate business? Because we're in a unique place in the real estate business and I think that will continue, as it has in the past, to show that we will do better in down markets thus far than a lot of our compatriots in the business.

Michael Bilerman - Citigroup

On leasing, you talked about your mark to market essentially being flat. You talked about doing a lot of early renewal builds and tending [inaudible]. One thing is just related to the deals you're doing, you talked a little bit about your trends on TI, capex, Mike talked a little bit about that being higher, maybe the length of the deals, whether you are moving more towards shorter term either renewals or leases, and in terms of free rent or other concessions that you're giving so that headline flat mark to market in the reality may be a little bit more negative given the additional capital that you're putting in, higher free rent, and things like that.

Douglas T. Linde

This is going to sound like a cop-out answer, so I apologize in advance for that. But I would say it's everything that you just described. In general and in the District the types of deals we're doing are long-term deals, long being more than five years. And the suburban transactions we are doing are generally involving no tenant improvement allowances. They are involving brokerage commissions and brokerage commissions are on a percentage basis.

And in the most part they are a reflection of what the current rent is and if, for example, we have a lease that's expiring in 2010 and the current rent for that space is $37 a square foot and the existing rent is $41 a square foot, we are acknowledging and allowing for a short-term rent reduction, on an as-is basis, but with an escalator. And so by the time you, from a GAAP perspective, you get to look at where the rent is on a mark to market basis, it's basically flat to slightly a positive.

On vacant space, there are sort of two broad extremes. The first is space that we are basically pre-building. And those pre-built suites are generally the smaller tenant spaces. And building that vacancy, those spaces, depending up on the marketplace, are costing us somewhere between $65 a square foot and $85 a square foot. And those are then being done on an as-is basis, and our hope and I guess at least our path evidence has born this out, because we did it at 7 Times Square when we did that build up, these spaces generally don't need much in the way of retro-fitting when these tenants move out.

So while we may be signing three-, five-, six-year leases, they generally have a life that's probably ten+ years. And so then the second time around you don't have to put any additional capital in.

On larger spaces that are vacant, depending upon the configuration of the space, we are not giving much in the way of tenant improvements but we are giving some free rent, depending on the market.

So a market like New York City, the Lehman Brothers space, quite frankly the TIs are relatively limited. In some cases they're as-is and in some cases it's $35 a square foot to $40 a square foot. But because the market is what the market is, we may be giving seven, eight, nine, ten months of free rent associated with that transaction, as part of the economics.

So I think that unfortunately, there really isn't a specific generalization I can make about all of the markets. I can only sort of make it on the types of spaces and the variance, the installations. I will say that the better installations are getting more activity and they are allowing us to capture vacancy at a much more rapid rate than space that really is a gut rehab where you're going to have to start over from scratch.

Edward H. Linde

Let me add one thing to what Doug said, which is that when you're talking about forward leasing of roll that may exist, that may come about over the next six months to a couple of years, we are taking advantage of the fact that in a lot of these spaces not only did we put in TI investment, but the tenant put in major TI investment.

So there's a real incentive on the part of the tenant, if the space was done correctly, which many of these were for the tenant's use, for them to stay there. And which gives us an advantage in discussing what the appropriate rental rate should be and what the appropriate terms should be going forward.

Operator

Your next question comes from Mark Biffert - Oppenheimer & Co.

Mark Biffert - Oppenheimer & Co.

My question is more related to the use of cash, you have a significant amount of cash available as well as your line completely available, and I'm just wondering if you're planning to keep that powder dry for acquisition opportunities, as well as are you seeing opportunities for acquisitions or development opportunities, or would you use some of that to pay down some debt if you could attractively go back and pay it off early?

Douglas T. Linde

The answer to your question is unfortunately not a simple one. I would say overall we are not uncomfortable with our current capital structure. That does not mean that to the extent that we were able to negotiate a discounted pay off of some debt or relatively speaking a high yield on that investment, that we wouldn't consider doing some of that work. And even improving our capital structure.

With regards to acquisition, I would love to tell you that I thought we were going to be doing acquisitions that would have an impact on our use of capital in the short term. I think that it's going to be a bit of time before that happens. As I think I sort of suggested there, there seems to be a very wide disparity between bid and ask rates on the sale side.

A lot of it has to do with the availability of third-party secured debt and a lot of it has to do with it seems to be an inability for the various participants in the capital structures on certain assets to figure out what direction they want to go in and/or for some group of parties to recognize that the valuations have changed and it's time to move on and they need to sort of look at what's right for the asset, not necessarily what's right for their own particular balance sheet, whatever they are, a bank, an insurance company, pension fund advisor that runs an open-ended account, etc.

And I think that that stuff is going to take a little bit of time, but as I suggested, I think maturities are not going to be the driver, I think it's going to be frictional transactional activity that's going to get that stuff unglued sooner rather than later because as assets have capital requirements or leasing requirements that are necessary, those parties are going to have no choice but to get together and start to realize what situation they might be in and that's going to cause an action and hopefully that's when these types of assets that we are interested in will be moving in a direction where we can use our capital in a very accretive and value-creation, positive manner.

Edward H. Linde

You asked about development as well, and clearly it's very early in the cycle to be thinking about development because of the imbalance between cost and rental rate. That being said, we are looking at, and have done, as the Princeton experience illustrates, build-to-suits. And there may be situations, and we are pursuing them as they come along, where build-to-suit is possible, even though the normal market might not be ready for development, and where we can lease at 100% or close to 100% in advance.

Mark Biffert - Oppenheimer & Co.

I guess added to that, are you seeing—I see what you are saying on the development side, but from a land perspective, have the opportunities—I think Ray had mentioned previously that you were looking at some opportunities in the D.C. metro and I was wondering if any of those had progressed along, as well, if you can talk a little bit about if you've changed your return hurdle that you're looking for, either for acquisitions or that land opportunity.

Douglas T. Linde

There's nothing that has percolated to the point where there's much in the way of commentary that we can make to the investor world on asset land purchases or other types of endeavors that we would want to make.

To answer the last question on our return levels, clearly, return levels have gone up. When there was an expectation that cash was plentiful and you could do financings at 4%, 3%, 5%, 6% and you could get 90% financing, that obviously had an impact on overall returns. And when you're, on a secured basis, maybe able to get 50% financing—maybe—and that financing has got a coupon somewhere between 7% and 8%, that clearly affects overall return levels.

In addition, the growth of rents had a pretty meaningful impact on what you thought return levels might be in short term versus the overall long term, and if you don't think rents are going to be appreciating at 30% or 40% over a period of time, it probably has a pretty significant impact, again, on what your overall return threshold expectation is for the next three to four plus years.

So the answer is clearly our return levels have gone up. I don't have a number I can give you. It depends on the investment. It depends on the profile of the asset. It depends on the replacement cost, and it depends on the submarket. And is the return we might be prepared to take on a building on Park Avenue that we could buy for $700 a square foot may be very different than what we would be prepared to take for a building in Reston, Virginia, that is vacant and we might be able to buy for only $200 a square foot.

Again, it's very, very different, depending on the particular opportunity.

Mark Biffert - Oppenheimer & Co.

The GM lease that you have in the GM Building, has their intent changed or would there be an opportunity renew that lease or is their expectation still to exit that space next spring?

Douglas T. Linde

We can't speak for the tenant. All we can say is that General Motors, unfortunately, put themselves in a position where they had the ability to bankruptcy to reject the lease at 601 and they have a lease that goes through the beginning of 2010 and we will see what happens with them. We really don't have anything we can say about that.

Operator

Your next questions come from Jay Haberman and Sloan Bolen - Goldman Sachs.

Jay Haberman - Goldman Sachs

Back to the question on capital structure, maybe for Doug, if you think about leverage and perhaps even further reducing leverage, are you factoring in cost of capital such that obviously looking at opportunities, either with the converts or your line of credit maybe, even out to 2011, that with a lower leverage profile, you can maintain obviously a lower borrowing cost as you think about revenues remaining challenged for the next couple of years.

Douglas T. Linde

If you're asking do I think that my overall leverage is going to affect my cost of capital from an unsecured bond or convertible bond perspective, I'm not really sure that overall the market is thinking about it that way. I think that relative to where we are today and our coverage ratios and our overall unencumbered asset base, which is really they think about the world, that's primarily what drives, I think, the ratings outlook for the bond investors.

And whether we're where we are today or we have a billion dollars left of debt, I'm not sure materially it would impact our access to the markets and the coupons that we would have. I guess if you look at the various types of issuers out there, there are issuers who have ratings levels and debt levels that are significantly lower than ours that are having a much more receptivity buy from the market because of the business lines they're in.

And so I'm not sure that there would be a meaningful change unless we had a total change in our capital structure and basically paid off the vast majority of our debt. So I don't think that would have a major impact.

Jay Haberman - Goldman Sachs

Can you speak a bit more about the Lehman spaces. You mentioned the 200,000 square foot potentials there. Can you give us a sense of how far those discussion are coming along, given that you talked about them a couple of months ago as well.

Douglas T. Linde

Yes. So as I said before, there are sort of three levels. We are negotiating leases and when you negotiate a lease that means there are legal documents going back and forth and as I think Mike described, things are just taking longer today because people don't feel a pressing need to do something, but there are certain companies that really want space and they are aggressively trying to get leases done.

There's the proposal stage, which is people have come to us and said they were interested in our space but not ready to make a decision as to which particular space they want or which building they want.

And then there are the we're in the market and we're looking for space. And I would say we have all three of those types of situations at 399 with regard to the Lehman Brothers space, and quite frankly, I wouldn't be surprised if we get some leases signed in the short term. But we never say something is done until it's done, unfortunately, in this business.

Sloan Bolen - Goldman Sachs

Back to the leasing question. You spoke about the different buckets for TI spend. Do you have a sense, or just maybe a budgeted amount of capital you would spend for leasing over the next year or two? Or how should we think about that?

Douglas T. Linde

We don't allocate, as a company, well, we're going to spend $35.0 million on leasing in Manhattan and $40.0 million of leasing in Boston, because it's obviously based upon with the lease rollover that we have. We think pretty analytically about the world and we look at net effective rents and we look at return on invested capital and we look on the various opportunities we have and at certain times we chose not to do a transaction because we don't think it makes sense from a capital investment perspective.

That being said, we think one of our advantages is our ability to adequately put capital to work and get, on an incremental basis, a pretty good return on that money, depending upon the tenant credit and quality and the location of the buildings that we're putting it in.

So if you said to me you needed a number to figure out your cap [inaudible] for distribution, what's the right number to be using for tenant improvements overall in the portfolio, I would say it is going to be in the high-30's. I'm guessing.

But like I said, there are going to be quarters when we have a 500,000 square foot lease that we're renewing and there's no tenant improvements and we do 600,000 square foot of leases and you're going to see a $5 or $10 average TI cost because of the quarterly impact of those big skewing.

And there are, as we described in Washington, D.C., some very significant transactions that we are working on that are going to have very limited, if any, tenant improvement dollars.

Operator

Your next question comes from Jordan Sadler - KeyBanc Capital Markets.

Jordan Sadler - KeyBanc Capital Markets

Just coming back to the opportunity that may be in front of us, you mentioned types of assets that you would be interested in, maybe by market or just asset class, would it be the same quality as the existing portfolio and would you pursue other markets?

Douglas T. Linde

I would say if there's one thing we're going to do is that we're going to be very clear in our strategy, which is that we believe that our advantage in our operating perspective is best suited to the high quality buildings in the existing markets that we're in.

And while there may be some real attractive opportunity from a return perspective that might at least elicit an interest level to do something outside of that, I think that by and far what you see us do is participate in the recapitalization of assets in our core markets that have a similar quality and a similar, at least, opportunity from a market perspective to be high quality, class A, suburban, and urban buildings within the very distinct submarkets that we're in, i.e. Midtown Manhattan, not lower Manhattan, and Reston, Virginia, not the Dulles Corridor and Tyson. And 128, not 495 in metro Boston. Things like that.

I don't you're going to see us going askew and trying to become an opportunity fund that is looking to take advantage of the gross reduction in values and hope that the momentum goes in the other direction so that we can sell these things and not have an expectation that we're going to be long-term holders of assets.

Mortimer B. Zuckerman

I'll add just a further refinement. We'll be on the upper east side of New York, not on the west side of New York. I mean, just again, it all goes to the same idea and we believe we've been able to do this in good markets and bad markets. There will be opportunities to develop properties and opportunities to purchase properties and that's what we're going to focus on in those particular markets and in the highest quality of those particular markets. Otherwise we will not go forward with acquisitions.

Jordan Sadler - KeyBanc Capital Markets

Mike, maybe just a clarification on the occupancy guidance. I think you're still guiding to 91% occupancy by the end of the year, which is what you said last quarter. But you said last quarter that you needed to do about 1.0 million square feet of leasing for the rest of the year to get there. Now you're talking about 850,000 square feet of leasing. I mean, you did 600,000 square feet this quarter. So the numbers seem to be skewed up maybe 100 basis points plus, just by the math that I'm looking at. I'm just curious if you could reconcile it.

Michael E. LaBelle

Well, the 600,000 square feet of leasing that we did doesn't all start this quarter. There is a roll over that is occurring in the portfolio as well. So we can try to go through it in more detail with you off line but there is not a significant change in what our leasing projections have been. And as I said, we still believe we will be in roughly the same occupancy place that we thought we were last quarter.

Jordan Sadler - KeyBanc Capital Markets

What do you have for a place holder within the 850,000 for the Lehman space?

Michael E. LaBelle

We are not assuming that we lease any of the Lehman space.

Operator

Your next question comes from Ross Nussbaum - UBS Securities.

Ross Nussbaum - UBS Securities

Doug, you just used a phrase to answer to Jordan's question. You talked about participating potentially in a recapitalization of assets. And that lingo would suggest to me that you're looking at opportunities, not necessarily at the equity level of the capital stack but up higher. So does that imply that you think the opportunities over the next 12 to 36 months are going to be Boston Properties inheriting existing distressed mezz in first mortgage positions and/or writing new loans to recap those assets?

Douglas T. Linde

I think you make me sound more sophisticated than I am. When I describe recapitalization I mean that you have building that have more capital stack in them than they're worth. And the participants of that capital stack are, theoretically today, equity owners, mezzanine debt owners, sometimes subordinated debt, and then first mortgage debt. And there has to be a come to Jesus session, a capitulation, whatever you want to call it on that value because none of those players have any value in their particular positions.

Now, that doesn't mean that we wouldn't consider, depending up on the asset and the particular situation, participating in the appropriate place in that capital stack. But I wouldn't suggest that we are going to be active buyers of tranches of debt with an expectation that we are going to become the party that is pushing forward for the recapitalization effort.

We will get in the right place at the right time in the right situation if we think there is ultimately going to be an opportunity to become the overall equity owners of the building.

Ross Nussbaum - UBS Securities

And what kind of unlevered IRs are you thinking about in terms of getting the company excited about putting capital to work in the current environment?

Douglas T. Linde

I tried to answer that question without answering the question when it was asked before so I'll do it again, which is it really depends on the opportunity. As I said, if an asset on Park Avenue became available at $700 a square foot and the cash-on-cash returns were 8.5% and the leases were stable for the next few years and they were all written between $50 and $75 a square foot, we might think that IRR on that was significant enough in terms of what the upside would be to jump at that.

On the other hand, if there were a vacant building in a suburban market and we thought it was going to take us two years to lease up that property but we thought it was a great asset, it has a different risk adjusted profile and it probably have a higher overall return expectation.

So I wish I were smart enough to be able to give you a specific number but I can't. The only thing I can tell you is that people are going to be doing this on a weighted average cost of capital basis that is accretive after debt. So if you think your cost of debt is whatever it is, the IRR is going to need to be higher than that.

Ross Nussbaum - UBS Securities

Mike, can you talk about your strategy on real estate taxes? I would assume that you are aggressively fighting every bill that comes in the door. How successful have you been on that? What kind of reductions are you seeing versus the original tax bills that you're getting?

Michael E. LaBelle

I really can't quote on specific reductions. I can tell you that we systematically review our tax bills and tax exposure in each of our markets individually every year. And we go to the taxing authorities and seek to get reductions. We have been successful. We've been successful this year in gaining reductions in a couple of our markets and some of our markets we haven't. But it is something that we do constantly in each of our markets.

Operator

Your next question comes from Jacob Strumwasser – BCC.

Jacob Strumwasser - BCC

Mort, you gave a pretty straight shooter view on your feelings on the economy and you often are considered to have a lot of Street credit when it comes to talking about these things, so on that vein I wanted to ask two specific questions.

What do you see going forward for LTVs and do you think that AFFO for you is going trend lower?

Mortimer B. Zuckerman

Doug, why don't you deal with the FFO question and then I'll deal with the LTVs.

Douglas T. Linde

We've already provided what we expect our guidance to be.

Mortimer B. Zuckerman

We are conservative in those estimates going forward, I would say.

Douglas T. Linde

So we expect to achieve that guidance. For 2010 we've given you some information to utilize to assess what our results will be in terms of what we expect our occupancy to be and where we expect to be impacting with our development pipeline coming on line.

Mortimer B. Zuckerman

On those numbers we have made certain assumptions with respect to space that is currently vacant staying vacant, rather than assuming any of our lease negotiations are going to be consummated. So I think that is sort of a standard practice of ours but we always try and realize the leasing opportunities we have and we still intend to do that.

LTV matter, I mean, I think we're, in an overall corporate sense, going to continue to try and stay in the [inaudible]. It's a very interesting question now as to what is the best capital structure for a publicly traded REIT and a lot depends in terms of what our availability of credit lines would be that we could have, but I think the equitization that took place already, where we raised in effect over $840.0 million, is a step in the direction that maybe the predominate sort of structure for publicly held companies.

The problem we have with all of that is the capital markets at this stage of the game are so fluid and they are intimidating at this point, in terms of both rate and availability and terms, but that may change.

And there are two ways it may change. It may change on the basis of securitized financing but it also may change in corporate terms, in terms of rate. And if that becomes a more attractive option I'm sure we'll do some of that as well as other more conventional forms of financing.

I think in our own minds, we're going to stay, as a company, in the range of 50% loan to value.

Operator

Your next question comes from Alexander Goldfarb – Sandler O'Neill.

Alexander Goldfarb – Sandler O'Neill

On the impairment, it sounded like the rent conditions were the driver of the impairment on the value added fund. If we think about the GM building, how would rent impact that? Is it signing new deals in the market or is just constantly assessing the marks and the building versus where brokers think the space would lease for today?

Douglas T. Linde

Just to refresh what I said earlier, our view is when we did our impairment analysis at the end of last year, which it really wasn't the end of last year it was just prior to the beginning of March when we file, we sort of had a view on where on where rents were and the various markets. And particularly in Manhattan. We really haven't seen much evidence of reason to change our perspective on those rents.

Number two is our perspective on rents for a building like the General Motors Building is one with a very, very long duration. Our expectation of where rents are on a building like Circle Star in the north peninsula market of San Francisco is a very different one. And so when you're doing you valuations, which are purely academic exercises, unfortunately, the length of your period of hold and your view on where rent's going to be over that period of hold makes a very significant difference in how those valuations occur.

So we really didn't have any reason to make changes to our input assumptions on our New York City portfolio.

Alexander Goldfarb – Sandler O'Neill

And to Mort's comment on New York, acquiring in New York, it almost sounded like he was thinking about acquiring on the upper east side is where you would focus on acquisitions. So does that mean the west side is only for development or would you consider also properties along the Sixth Avenue, etc. corridor?

Mortimer B. Zuckerman

I think we would consider properties on the Sixth Avenue corridor. I guess I've always, Sixth Avenue was on the east side. So you're absolutely right. But the west side, I'm talking ninth, tenth, those kinds of further, where frankly, there are opportunities for blocks of space to be assembled. But I just don't know that that would be where we would focus our investments.

Alexander Goldfarb – Sandler O'Neill

With all the news out of Washington and focus on taxes, etc., from your tenants, especially tenants who have been around for a while, is there any sense that they may alter their decision making or is their view that Washington constantly goes through these cycles and they just roll with the punches and continue on with their businesses?

Mortimer B. Zuckerman

I don't know that we have any sense of any—nobody is happy with what's going on in Washington in the business world, for sure. By and large I think there's a real dismay in terms of the ineffectiveness of the stimulus program, the fact that it was turned over to the Congress, and now you have the health bill going through that is being rushed through, with most people not even having read the legislation, which is like over a 1,000 pages of each version. And the House proposing dramatic increases in taxes. I don't know whether that's going to come out. I don't think that's going to help anything myself, so I think we're in for an administration that is going to be taking, shall I say, in general, not a pro-business attitude and not a pro-investment attitude, and not a pro-entrepreneurial attitude, whatever they say. The substance of the programs, I think, is going in a very different direction.

Whether they get the health bill through or not, I don't know. I think they are thinking in popularity and I think that popularity is going to continue to go down, primarily because I think the unemployment rate, as I indicated before, I think is going to go up and stay up. Certainly through next year. And so come the Congressional election next year, that administration is going to be in a very different place politically to be able to get some of this legislation through, which is part of the reason why they're trying to jam it down now.

But they are, and I've said this before, they are in effect, they're trying to boil the ocean. They're trying to do way too much and I think there's a very real apprehension in the business community about what's going on, and a justified one. And frankly, I supported Obama in the general election, but I must say I'm very dismayed by the approach that they're taking to legislation.

Operator

Your next question comes from Michael Knott - Green Street Advisors.

Michael Knott - Green Street Advisors

You mentioned the possibility, or the hope, to acquire on Park Avenue at 8.5% cap on sort of a stable rent roll. Do you think the odds are good that you'll have the opportunity to do something in that range over the next one, to two, to three years, or do you feel like that is not likely to happen and therefore you'll have to either pass on adding to Midtown, or have to lower those hurdles a little bit?

Douglas T. Linde

I don’t know. I know, for example, that there's a condominium interest on Park Avenue that's trying to be recapitalized right now. And the equity pref on the thing is going to be somewhere between 8.5% and 9%. So there sort of deal brewing right now in that range. But honestly, it's going to depend on the individual asset, the individual capital structure, and if somebody had a big mortgage on an asset and that mortgage is clearly the vast majority of the capital structure and it has a refinancing date impending and there's a recognition that the mortgage is going to have to be cut in half and it was a $700.00 million or $800.0 million mortgage or a $400.0 million or a $500.0 million mortgage, I think those are where those types of opportunities are going to avail themselves.

So we're optimistic, we believe that the capital structure for private owners of real estate in large markets, like Midtown Manhattan, are going to change and there's going to be a significantly enhanced requirement for equity and there are going to be relatively few organizations that have the ability to raise that equity and the ability to operate those buildings, and we believe we're one of them.

So I think we're hopeful that we're going to find those types of opportunities.

Edward H. Linde

Let me add one other thing to that. There are now a number of major pools of capital that are looking to invest in some of these markets, not on their own, but in partnership. They have certainly approached us to see if they could, in a sense, joint venture with us on acquisitions.

And that will, I think, further enhance the opportunity that we will have in those very special situations, which Doug said, are going to be particularly crystallized by the possibility of financing that's going to be coming due.

And I think that is what everybody is worried about in terms of the commercial market, which is that there is going to be a lot of CNBS paper that is going to come due and people are going to be able to refinance because the financial markets, the credit markets, are much worse than the equity markets.

So those people who have the equity, and particularly if those people can attract additional equity, which we can, I think are going to be in a position to have the best opportunity to make those purchases.

The question will be that is that we don't even know what all the financial structures are but one of the things that we are doing, of course, in the various markets that we are in, since we're one of the people who are relatively well capitalized, is we're trying to sort of look around each one of these markets to see which properties might become available and to see if we can sort of get prepared for that possibility, or even to, shall we say, be proactive in those particular situations.

So that is I think the general makeup. But most of this is just happening in our heads at this point. There have been just been very few situations that we know are literally either in the market or on the verge of going into the market.

Michael Knott - Green Street Advisors

And the JV comment tied into my last question, which is as you contemplate how to finance future external growth I would guess in a significant way, over the next two or three years, are you more inclined to use asset-specific joint ventures like you did with the Macklowe purchase last year rather than sort of an opportunity fund as it's been reported that some of your peers are considering.

Edward H. Linde

I don't think we're going to do an opportunity fund. We don't want to have a conflict between the opportunity fund and what we are doing and we just think we ought to keep things simple and clear and clean. I think there's a real issue in those opportunity funds as to who you're serving. We have shareholders and that's our principal concern and we don't want to be in a position to have that possibility of a conflict of interest.

Operator

Your next question comes from Jamie Feldman – Bank of America.

Jamie Feldman – Bank of America

Doug, can you walk us through the largest blocks of space that are in your June 30 occupancy percentage number that are either vacant or under-utilized or on your credit watch list?

Douglas T. Linde

Not quickly. Just because I don't have the information sitting at my fingertips here. But we can get on the phone and we're happy to do that for you. I would say that for the most part, occupied space as of June 30 has limited, if any, major blocks of "shadow space" or unused space. Even an organization like Citibank that has significant space in our portfolio, in 601 Lexington and Citigroup Center, is still utilizing the vast majority of that space.

That doesn’t mean that if someone came along and said they would like 300,000 square feet at 601, they wouldn't be able to get out of it in six months. Because they probably have external space in other parts of their portfolio that they can move people into. But as we go through our portfolio, there really is, that I'm aware of, very little "non-used" space that is occupied today.

Jamie Feldman – Bank of America

So if you think about pending big blocks for New York, it's really the GM Building that's the big question mark?

Douglas T. Linde

Well, it's not the General Motors Building that's the question mark. It's 601. 601 is where, unfortunately, General Motors had a lease for 120,000 square feet and we no longer have 120,000 square foot lease.

Jamie Feldman – Bank of America

I'm saying their March expiration.

Douglas T. Linde

Oh, you mean in terms of what the future expiration?

Jamie Feldman – Bank of America

Yes, in terms of what's to come. Exactly.

Douglas T. Linde

Well, you ask the question about what was not being used as of June 30 and I can you right now that the General Motors Corporation is fully engaged in those three floors at the General Motors Building. They're chocked all over each other there. So there is no vacancy in that space.

Jamie Feldman – Bank of America

And to follow up on your comments on the unsecured market, what gives you comfort that it will stay open at the prices you quoted?

Michael E. LaBelle

I think that you never know what is going to happen to that marketplace. The volatility that it experienced from mid-last year until kind of April of this year was pretty unprecedented volatility. We don't have a crystal ball to know if that's going to happen again and if spreads are going to widen out again.

What we attempt to do is, as I mentioned, maintain to all of the capital markets so that if one is unattractive to us or unavailable to us, we have other places to raise capital.

My sense is that the winds are blowing in the right direction for the unsecured debt market right now and it has moved in over the last six to eight weeks, which I view as a positive thing. And if you talk with investors, they take great comfort in the credit characteristics of companies like ours, where we have a significant unencumbered pool of assets where the quality of those assets, the occupancy of those assets, and the rollover criteria of those assets give them great comfort.

That they can look for a relatively long term and have comfort with what they have as their collateral, effectively, even though they're unsecured, they see that as their collateral.

Douglas T. Linde

I also will answer the question in a sort of negative way, which it's the lesser of all evils. Relative to all the other markets, I see more hope that the unsecured market will remain open than I do that the secured debt markets in the form of securitization, or the bank market in the form of large syndicated loans, is going to be open and accessible over the next period of time, defined as nine months, twelve months, eighteen months.

So relatively speaking, that market seems to be, because of its breadth and the constituents of who those bond holders are and the relative covenant-type protection that they have in terms of how those companies are structured that are borrowers in that marketplace, I think it has the best chance of all the markets of functioning more normally than everything over the long haul.

Michael E. LaBelle

I also think that that market has taken great comfort in the re-equitization that has occurred in the remarket and all the equity that has been able to been raised. And that's part of the reason that that market has improved significantly.

Jamie Feldman – Bank of America

The numbers you quoted for 399 Park, in terms of asking rents, the 60's and I think you said high 80s, where would you put that on a net effective basis?

Douglas T. Linde

Do you mean what are operating expenses?

Jamie Feldman – Bank of America

Operating and then SRTIs and free rent.

Douglas T. Linde

When we do a deal, if we do a deal on a as-is basis, there are no TIs so it's a question of what the rent is and how long the lease is for a brokerage commission perspective. So it's very variable.

All I can tell you is operating expenses in Midtown Manhattan are generally in the high-20s. So you can do your own calculation as to what you think our various level of transaction costs might be, but as I said, depending upon the deal, there is between zero and $40+/- of TIs that are sort of on the better lease space. And free rent is a really interesting way to think about it because if there is no tenant leasing the space, I'm not sure your free rent calculation should or shouldn't be, depending upon your perspective, part of your NER calculation if you don't think you have another alternative to lease that space.

On the other hand, if you do think you have another alternative or you think rents are going to be moving up or down, you have to factor that in to how you think about it. So it's not an easy analytic one-number type of a decision analysis that you can come up with.

Operator

Your next question comes from Nick Pirsos - Macquarie Securities.

Nick Pirsos - Macquarie Securities

The government's bank stress testing earlier this year assumed considerably lower unemployment levels than are today. Couple that with your more dire assessment of the job picture, are you concerned that commercial bank stress testing needs to be revisited, which could potentially offset some of the gains we're seeing in financing conditions for commercial real estate.

Mortimer B. Zuckerman

I don't know what gains you're seeing the financial conditions for financing commercial real estate. I think they're very, very limited to date. And I think a part of it is that the commercial banks have a huge amount of credit card loans outstanding.

Fortune magazine did this article on the four major banks, they have $3.6 trillion in credit card loans, both business and individual, student loans and auto loans, and some home equity loans, etc. And they are going to be faced with a soaring default rate on those credit card loans. And I think that's going to affect the credit ability across the board. They're just going to have to hoard cash in order to deal with that.

You saw that in the reports of several of those banks that just came out within the last few days, where they all made comments on their soaring losses in credit cards. I think it's just beginning.

So I think the commercial banks are by and large, and especially the large ones, are in serious troubles with that. The number of business credit cards went from 5.0 million in 2000 to like 29.0 million last year. This is for small businesses. And they're defaulting at a rate even more rapidly than the individual holders of credit cards.

I think that's a huge exposure to the banking world and I think they all know it and I think it's going to constrain their lending. So I'm not looking, I can't imagine that there's going to be much in the way of commercial bank financing of commercial real estate. Bank financing commercial real estate I think is very, very limited and will continue to be very, very limited and I think as we say, on a secured basis, I think that financing is very, very difficult to come by on terms that are, in our judgment, reasonable.

If it's true for on an individual basis then the REITs, who have been able to raise equity money, and who are in good financial shape, who are going to be able to have opportunities that would come up over the next period of time.

So the banks themselves, I think are going to be out of the market in terms of the commercial real estate for at least as far as I see. I think we're looking at not months, but years.

Nick Pirsos - Macquarie Securities

Given just the overall absence of job growth, how would you characterize the leasing activity in the recent quarter? Are there increased market shares, is there strong or pent-up demand?

Mortimer B. Zuckerman

It's a very good question and I'm not quite sure how to do it, but as I say, the market is different for different buildings. And different locations. I wouldn't want to be downtown today in terms of having to lease space, or indeed some of the west side of the city of New York, just to pick an example. I'm sure we could go through our individual market.

But where you have the best buildings and the best locations, there will be people when these rents go down, and they have gone down, who are saying they would just as soon be in 399 Park. And there are people moving up from downtown into our buildings, or at least we're talking to them very seriously, into moving into those buildings.

That's why I think the more conventional space is not going to do as well as the quality space, in this kind of a downturn. It may sound counter-intuitive but it's what has always been the case in the past and is clearly happening again this time around.

So I think that's sort of the way I read the market and I think I can characterize what has happened to us. And I think it's going to continue. There are always tenants moving around. It's just in the nature of the beast. Leases come up, some tenants are doing well, some tenants are doing better. Law firms which have the big bankruptcy practice are a lot busier than those which have the big corporate practice.

So you will always find tenants and some of those tenants are going to be in the zone where they can say they would rather be in one of the more prestigious buildings and pay a little bit more for, not a huge amount more. And I think that's just going to be way the market is going to look for the next year or two. And I think we're going to be one of the beneficiaries of that.

And on the financing side, as I say, I mean that's also going to provide an opportunity for us and that's one of the reasons why we did that major equity offering because we think those opportunities will be available and we want to be prepared for them. Nobody can promise the, we're going to be in the hunt, so to speak, on that and we'll just have to see how it goes.

But we're kind of well positioned to take advantage of whatever may come up. We don't know exactly what's going to come up and that's the unpredictable part of all this. Things may get a lot worse, for everybody. That's also a real possibility. I don't want to dismiss that possibility because frankly, I think this that for the so-called stimulus to have been effective you have to have gotten the money out early. Once this downturn begins to feed on itself it's much tougher to turn around and that's the big opportunity that they have lost.

And anybody from the government who tells you that they really expected this stimulus money to affect it in the second year, is giving bull shit to what it really [inaudible]. Room temperature in economics will tell you you've got to stop it early, not in the second year. So I don't know what they were thinking about and it's very frustrating to see.

But anyway, there we are. We are what it is and it's both an opportunity and a risk.

Operator

There are no further questions in the queue.

Douglas T. Linde

We apologize for the length of the call but obviously people wanted to hear what Mort had to say about his views on the economy and we didn't want to cut him off. And given that there was nobody us on the REIT side after us, we appreciate your indulgence on sticking out if you stuck it out.

Operator

This concludes today’s conference call.

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