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Boston Properties Inc. (NYSE:BXP)

Q4 2007 Earnings Call

January 30, 2008 10:00 am ET

Executives

Mortimer B. Zuckerman - Co-Founder, Chairman, Head of Office of the Chairman, Member of Special Transactions Committee and Member of Significant Transactions Committee

Edward H. Linde - Chief Executive Officer and Director

Douglas T. Linde - President

Raymond A. Ritchey - Executive Vice President, Head of the Washington, D.C. Office and National Director of Acquisitions and Development

Michael E. LaBelle - Chief Financial Officer

Analysts

Jordan Sadler - Keybanc Capital Markets

David Harris - Lehman Brothers

Jay Habermann - Goldman Sachs & Company

Michael Billerman – Citi

Jamie Feldman - UBS

Operator

Welcome to the Boston Properties fourth quarter 2007 conference call. At this time all participants are in a listen-only mode. Later in this presentation we will conduct a question and answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this conference is being recorded today, Wednesday, January 30, 2008.

I’d now like to turn the conference over to Marilynn Meek. Please go ahead.

Marilynn Meek

Good morning, everyone, and welcome to Boston Properties fourth quarter 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 non-GAAP financial measures to the most directly comparable GAAP measure in accordance with reg G requirements. If you did not receive a copy of these documents, they are available in the Investor Relations section of our website at www.bostonproperties.com. Following this live call, an audio webcast will be available for 12 months from the Investor Relations section of the website. To be added to our quarterly distribution list, please contact the Invest or Relations department at 617-236-3322.

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 obtained. Factors and risks that could cause actual results to differ materially from those expressed or implied by forward-looking statements are detailed in last nights 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.

With us today I would like to introduce Mort Zuckerman, Chairman of the Board, Ed Linde, Chief Executive Officer, Doug Linde, President, Ray Ritchey, Executive Vice President and National Director of Acquisition and Development, and Mike LaBelle, Chief Financial Officer. During the Q&A portion of our call, Mike Norville and other members of the regional management team will be available.

Now I would like to turn the call over to Doug Linde. Doug, please go ahead.

Douglas T. Linde

Thank you. Good morning, everybody, and thanks for joining us for the fourth quarter call. Each year at this time I actually go back and look at the transcripts from previous years just to sort of get a sense of the context of where we have come from and last year when we had this call we were talking about the strong demand and the rising rents and most importantly the robust capital flows that were in the office building business. If everybody remembers, it was in February of last year that we closed our sale of 5 Times Square in which our buyer financed the $1.82 billion purchase with a $1.9 billion 10-year interest only CMBS financing at less than 6% and then in February Blackstone completed the sale of a number of those EOP portfolios to people like the Macklowe organization.

As we will discuss in a few minutes, overall demand is still healthy. Rents still seem to be rising albeit at a slower pace, but the capital markets are anything but robust. Today the extraordinary pain that is being felt all across the financial markets and the tremendous unwinding of the leverage as we sort of look at it in our financial system that’s occurring on a daily basis is unlike anything we have ever seen in our careers. The most daunting aspect of it is that no one seems to know where and how deep the losses are going to go and I think Mort will probably comment a little bit about that as he makes his comments towards the end of the call.

To date the effects on our business have manifested themselves in reduced availability and higher cost of capital. It has not yet had any discernible impact on our operations but it has impacted building valuations and our stock price. The large loan commercial mortgage backed securities market for all intents and purposes today is closed, hopefully temporarily, and while an owner may be able to get a conduit quote on a $50 million loan, the lack of any meaningful secondary trading of CMBS paper has led to extraordinary spread widening for that thinly traded paper that it does move has prevented the investment backs from taking down any large loans that they might be required to warehouse for extended periods of time given the changes in interest rates and spreads. They’re just not prepared to take those risks.

This is a pretty critical issue for the office building business, particularly for large buildings. The life insurance and pension fund companies are unlikely to completely fill that breach and lend more than $100 million or so per participant on any one assets and finding two or three insurance companies to finance every large office building in every city is going to be very difficult. Five years ago we made the decision to supplement our use of the security insurance and pension fund market in the CMBS market with the investment grade bond market and we continue to be an active borrower in that market along with the commercial banks which have been the source of innumerous numbers of our construction loans and which actually are probably the group or the place where the largest void from the CMBS breaches currently being filled.

As a result, Boston Properties has access to capital. The cost of the financing is fluid. Credit spreads continue to widen in the various markets, and in addition, the volatility in the underlying treasury spreads has been striking. Last Thursday, for example, the 10-year opened at 3.43 and closed at 3.71. In November we were satisfied to complete a five-month hedging program where we locked in $525 million of underlying 10-year treasuries at an average rate of about 4.63%. Clearly we did not anticipate the turmoil and the resulting rally and bond or the hundred plus basis point reduction in short term rates by the Fed that’s occurred over the last 60 days. Hindsight is a wonderful but not particularly effective tool. Consequently, it’s with some caution that we discuss the impact on the current economic and financial environment on our operating portfolio.

We do expect to see an increase in unemployment, continuation of near term head count reductions from Wall Street and other financial intermediaries, and in all likelihood, a slow down in overall job growth. At the same time, we confess uncertainty in predicting the significance or timing of these factors on our markets. I know we’ve said this before, but location really matters in the real estate business, and it’s not just by market, it’s by street address or corner. We have always been looking to operate at the high end of the market in supply constrained places and as we will discuss, the good news is that the current availability is very limited in our markets and there still is growing demand.

Let’s start with Manhattan. The mid-town Manhattan vacancy rate is still under 5% and the availability rate, which includes space that will be available in the next 12 months, is under 8%. Market rates are up about 4% from last quarter and over 25% in 2007. Market sentiment, and this probably stretches across all of the markets that I will discuss in the next few minutes, is that if you are a user and you can wait, the economic uncertainty [can blow inure] to your benefit but if you have a lease expiration or you need additional space, there’s been no relief in terms of rental rates or concessions. Rent from [the infirm], concessions have not increased.

During the last week in December, we recaptured a combination of units leased by Citigroup in both Citigroup Center and 399 Park totaling about 130,000 square feet and we re-leased that space at rents that were $35 per square feet higher than the rent that Citibank was paying on those spaces. By the way, those spaces had been on the market for the past 12 months and the availability was not related to the issues that Citi has faced since June.

Just before the New Year we signed our first lease at 250 West 55th Street with a law firm that will be expanding fro m170,000 square feet at 200 Park Avenue into 222,000 square feet at the top of our new tower in 2010 when that building is delivered. Excavation has begun which is the first step towards the delivery in late 2010. If you have a space requirement in excess of 150,000 square feet in Manhattan, you are typically in the market 2 to 3 years ahead of your actual need. We are in active discussions with other tenants, all lease expiration driven, that could effectively fill the remaining space at 250 West 55th Street. Now my point is not that we’re fully committed by rather that there continues to be activity and there are tenants that must make leasing decisions.

New additions to the inventory in mid-town Manhattan are limited to our building, a tower across from the Port Authority at 42nd and 8th, the Bank of America building on 5th Avenue, and the Macklowe organization’s small floor plan of 350,000 square foot 30-store tower on Madison and 53rd. Without a dramatic increase, in blocks of sublet space, there is unlikely to be a change in the operating fundamentals in mid-town Manhattan. When you think about the demand underpinning Boston and San Francisco where we have the bulk of our, while be it limited exposure, in 2008 and 2009, you have similar situations.

Neither CBD has seen any new construction for a number of years and while each city lost significant headquarters financial services tenants from the consolidation that occurred during the last decade, the reduction has been offset by asset management, technology, biotech and life sciences, and most importantly, the professional service firms that surround those industries.

In addition, each city has seen properties once owned by equity office properties in the control of an owner with a much more hardnosed approach to leasing space. So if you think about Boston, the vacancy rate is about 6% and it moves to about 8% if you include sublet space. In Cambridge, the vacancy and availability rate are slightly higher at 7% though in Kendall Square where we have our 1.8 million square Cambridge Center portfolio, the vacancy rate is under 5%.

One might characterize the demand growth in greater Boston during the last 5 years as measured organic expansion. After the over-exuberance of tenants from 1999 to 2001 in that dot com era, tenants in Boston where very, very reluctant to take additional space until they had immediate needs for those employees. Virtually all of the sublet space that the greater Boston market has seen over the past few years has been caused by M&A activity. Interestingly, overall vacancy has declined even as we have digested the B of A fleet merger, the Manulife-Hancock merger, and the P&G-Gilette merger with the resulting reduction in overall vacancy rate and today we are working through the last of these, the State Street Investors Bank and Trust merger. Expansion continues albeit in a much more granular manner throughout the market. Although we do still have some dynamic growing asset management firms and professional services firms, two of them are at the Prudential Center with Bain Capital and Ropes and Gray who made that commitment last quarter to expand into the Prudential Tower in 2010.

Cambridge has seen a dramatic resurgence of technology companies that have a high space utilization requirement with Google, ACaMI, EMC, VMWare, and Microsoft all taking significant space in the latter stages of 2007, each with expansion expectations and we still have a very vibrant biotech and research user base in MIT and Harvard. Out in the suburbs of Boston in Waltham and Lexington, there continues to be strong activity although there is modest new construction but it is serving a group of growing technology tenants. Many of those tenants have not been impacted by the financial turmoil since their funding does not rely on access to debt capital markets. We are negotiating a lease, for example, with a technology tenant at 77 City Point. That’s tenant’s lease requirement has grown fro 150,000 to 165,000 square feet over the past few months and they will be taking all of the remaining space at 77 City Point and they are looking for additional expansion opportunities in our other City Point assets.

Moving over to San Francisco, there the overall vacancy rate still stands at about 7.5%. Rental rates have risen 30% in the last 12 months although this trend again is probably going to moderate in ’08. Asset management, law firms, management consulting firms, venture capital, and a few technology companies dominate the downtown market. Current activity in the Embarcadero Center is pretty consistent with what we were seeing in January of last year, although again, with an expectation from the tenant side that rentals not dramatically increase in ’08, the need to lock in rent early is not driving tenants to make decisions quickly. While tenants are cautious about the direction of the economy, there has been little publicly announced reductions in the workforce. I think Yahoo! is probably the only one that’s out there in the greater Silicon Valley marketplace, and no noticeable increases in high quality sublet space. The Silicon Valley continues to show good new activity with consistent rental rate growth and again the Class A vacancy rate is under 10%. The vast majority of the tenants in the Mountain View area, and this is where we purchased our new portfolio of buildings in the last quarter, are established technology tenants like Google and Apple and eBay and Avidia and Adobe and Sysco or they’re start ups in the health care or other technology or alternative energy areas that are backed by venture capitalists or entrepreneurs that have been funded by the wealth created by events like the Google IPO. Once again, these tenants are not relying on debt capital, but they obtain their resources through cash flow, venture capital funds, or other equity sources.

However, there is no doubt that everyone is concerned about the economy and the boards of lots of smaller companies are being very cautious about major decision making and I’m sure this is going to start to slow things down. Washington, DC is probably the one where market supply is the issue but it happens to be the one market where Boston Properties’ portfolio is 99% leased and has the least amount of rollover in 2008. The district has 5.4 million square feet under construction and another 3 million of major renovations that are underway. Some of the spaces in the southwest, which is strictly a GSA contractor market, and there a large requirement can occur at any time, but average annual absorption is still between 1.5 and 2 million square feet in the greater DC area.

Law firms clearly dominate the private sector space. This is the one profession that has seen significant growth across every market that we have been in and there’s no question that if general economic slowdown would have the effect of reducing or weakening of the smaller firms and accelerating the consolidation that has been occurring in this profession over the past number of years. In 2006 and 2007 in northern Virginia, there was significant speculative construction starts with limited pre-leasing. While much of that space is now completed and as Ray Ritchey likes to say, it is unencumbered by tenancy. Once again, location is crucial and during the last quarter, Boston Properties completed and additional 110,000 square feet of leasing at our South of Market project in Reston that is now 81% committed and we increased the leasing in our next building in South of Market which is scheduled to begin construction in the second quarter. We’ve now leased 180,000 square feet or approximately 77% of that building.

On a portfolio level, we have seen additional improvements in market rents. At the end of the quarter, our mark to market had moved up to $10.10 from about $8.80 last quarter. This works out to embedded growth of about $1.87 per share. Again, as we’ve repeated in the past, our leasing strategy has always been to sign long term leases with the best credits available. The strategy modulates the swings in our rental revenues but if we enter a down market it also limits our exposure. In ’08 we have roll over of about 1.6 million square feet which is pretty small with an average expiring rent of $38.78. We estimate our mark to market on the space is $47.50 or about 25% higher than our expiring rents.

Our leasing staff this quarter probably do merit some explanation. First, you’ll note that there is no contribution from the New York City portfolio. If we included the three deals that we completed in late December, but because they don’t start until January, they’re not in the statistics for the fourth quarter, the positive increase for the portfolio would have been 15% on a gross basis and 24% on a net basis. Second, in Boston, there’s 100,000 square foot 10-year lease that we signed in late 2006 with only $10 of transaction costs which dramatically reduced the face rate and yet greatly enhanced the net effect of rent.

Finally, the second and third floors of Embarcadero Center had a roll off in rent of about $70 per square foot and it was replaced with a new deal in the $50s. Again, the devil is definitely in the details in those leasing statistics. The fact that we saw a slight reduction in our gross is not an indication that rents are softening or that concessions are going up.

Now before I turn the call over to Mike LaBelle, I do want to make a few comments about the outperformance plan that we filed last evening.

The plan blends absolute and relative outperformance hurdles which is something we have not seen in any other plans. There are no interim measurements, no ability to earn or lock in any portion of the plan prior to the final measurement date which will be in three years. Participation in the plan was very broadly distributed since we firmly believe that our success is a team effort requiring dedication, hard work, and great skill throughout the organization. We believe it will provide the appropriate incentives as the company moves forward over the next five years.

With that, let me introduce Mike LaBelle, our new Chief Financial Officer, who will walk you through the fourth quarter results and provide some assistance as you think about 2008.

Michael E. LaBelle

Thanks, Doug and good morning, everyone. I’m excited to be here with you this morning and look forward to meeting many of you in person over the coming months. I’m working side by side with Doug and Mike Walsh, so please feel free to call any of us if you have questions about the call or anything else.

I thought I would start with a review of our fourth quarter earnings. Our fourth quarter FFO was $1.22 per share or $0.03 above our guidance, bringing our full year 2007 FFO to $4.64. The positive variances from the quarter included $2.9 million of termination income, primarily from the lease recaptures with Citigroup that Dough mentioned earlier. We typically budget $1 million per quarter for termination income, so the net positive variance is $1.9 million. We had holdover rent from the Washington Group in Princeton totaling almost $500,000. We successfully prevailed in a number of tax abatement cases in Cambridge going back to 2005 and received a refund net of expenses of $635,000. The Cambridge Marriott Hotel had a strong quarter, coming in $340,000 ahead of budget. We had additional third party fee income of $1.1 million and the overall portfolio revenue from early rent commencements, percentage rent from our retail, and parking, offset by some spaces that did not lease as expected, resulted in a positive contribution of $1.3 million. These positive variances totaled $5.8 million. Offsetting this was $1.6 million of lower net interest income stemming from the combination of much lower interest income from our cash investments resulting from the declining interest rate environment as well at the use of capital for the purchase of our newest development opportunity in San Jose.

During the quarter we also purchased two research and development parks in Mountain View, California for $223 million. These are repositioning and releasing opportunities that match well with our value fund parameters. Subsequently on January 7th we admitted our fund partners into the deals and are in the process of arranging third party mortgage financing for approximately 55% of the purchase price. We will have a 40% nominal interest before any promotes in the properties. On the disposition front, we completed the sale of our Loudon County portfolio which brings our total sales over the past two plus years to $4.25 billion. At the moment we do not have any assets on the market but we continually review our portfolio and may consider additional sales in 2008.

As Doug discussed, we have limited rollover in 2008. We think the best way to consider our 2008 FFO expectations is to use the fourth quarter run rate adjusting for two items. First, the completion of our 50% joint venture at 505 9th Street which came into service in October at 75% occupied and will be reported on a consolidated basis, and second, adjusting for the fourth quarter property sales. The properties we sold during the fourth quarter were unencumbered, so the only adjustment that needs to be made is for the GAAP NOI contribution which was $1.2 million for the quarter.

Without any increase in portfolio occupancy, we expect portfolio results after adjusting for the sales to grow between 2.5% and 3.5% on a GAAP basis. Included in the GAAP numbers are straight line rents of approximately $43 million to $45 million including the delivery of South of Market which starts in February. Another way to look at this is to focus on our same store portfolio. On a full year basis, we expect our same store portfolio to increase 3% to 4% over 2007 on a GAAP basis and 5.5% to 6.5% on a cash basis. We estimate $150 million of development is placed in service by the end of the second quarter and an additional $150 million by year end. As we suggested during our last call, a 9.5% return on cost is a good approximation for the yield on these developments.

Additionally, we are budgeting 2.8 million of termination income in the first quarter and $1 million in each subsequent quarter as part of this revenue base. Again, the fourth quarter is a good place to start as you think about our interest expense for 2008. The expense will be modestly reduced as we ramp up our capitalized interest on our two major developments, reaching $12 million per quarter by the end of 2008 for capitalized interest.

As Doug mentioned earlier, we have hedged $525 million of 10-year treasuries. We will be refinancing this maturing debt during the second half of the year and with the volatility in credit spreads, we have currently budgeted 7.5% for this issuance. This compares to the current rate on this debt of 6.7%. We will be making our special dividend and regular dividend payments totaling $6.66 per share today. Our cash balance after the dividends and taking into consideration our purchases in California last quarter will be about $750 million. As the Fed has cut rates, short term investment returns have been dramatically reduced and we have lowered our short term investments rates by over 200 basis points for 2008, thereby reducing our budget for interest income by $15 million.

Our G&A expense is anticipated to run between $74 million and $75 million. This is an increase from our estimate last quarter due to the inclusion of the outperformance plan which adds approximately $4 million in 2008 net of capitalized wages. Capitalized wages are expected to be between $12 million and $13 million in 2008, increasing along with our development efforts, our G&A expenses net of all capitalized wages. Our third party management and development fee income for 2008 is projected to be between $19 million and $20 million, flat over 2007. This, however, is in increase over the guidance given last quarter due to the additional leasing and management fees we are projecting to earn at 280 Park Avenue and the fees generated from the additional value fund investments that we made last quarter.

We assume the contribution from the hotel will be between $10 million and $11 million for 2008. When you consolidate all of the assumptions outlined over the lat few minutes, there’s three primary changes from our last call. The outperformance plan, $4 million, lower interest income, $15 million, and higher interest expense of $2.5 million. Our 2008 FFO guidance is between $4.55 and $4.65 with $1.09 to $1.10 for the first quarter with our hotel only contributing $500,000 in the first quarter due to seasonality.

While these decreases I outlined total $21.5 million or $0.15 per share, improvements in the portfolio assumptions provide for a recovery of a portion of the changes so our full year guidance range has only been reduced by $0.07 per share. Our guidance does not assume any acquisitions or dispositions in 2008.

While we have said this before, we think it bears repeating. We will have distributed $13.88 in the form of special dividends from gains on asset sales over the last three years. Our decision to sell assets makes significant special dividends and shrinks the company’s asset base has the short term effect of dampening our year to year earnings growth. We have made the decision to return capital to our shareholders with the result of lowering our earnings but positioning our development pipeline to have a more significant impacted on future growth. Had we completed 1031 exchanges in connection with the property sales and the properties that yielded as little as 5% on a GAAP basis, we could be reporting additional FFO of $0.69 per share.

Douglas T. Linde

Thanks, Mike. Our development activities are considerable at this juncture and we are making significant progress on obtaining major leasing commitments for our two largest projects, Russia Wharf and 250 West 55th Street. Our view on the capital markets remains I guess what I would refer to as aggressively cautious. Though our balance sheet is extremely healthy, we are confident that we will have access to capital and will be put in a position to take advantage of selective acquisition opportunities that should arise as the changes in the credit markets create increased pressure on highly leveraged owners, and while 2010 and 2011 may seem far away, knock on wood, we will have delivered $2 billion of development at returns which will reward us for our development expertise, and I think I’ll turn the call over to Ed who I think will have some additional comments on our development platform.

Edward H. Linde

Doug, listening to you, listening to Mike, I think you’ve really covered the waterfront here and I want to leave time for Q&A. The only points I would make are one, we really believe that we are going to be rewarded for the strong balance sheet and conservative posture that we’ve taken. It’s going to be interesting as the year rolls out to see what the acquisition opportunities are and at what cap rates quality buildings may sell for. The cap rates are certainly going to end the constant downward trends that they had for the last 4 or 5 years and the question is, how quickly and how dramatically will cap rates go up? We are posted to be able to take advantage of that if and when it happens and I was going to comment on our development pipeline but I think that’s been covered so the only thing I do want to do is to provide some additional guidance and that is Patriots 41, Giants 23.

Let me turn the call over to Mort if he has any comments to add. Mort?

Operator

Sir, please stand by, Mr. Zuckerman’s line disconnected. We’re calling to connect him right now.

Oh. Okay, we’ll stand by and -- oh, here he is.

Mortimer B. Zuckerman

Hello . In the first place, let me just say the following based on macro economic analysis and very deep insights into the economy. It’ll be Giants, 41, Patriots 23. With that minor correction of my normally rational partner of great judgment, let me just say that we’re in a very, very unusual, really unique macro economic environment. The credit bubble which has bust is part of the result of it, the bust in the housing bubble. Nobody knows here the bottom of that is. It was astonishing to read of the events at Societe Generale where a 31 year old trader had 73 billion of the bank’s money in an attempt to do well in the futures market, betting on two indices, the German stocks and the European stocks, two specialized indices. Who knows how much they would have lost but they ended up losing 7.2 billion but you have to think about the fact that somebody was able to do that kind of trading without the awareness of the senior management who will shortly be leaving, no doubt. This is going to, I think, be a part of what we are going to be dealing with going forward because I frankly think that a lot of the senior management of financial institutions are involved in the purchase of highly leveraged financing of securities whether it be CDOs or what have you and those are becoming unraveled for various reasons. Relying on the rating agencies has proven to be a sad experience since even the president of [Moody’s] has now acknowledged, “They made mistakes” and that’s putting it mildly and the computerized systems that have mathematical models only show you that computers make quicker mistakes so I think we are in a period where nobody knows that the potential vulnerabilities of the financial system may be. As Dough has already indicated, however, it has had a big effect on the availability of financing almost across the board.

We have to say, I mean we did not predict this, but we did as you know take a very interesting and completely contrary view of holding certain real estate assets and we sold as was mentioned over $4 billion of those assets at numbers that we could never replicate today, and I think we were the only REIT to do that I’m very glad that we did. We just frankly felt that at certain values we were prepared to be sellers because we could then roll over the money and translate it into development projects where we could make much higher returns and that to us was a really wonderful option since development is the DNA of this group of people who’ve worked together for so long on these kinds of projects. Now there are going to be opportunities to make acquisitions. There are going to be a number of people who are going t o be either forced to sell or willing to sell properties and we are working on some of them and without any idea whether or not we will be able to consummate them we are working with other financial institutions to see if we can form partnerships in these acquisitions and we probably will be able to do that. Whether we will be successful in bidding for properties is anybody’s guess but there is no doubt as Doug says that certain highly-leveraged people are going to be forced to do something and that is going to be an ongoing process because there was a lot of financing that went in the fairly short term, not just a year, but two and three years, and some of that financing’s going to come due over the next couple of years and people are going to be forced to sell.

So there will be acquisition opportunities but as indicated before, we still feel that we have outstanding development opportunities and we’re going to continue to focus on that. That gives us the highest returns for invested capital and invested management and that merger of management capital is what we think we bring to the table. So we are frankly in a very, very strong position and we’re all very comfortable about the opportunities that we might have and the ability to take advantage of those opportunities so I think I’ll just st op there and we’ll look forward to seeing more interesting reports from financial institutions than you will from REITs.

Okay, operator, you can open up the queue please.

Question-and-Answer Session

Operator

Thank you, gentlemen. Ladies and gentlemen, this will begin our question and answer session. (Operator Instructions) Our first question comes from the line of Jordan Sadler of Keybanc Capital Markets.

Jordan Sadler - Keybanc Capital Markets

Thank you, good morning. I’d just like to explore a little bit maybe your appetite to get involved on the investment side outside of development maybe through acquisition, from a distressed Seller. Just hearing some of your commentary, Mort you said that some of your prices could not be replicated on the asset sales and you spoke of your aggressive caution. I’m just curious as to what that would do to your underwriting for a distressed asset. So what you would be looking for in terms of a cap major return versus a development today.

Edward H. Linde

This is Ed. I don’t think our underwriting is going to change in the sense that as we looked at these assets that came on the market when times were let’s say more buoyant, we were appropriately conservative and applied the same standards we’ve always applied to looking at things like rental rates, rental growth, opportunities to increase the net operating income, and therefore the FFO, from these assets and that’s still a very, very big part of any underwriting, and when it comes to the cap rates, we were not buyers at 4% cap rates or 3.5% cap rates or 4.5% cap rates. I think that the cap rates are going to move up. I don’t want to sort of state a hurdle but it would be surprising if they didn’t move up by 200 or 300 basis points from what they were and given the strength of our balance sheet, if we have both cap rates moving up and an ability to look at the cash flow in these properties and see opportunity for increase, then we’re going to be acquisitive.

Jordan Sadler - Keybanc Capital Markets

That’s helpful. Doug, you mentioned the Macklowe situation as one of the short term situations. Could you maybe take a guess at how you think that might play out or whether or not you’d have some interest?

Douglas T. Linde

I think I prefer not to do that. I will just say the following, which is I think it’s universally recognized that the financial structure that the Macklowe organization used to purchase the EOP assets cannot be replicated today and therefore there is a liquidity issue associated with coming up with the proceeds to fund the debt that is maturing and the issue is certainly one of whether or not the values that he paid for those buildings are comparable to where the values are today but also what the relative amount of equity is that is required and I think we’ve said in the past, to date there has been a denial from at least the financial community’s perspective in terms of how they’re outwardly looking at the world that someone has to take some amount of a reduction in the value of what they have either equity or the loans that they were put on that and until that occurs, I think we’re going to have to be patient and wait and see.

Jordan Sadler - Keybanc Capital Markets

Thank you.

Operator

Our next question comes from the line of David Harris with Lehman Brothers.

David Harris - Lehman Brothers

Good morning. Mort, I’ve got a question for you. Where’s all the foreign capital and do you need to spend a little bit more time schmoozing with the sovereign wealth fellows?

Mortimer B. Zuckerman

Yes, the answer is there is foreign capital. We are in conversations with some of these sovereign wealth funds, in fact, I probably had 3 or 4 of them just in the past week so there is again a sense that this might be an opportune moment for them to invest in the kind of properties they want. They have a longer term view of things in general so they’re the right kind of partners for us and they look to us obviously to come up with the assets to manage the assets and we’re trying to do that but as Ed and Doug are both implying, we’re not going to rush into these things unless we can see the right kinds of internal rate of returns over a period of time and it’s just entirely unpredictable. It doesn’t mean we aren’t going to make efforts. We believe we will not over reach on the buying and we didn’t over reach on the holding. We were very, very happy to sell assets when we did. It has put us into a very strong financial position. It enables us to continue with our development program and it does enable us to make acquisitions if we can find the right acquisitions. We’re going to be very selective about it, even more so because we think we have the opportunity to be even more selective now than in the past. The competition for these kinds of assets are going to be dramatically reduced because a lot of people aren’t going to be able to get financing and we can. So we’ll just have to play it out. I don’t want to in any sense diminish the role of the sovereign funds or foreign investors. They are clearly the ones who are also seeing this as an opportunity and we are going to be working with them and they are still looking to us to come up with the appropriate purchases and that’s what we’re trying to look at.

David Harris - Lehman Brothers

What’s striking about this time we’re in is the returns that they’re receiving on their investments in the underlying credit, the financial stocks have been taking positions on, typically so convertibles have been 7 plus and we’ve seen higher returns than that. There’s quite a gulf between a 4% or 5% cap rate on a property which we might surmise is kind of the going rate and the returns that they’re actually receiving on that investment and the underlying tenant credit.

Mortimer B. Zuckerman

I think that’s an extremely good point and because I think it demonstrates something, that I think there is a misperception in the marketplace if you think that the sovereign funds are going to run in and basically buy properties on the same basis that they might have brought them 12 months ago and so I think the gap between what you just described, the investments they’re making in other areas and real estate is going to have to close. Now real estate has something going for it that I think they give great credit to, and that is well-located, high quality buildings. They can count on values out further that are going to grow significantly and that has to be taken into the equation as Mort just said, when you do an internal rate of return calculation but if the world at large thinks that these sovereign funds are going to come in and put Humpty Dumpty back together again, I think they’re making a big mistake.

David Harris - Lehman Brothers

Thanks so much.

Operator

Our next question will come from the line of Jay Habermann from Goldman Sachs.

Jay Habermann - Goldman Sachs & Company

Hey, good morning. Doug, in your comments you mentioned rents that actually held up fairly well. I’m just curious in your outlook if you are making any assumptions, whether or not you’re taking into account risk of recession. It was mentioned last week that net effective rents on another call, rents could be down 10% to 15% in Manhattan. Can I get your thoughts there obviously on rents going forward?

Douglas T. Linde

I guess I would tell you that while we are not predicting a reduction in base rents, we certainly have moderated our expectations about growth and part of that, and we’ve been saying this for quite some time, is that the extraordinary growth that we’ve seen over the past 2.5 years has pushed rents to levels that we’re quite comfortable leasing space at day in and day out and we believe that given the relative lack of supply in the markets that we operate in plus, and sometimes it matters and sometimes it doesn’t, the cost associated with building new inventory and what replacement cost rents are necessary to justify a new building that would have to get constructed, that we’re not uncomfortable with a sort of flat to moderate increase expectation in the markets where we operate and that includes everything from suburban Boston to the Silicon Valley and our CBDs. I will say that the one market, and Ray should probably comment on this, is that there is a supply issue in northern Virginia and Reston Town Center is very different than the toll road in northern Virginia and as we discussed, we sold literally every building that we have that’s not in Reston Town Center or under the immediate side streets around it, so our portfolio there is different than other people’s portfolios, but I think that’s the market where if we had space on the toll road, we probably would be anticipating a reduction in net effective rents over 2008. Ray?

Raymond A. Ritchey

Let me make one comment about Manhattan. We’re in mid-town Manhattan and we’re at the upper end of the spectrum of assets in mid-town Manhattan. There are very, very few sites available. There’s no excess inventory in mid-town Manhattan and as you look forward, the next 3 or 4 years, our building on 8th Avenue and 55th Street is going to be the only building done between now and then and there will be a couple of buildings on 42nd Street much further to the west but I have to tell you, there is not going to be a lot of new building space available in Manhattan and it is true that there is a lot of turmoil in the financial world and there will be some diminution of occupancy by some tenants but there still if you look at the amount of money that’s being managed by hedge funds, it’s still gone up dramatically and you have not seen the kind of displacement of people out in Manhattan as compared to other parts of the operations of many of these financial firms so we just do not... And we have very little space rolling over, but I will tell you, at this point, we just do not see any kind of weakness in the market and frankly of the building that we are doing and we’re doing this building, a million square foot building, we had an extraordinary demand for that space from more than the tenants that we made either the one transaction that we have signed in the lease form and the others that we are quite advanced with. There are backup tenants really looking for space that really cannot be met at this point in the current market so we do not see any kind of real 10% to 15% downside, at least not in the upper end of the mid-town market. This may be the experience of others. We haven’t seen it and we haven’t seen it going forward, that is to say in terms of forward leasing either for new space or for existing space and it may be that we are just, as Douglas said, we’ve got buildings in the right locations, but it seems to me stronger than that.

Jay Habermann - Goldman Sachs & Company

So basically you assume that yields on development, your prior assumptions, are still holding true at this moment?

Raymond A. Ritchey

Frankly we are doing better than we expected. The one area where we are seeing some improvement in terms of calculating our yields going forward is that our construction costs at the very least are not going up the way we expected because of the decline of construction activity so in that sense I think our costs of these new developments are at the very worst well under control if not actually going down in absolute terms compared to where our budgets were, so our yields will, if anything, come in a little bit higher than we expected, assuming we sign the leases we believe we will sign. I don’t want to over state that. We’re not going to be getting double digit yields but frankly the market remains very strong. There are tenants and there are backup tenants. If there is any improvement at all, it’s on the construction side.

Jay Habermann - Goldman Sachs & Company

Great and just one point of clarification. Did you mention the asset sales or whether or not you’d be a net seller this year?

Douglas T. Linde

I think what we said, Jay, was that right now there’s nothing on the market. We continue to look at the portfolio. I can tell you there are assets that we could consider selling every year and I think it’ll be dependent upon the advice we get from others, our own internal expectations about whether or not those assets will be... we’re better off selling those assets today or holding on to them, and what the right... and maybe we sell an interest in some of those assets to some institutional partner who might have a consistent perspective in terms of how to operate them as we would. So right now we’re not budgeting anything but it’s something we’re certainly looking at.

Mortimer B. Zuckerman

By the way, just in terms of comments on the residential side of mid-town New York, I was just last night talking to somebody who is probably one of the two or three leading brokers of high quality residential projects and she said to me that there has been absolutely no diminution of demand and still a complete inadequacy of supply for the upper end of that spectrum as well and she says maybe prices aren’t going up quite as fast as they were but there’s certainly been no weakness in that so I just give you that as another reference point for Manhattan.

Jay Habermann - Goldman Sachs & Company

Thank you very much.

Douglas T. Linde

Ray, do you want to just give a couple of comments on northern Virginia?

Raymond A. Ritchey

I would say that our comments in northern Virginia are going to be diametrically opposed to any other REIT operation in that corridor. Reston Town Center is a submarket unto itself even though as you pointed out earlier, Doug, we’re 80% or 85% leased on our nearly 900,000 square feet of development, we are still getting relatively strong demand for the bits and pieces that are left. Is it as active as it was a year ago, no, but we think a function of that is that we are now in the box of [20 85 ascended] 20,000 square feet as opposed to the larger box, but clearly if we were playing the commodity game, we’d be having a wholly different type of success rate than we’re enjoying in Reston Town Center.

Jay Habermann - Goldman Sachs & Company

Great, thank you.

Operator

Next question comes from the line of Micheal Billerman of Citi.

Michael Billerman - Citi

Good morning, John Litt’s on the phone with me as well. Ed, I wanted to come back to your comment regarding cap rates. I think in the opening prepared remarks you talked about not knowing if and when you’d see a rise in cap rates and in response to a question you said the company wasn’t buyers of assets at 3.5% to 4.5% cap rates and you could see a 200 to 300 basis point rise which would imply significant decline in valuations of assets and I’m just wondering if you can sort of clarify a little bit in sort of a collective wisdom where you see cap rates heading.

Edward H. Linde

The first thing I want to clarify is that we sort of ascribe a precision to these comments which it probably is undeserved because we’re all speculating about what will happen in that marketplace and there is a dichotomy between the valuation that you might suggest is appropriate on a square foot basis and one that the initial cap rate, initial yield on current NOI or [INOI] for the next year gets you to because we know the replacement cost has gone up considerably and that does put something on the floor under cap rates. We know especially if you’re talking in a place like Manhattan, we know how difficult it is to put together sites and so if existing buildings come back on the market at something less than the 200 basis point spread that I talked about but you can look at their cash flows and look at what the expected rollovers are and whether the rents are above or below market, et cetera, you might say to yourself that cap rate’s for that building may be lower than my implied 5% to 6% so I find I have a hard time being precise about that. I know when I look at my portfolio I say to myself, “You know, this is a hell of a portfolio and over time it has a value that is certainly justified by and then some by what some net asset value calculation might yield” so I’m sorry to be muddled on the answer but I don’t think precision is really possible.

Michael Billerman - Citi

Right. Maybe switching to the core, Doug, I think you talked a little bit about the leasing stats in the quarter and how there was some leasing that was done in the beginning of the year. Can you sort of just elaborate a little bit more on some of the activity that you’ve had so far in the first quarter or at least that has commenced in the first quarter in terms of volume and in terms of rent spreads and how that’s positively affected your outlook for ’08 on the core portfolio.

Douglas T. Linde

Sure. Let me start with the following, which is we have relatively little portfolio rollover during the year and as you know, timing is everything, so that’s why we’re not assuming much in the way of any increase in occupancy during the year, but I would say that we continue to across our markets have steady, healthy demand as characterized as tours of spaces and proposals that are on the market. I’ll give you an example. In Cambridge we had a tenant this quarter that went belly up on 29,000 square feet. It was a company that was designing an internet portal for Victoria’ Secret and they did something wrong and they literally shut the doors on January 1st. That’s in 1 Cambridge Center. We have had 4 or 5 showings from technology and biotech companies looking at that space and we got 3 proposals outstanding on that space. As I said before, I spoke with our leasing team in San Francisco two days ago and they have had tours that are comparable to the number of tours that they had in January of last year although I think last year at this time they were tech companies that were looking to make leasing decisions because they were really concerned about the rents is going up. This was just on the heels of the EOP sale of Blackstone and the potential sale of that to another portfolio and they were worried about the dramatic increases in rents that were occurring and again the demand continues to be the same. Suburbran Boston we continue to see great activity on all of our vacant spaces in our older second and third generation buildings. New York City, unfortunately we don’t have any space to lease, but we are still the leasing agent at 280 Park Avenue and we have two smaller spaces there and we have two or three tenants that are looking at each one of those s paces, so it’s not a frenzied activity where we have tenants rushing to make decisions, but the level of volume is pretty consistent with what it would be at a normal year compared to sort of where we were on the past few years on a quarterly seasonal adjusted basis. With regards to the actual rates, nobody in our company has come to us and said “We’re concerned, we think we should be reducing rates.” The question is, how far and how quickly we can push rents continually based upon the competitive environment and the space that we have and I think that’s where there might be some resistance and I will tell you, a lot of it is based upon everyone’s assumption that things are going to get softer in the economy and that the R word is in fact going to become a reality but nobody on the business side that we deal with on a day to day basis has beena ble to point to concrete evidence that that has occurred.

Michael Billerman - Citi

You gave a pretty good update on the West 55th project. Can you just give a sense of where Russia Wharf is as well as where you are on the other New York site at 8th and 46th?

Douglas T. Linde

Sure. Russia Wharf, we are under construction. We actually have the old buildings have been taken down and we are doing our test borings right now to put our slurry wall in and we are making good progress with tenants that we are discussing long term leases with and if knock on wood things go well, we should be in a position where we’ll have some firm commitments on that building before we speak to you gain in three months. On West 46th Street I think as we expected we are slowly and meticulously going through the planning of that building and the assemblage issues associated with the [as of] right development because we have to sort of go through a whole set of city approvals because we have to build a parking garage and get a fuel oil permit and other things like that, and our timing is probably consistent with what it was before which is we would anticipate being under construction assuming we made the decision to go sometime early in 2009.

Michael Billerman - Citi

Okay and last just going back to the leasing, is there anything that has been signed over the course of this year or maybe even last that may be beginning in ’08 that would skew the statistics one way or another during the year similar to what happened in the fourth quarter?

Douglas T. Linde

You’re asking so when we come to you in the first quarter what are our leasing statistics going to look like? Is that what you’re asking?

Michael Billerman - Citi

Well in the first quarter or the second is there a big lease that may skew it one way or the other similar to what happened this quarter where we sort of had to dig down a little bit to actually find what it was?

Douglas T. Linde

I will be honest with you, I’ll have to go look and see. I haven’t been focusing on what’s coming next quarter but I’ll be happy to get back to you on that one.

Michael Billerman - Citi

Okay, thank you.

Operator

Mr. Billerman, does that answer your question?

Michael Billerman - Citi

Yes.

Operator

Next question will come from the line of Jamie Feldman of UBS.

Jamie Feldman - UBS

Thank you very much. Can you talk a little bit about the acquisition in the quarter and your expected returns there and I guess the decision of why acquire now rather than wait if you think there’s going to be more coming on the market?

Douglas T. Linde

I guess it’s all a relative question. The buildings that we purchased, one was a site and it’s a development site that we anticipate getting rezoned for 1.3 million square feet. The other are two what I would refer to as single story R&D parks in the heart of Mountain View which as many of you probably know, is second to Palo Alto in terms of rental rate appreciation and sort of where business decision makers would like to be with their smaller companies. We saw the opportunity to dramatically increase the occupancy and the rental rates associated with those properties. It was a $230 million investment plus or minus. We intended to put it into our value fund when we made the acquisitions. The reason that it’s a 40% interest as opposed to a 25% interest is because the buildings, the assets were a little bit larger than what the fund had as commitment and instead of going to the brain damage of trying to get the institutions that were in those funds to go back to their credit committees and their investment committees and get their funds increased, we just said, “Look, we’ll take the rest of the capital that’s in the fund and whatever’s left over, we will put in as additional equity investment.” Now if we the same circumstances had occurred 9 months ago, we would have been 25% owners of that property because we would have anticipated raising more debt on those assets. We are anticipating doing a 55% loan on average on those buildings as opposed to a 65% or 75% loan, which is where the value fund originally had conceived of doing investments, which is the reason for the larger non-promoted position. But we still have our promoted structure working in those buildings.

To be truthful, these buildings are not class A, long-term, high-quality office buildings that necessarily we think should be in the portfolio for the next 20 years. We think there is a repositioning play and while we may hold onto them for seven years, we could also see moving out of these assets in four years, which is the reason for their placement in the value-added fund.

Jamie Feldman - UBS

I think on the last quarter call you suggested that maybe you’re looking a little more aggressively at the debt side of the capital structure for investment. Are you still focusing there? Where do see the opportunities there?

Edward H. Linde

Well, the answer is we are looking at that because that’s clearly where the potential might be for some of the distress to occur and it’s manifesting itself in two different ways; neither of which we have taken any opportunity on yet.

One is the spreads on the more junior pieces of the debt structures have, in our minds, widened out pretty dramatically. So if you are looking to do a mezzanine loan on up to a 70% or 80% LTV -- and I don’t know if LTV means value or cost at this point -- you’re talking about double-digit kinds of spreads. That’s the first way.

The second way is that that is clearly where some of the pain is going to come most quickly and it doesn’t make sense in certain of these circumstances to get involved in those more junior pieces of debt like some of our brethren have done, namely SL Green and Vornado, in order to put yourself in a position where you can take control of the assets.

Now depending upon how leveraged those buildings were when those finances were put on, those pieces of paper may or may not be money good. We have been cautious about that.

Jamie Feldman - UBS

Finally, the 5.5% to 6.5% cash same-store growth you’re projecting for next year, what does that assume for occupancy and what does that assume for leasing spreads?

Edward H. Linde

For occupancy, it assumes flat. For leasing spread, if 25% is what we said where the mark to market would be on the rollover, obviously, there is vacant space where the spread is going to be infinite. So it depends on where the space is, Jamie.

Operator

Your next question comes from Mitch Germain - Banc of America Securities.

Mitch Germain - Banc of America Securities

Going back to the second development site in Manhattan, what sort of deterioration in New York fundamentals would make you potentially not look at doing the development?

Edward H. Linde

I think that’s actually a pretty easy question to answer, which is sublet space. If there were millions of square feet of sublet space on the market in midtown Manhattan where an institution could put a block of space together that would allow a user to take 150,000 or 200,000 or 250,000 square feet for 15-plus years, that would certainly affect the demand for a new building versus some of those spaces which may have a location -- whether we like it or not -- that is closer to Time Square and/or Park Avenue.

I think that would ultimately be the thing that would certainly be the most concern and is what I think everyone is worried about when they think about a potential slowdown in midtown Manhattan: will there be significant sublet space put on the market? As Mort discussed, there are very few opportunities for additional new space and the financial services industry are large users of space and to the extent that something significant happened that would, I think, be the one potential downside.

Mitch Germain - Banc of America Securities

In looking at the future development pipeline, San Jose, what would you probably consider to be the next region that you would start to build out?

Edward H. Linde

Boy, that is a really tough question to answer. I would say that the company on the whole is probably less excited about taking speculative risk today than they were a year ago. I think it will be dependent upon where a tenant may rear its head and say where we might be interested in something.

So for example, there could be a 250,000 square foot tenant that pops up in suburban Boston that says we are looking for a building and by the way, Boston Properties has a 400,000 square foot project called 10 and 20 CityPoint that we could start construction. On the same token, someone like Adobe may say we’re looking for another 300,000 square feet of space in downtown San Jose and we have an 850,000 square foot project of multi-towers that we can start a tower on. Or Lockheed Martin could say we would like to make 150,000 square feet and by the way we just entitled another 500,000 square feet on Zanker Road. So I think it’s going to be hard to sort of characterize that.

I will say that the one site that we are positioning to start development on in the portfolio is one that Ray and Peter are working on in Washington D.C., which we refer to as 2200 Pennsylvania Avenue, which is the former site of the George Washington Hospital. We are going to enter into a ground lease hopefully very, very soon and start the development of a garage which is going to take some time. On top of that garage is going to be a 450,000 square foot office building?

Raymond Ritchey

I think the key thing there too, Doug, is we have tremendous unsolicited interest from both the public and private sector in that site. So while speculative may be the approach like almost all of the projects here, we expect substantial pre-leasing very quickly after starting construction.

Operator

Our next question comes from the line of Lou Taylor - Deutsche Bank.

Lou Taylor - Deutsche Bank

Could you just talk a little bit more about your ‘08 debt maturities in terms of any thought to maybe letting the hedges just lapse and either prepay those mortgages on the line? Maybe give us a little color in terms of when those mortgages mature within a year?

Michael LaBelle

Sure. We have two major ‘08 debt maturities. One is a secured financing on the Prudential Center that matures in July and can be prepaid a little bit early. One is the Embarcadero Center 1 and 2, which is late in the year. Both of those are about $250 million and those were the two maturities that we were focused on when we designed our hedging program.

At this point, we are planning on refinancing those maturities with another type of issuance whether it be a secured issuance or an unsecured issuance in the second half of the year. It’s certainly possible that we could do something else, but at this point that’s what we are budgeting.

Operator

Your next question comes from Ian Weissman - Merrill Lynch.

Ian Weissman - Merrill Lynch

Going back to the cap rate question again, asked another way, what are unlevered return expectations in New York City today?

Edward H. Linde

I am going to answer a different question before I answer that one, Ian, which is if you look historically at cap rates on CBD office buildings, I am not aware of any time when CBD leased office buildings in any of the major cities that we operate in were trading for seven cap rates or higher. So the range under which someone will purchase a well-leased office building in Manhattan, San Francisco, Washington, D.C. or Boston I think there’s a bandwidth and maybe the bandwidth got down as low as 3% and it’s as high as 7%, so that’s sort of where we are talking. Other than the last, call it 12 to 15 months, my guess is that bandwidth is probably closer to 5% plus to 7%.

But getting back to the answer to your question, my expectation is that unlevered equity returns for core investments, meaning investments where there is very little in the way of opportunity or risk associated with lease exposure and rents are close to market is probably somewhere in the 7.5% to 8% range and that assumes that you’re not talking about valuation on a dollars per square foot basis that is in excess of what replacement costs might be.

Now replacement cost obviously has one very critical component which is the land value. The replacement cost decision that is discussed with regard to a building on Park Avenue may be different than one that’s with regard to a building that is on 8th Avenue.

So as long as you are within the spectrum of what people consider to be reasonable replacement cost, I would expect that’s where those returns would be. If it meant that either replacement cost number or the dollars per square foot that someone was purchasing a building at to get to those returns, because there was above market leases or whatnot got you to, as an example, $2,500 a square foot I don’t think that a 7.5% to 8% return would be appropriate for an unlevered equity return.

Ian Weissman - Merrill Lynch

As a follow-up to an earlier question about that second site you have in New York City, are all of your entitlements in place today? Meaning could you start a development tomorrow? Just remind us where you are.

Edward H. Linde

Well. I am going to let Robert Selsam, who I hope is on the phone, answer that question. Let me just give you the following which is, not until last Friday did we have all of our entitlements in place so that we could actually physically start the construction of 250 West 55th Street, because we had to get a bunch of approvals even though it was an as-of-right development.

Robert, why don’t you go ahead?

Robert Selsam

Yes, the answer to your question on the other development is that we will have to go through a public review process which we have not done yet. But we are working on bringing it to the starting gate.

Ian Weissman - Merrill Lynch

But you have all the lots in place? I mean, you have accumulated all the lots?

Robert Selsam

That’s correct.

Operator

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

Michael Knott - Green Street Advisors

Ed, if I can go back to your comments and just ask it a different way, do you guys feel like certain CBDs or certain markets are going to hold up better than others over the next year or two in terms of values?

Edward H. Linde

That’s a softball, you know. Clearly we are very happy to be in the markets in which we are in and for the reasons that we’ve said many, many times before. Actually what we are seeing in those markets today, which is continued demand by the very companies that we expect to have that demand from.

So, do I think New York and especially midtown Manhattan is going to hold up? Absolutely. I would say the same thing about CBD, San Francisco, Boston, and Washington. In Reston and in Waltham, I have great confidence that those will hold up. There may be a hiccup here and there but I think it’s a bet we have made for a long time and it’s never disappointed us.

Michael Knott - Green Street Advisors

So, the spirit of your comments earlier about cap rates increasing potentially dramatically would possibly apply equally to all of your markets?

Edward H. Linde

Clearly midtown Manhattan is a market unto itself. Its desirability by a whole wide spectrum of buyers exceeds what those same buyers might apply to a Washington or Boston or San Francisco. That’s what you saw. You know everything’s relative. It’s what you saw when people were buying properties for decreased cap rates, the decrease was greatest in midtown Manhattan, for reasons which I think are totally understandable and legitimate.

Namely of all of the constrained markets, it’s the most constrained and it still remains, if not the certainly a world capital for finance and I think it’s going to continue that way. So yes, if I had to rank them that one has to be first and the others will vary depending upon the flavor of the day.

Michael Knott - Green Street Advisors

Doug, could you comment on just the status of Boston development? Where the addition to the Prudential Center may stand and then if Ray could comment on the three Maryland developments?

Edward H. Linde

With regard to be Prudential Center and our other developments, so just sort of starting with what’s closest versus what is furthest away, 77 CityPoint as I said we have a 165,000 square foot lease. We have a lease that we expect will be executed some time in the near future before our next call that will have that building 100% leased with no vacancy.

We are, as I said, underway with Russia Wharf and we’re anticipating delivery of that building sometime in late, late 2010, early 2011.

With regards to our permitting at the Prudential Center, we’re working through the city and the community review process with an anticipation that we will get the size of 888 Boylston Street increased from its current size of about 250,000 square feet to what I think we have publicly asked for which is 440,000 square feet as well as getting entitled an additional residential pad, which we are in discussions with a residential owner to do a long-term master lease on. We will not have any development interest in that but we will create value by leasing that ground to that entity for a long term. That is the status of our Boston developments, if you will.

Raymond Ritchey

Michael, as you know, we have three projects under development in suburban Maryland. One Reserve is the first I will address. That now has topped out, it’s a phenomenal looking building. That building is about 180,000 square feet, already 20% committed with really solid activity. But we are seeing larger and deeper demand in suburban Maryland in the 270 corridor than can we see in Virginia right now.

Annapolis Junction is our 50-50 joint venture outside of Fort Meade. This is a 100% skiff building. This is 117,000 square foot building. Really, we’re dependent upon the direction of NSA to its contractors to vacate the base and all indications are that they are going to leave the fort very, very quickly and that activity will be extremely brisk in the coming year there. We do have 18 months of lease up, so we are still very confident of a very successful project there.

Last and certainly not least is Wisconsin Place, our 292,000 square foot project underway in Chevy Chase. Again, that’s a joint venture basically a two-thirds/one-third joint venture. I’m very pleased to say that that building is 91% committed with very, very strong activity by a full array of tenants clearly 15 months before completion. So like virtually all of our projects, we are experiencing strong demand. They’re all being completed on time, within budget and fully consistent with our return expectations.

Michael Knott - Green Street Advisors

So it’s fair to conclude that Maryland is seeing better demand or better fundamentals at this point than Virginia?

Raymond Ritchey

I think the Wisconsin Place is really indicative of not Maryland or Virginia, but inside the Beltway versus outside the Beltway. The desire to be in an amenity-rich, 24/7 environment in a high barrier-to-entry market, similar to what you see in some of markets in Arlington we are certainly realizing in Wisconsin Place. I mean we are pushing and exceeding $50 a square foot for rents in Wisconsin Place. Outside of Beltway, suburban Maryland is probably a similar dynamic to suburban Virginia, but at this point in time in the cycle, we’re just seeing because there is less supply, a little bit more demand for the buildings that there are going forward.

Operator

Your next question comes from David Cohen – Merrill Lynch. Please go ahead.

David Cohen – Merrill Lynch

Can you guys talk a little bit about your CapEx? It has gone up quite a bit in the fourth quarter and then obviously for the last four years sequentially. Can you talk about that as well as just the TIs and the free rent that obviously went up quite a bit?

Edward H. Linde

Well, let me comment on the TIs and the leasing commissions first because I think that’s a question that is much more easily answered. We have been saying pretty consistently that people should be using a $25 to $30 square foot number for expectations for TIs and leasing commissions for our portfolio. It’s very dependent upon the particular deal and the timing associated with that deal and the space.

As an example, in this last quarter and I will just try and give you a sense of the variety, we had and neither one of these spaces didn’t hit our leasing stats on the revenue side because it was not occupied during the last year. We had a deal with one of the technology tenants in Cambridge where we got a rent of almost $50 a square foot on 60,000 square feet and we gave them a $35 work letter. That was in Cambridge.

We had a deal in Bedford on a property that we’ve owned prior to Boston Properties becoming a public company, prior to Boston Properties even being formed. It was an old legacy property from the former days of Boston Urban Associates. That building we leased to a company called iRobot. We basically had to totally gut the buildings, they were R&D buildings and they hadn’t been touched for 15 years, and we put $30 a square foot into those spaces. The leasing commission on a deal in New York City today and $125 rent is probably $45 to $50 a square foot. So, things are all over the place.

On the other side, we did a ten-year lease with a company in suburban Lexington, where we paid $10 in transaction costs in total. No brokerage commission, we gave them $10 for a ten-year commitment and the rent was adjusted accordingly.

So, it is very varying and that’s why I say that we think that if someone is trying to do a run rate and FAD calculation for us, the best number to use is $25 to $30 on average across the portfolio because depending upon renewals and new tenants and brokerage commissions, it’s very skewed.

With regards to capital expenditures, we have been pretty consistent in saying we have the expectation of spending somewhere between $0.75 and $1.00 per square foot across the portfolio year in, year out which is somewhere between, if we have 30 million square feet of office space that we are using in that equation, somewhere between $25 million and $30 million.

The last year we undertook a major renovation at the Prudential Center in Boston and we are spending almost $10.5 million on the lobby at the Prudential Center. When we do those kinds of jobs we clearly have a much higher recurring non-income producing capital expenditure.

You will see for example my expectation in late 2008, a similar project at Citigroup Center where we are going to undergo a $15 million to $20 million capital expenditure job and change the entrance of that building so that you no longer enter the retail if you are an office tenant, you enter into a office lobby and an office location.

Those kinds of jobs are going to be included in our recurring non-revenue-producing capital expenditures and so there may be some fluctuation based upon those jobs. When we have those, I’ve tried to point those out and Mike will try and point those out over time, so you are aware of where the average changing a chiller, replacing an elevator cab, redoing the electrical system or the life safety system for a particular building; that stuff sort of comes out and that’s the $0.75 to $1.00 square foot stuff and then you have these major lobby type issues, of which there are not very many in the portfolio, that will skew the numbers.

David Cohen – Merrill Lynch

You guys talked about a higher lease term fee in the first quarter. Who was that and you have a lower number for the rest of the year but are you seeing any kind of greater increase, especially on the suburban side?

Raymond Ritchey

David, we have a couple of expected lease terminations in the first quarter which is why we have a projection that’s higher. We have a retail tenant at the Prudential Center in Boston where we got a $1 million termination penalty and actually we’ve already released that space with no downtime.

We also had a penalty that Doug mentioned earlier on a tenant in One Cambridge Center which in that situation we believe that we’re going to be able to achieve a significant roll up in the rent on that space. As Doug mentioned, we’ve had four or five or six tours already on that space.

Edward H. Linde

But those are in the bank, so we wanted to put them out there and not hold them in our pocket, if you will.

Operator

Our final question comes from the line of John Guinee - Stifel Nicolaus.

John Guinee - Stifel Nicolaus

Great job in the area of free debt. You’ve sold $4.2 billion worth of assets, returned $2 billion to the shareholders. You also raised essentially $1.3 billion of free debt through convertible notes. You have a great development pipeline to complement the embedded mark-to-market. In the era of no debt, can you just give very, very succinct four or five bullets as to the 2008 strategy?

Edward H. Linde

With regard to our capital?

John Guinee - Stifel Nicolaus

Capital and deployment of capital.

Douglas T. Linde

I will try to do that. I guess it’s as follows. Capital availability is a strength. It’s not something that we look at as something that we can just throw around on a willy-nilly basis. We are being, as Ed said, very, very aggressive about looking at things and we are being very, very conservative about our expectations in terms of our hit rate on the kinds of assets and investments that we will look at in calendar year 2008.

To the extent there is a major transaction that comes along, we will be able to access additional debt even though we have a line of credit of $600 million and cash of $700 million. Some of that is obviously geared towards what our expected development needs are over the next few years, but given that our balance sheet has tremendous amounts of capacity, we can raise debt.

The question is how expensive it will and what’s going to be the most efficient form, be it the bank market, the investment-grade debt market, the convertible market, whatever it might be. We are aggressively cautious about what we’re going to look at and what we’re going to do in 2008, largely based upon the uncertainty we have with regards to how deep and how long the issues associated with the financial turmoil are going to last.

Everyone has been sort of saying, well, when we were in July let’s get through August and Labor Day; and then when we got to Labor Day, everyone was like, well, let’s get through the holidays and get to January 1. Now that we’re in January 1, everyone’s saying well, it’s going to be hopefully within three to six months. Everyone is sort of just looking for a signal and some indication that there is some liquidity and that we’ve reached a point of stability with regards to the trading on a cash basis and a secondary basis of this paper that’s all over the financial community. Until that happens, we don’t feel real comfortable being aggressive about anything. We’re going to have to see a terrific opportunity in order to want to use some of that precious capital that we have.

Edward H. Linde

Just to add to that and also to add to Lou’s question earlier, we have the capacity right now where we don’t have to raise debt. We can pay off our maturing debt, we can fund our development pipeline this year without doing that. However, we see that there’s going to be opportunities so we would like to raise capital in order to supplement that capacity that we have.

Operator

That was the last question, sir, so if you would please continue with any closing remarks.

Douglas T. Linde

Thank you for your patience. There was nobody behind us today, so everyone was probably hanging around. We hope that things continue to stay strong on the operating side. We’re obviously thinking long and hard about how we use our capital and hopefully we’ll have additional positive things to talk about when we get to this time in April. We will see many of you down in Florida in March. We look forward to those conversations as well.

Thank you very much for your time.

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