Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Boston Properties Inc. (NYSE:BXP)

Q2 2008 Earnings Call

July 23, 2008 10:00 am ET

Executives

Arista Joyner - Manager of IR

Doug Linde - President

Mike LaBelle - CEO

Mort Zuckerman - Chairman

Analysts

Anthony Paolone - JPMorgan

Michael Bilerman - Citi

Irwin Guzman - Citi

Ee Lin See - Credit Suisse

Jay Habermann - Goldman Sachs

Mitch Germain - Banc of America

Jordan Sadler - KeyBanc Capital Markets

Ian Weissman - Merrill Lynch

John Guinee - Stifel Nicolaus

Lou Taylor - Deutsche Bank

Matt Wocash - Green Street Advisors

Operator

Welcome to Boston Properties' second quarter earnings call. (Operator Instructions) I would now like to turn the conference over to Arista Joyner, Investor Relations Manager. Please go ahead madam.

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 this 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 website 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, Ray Ritchey, Executive Vice President and National Director of Acquisitions and Development, 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.

Doug Linde

Thank you, Arista. Good morning, everybody. I hope everyone's having a nice summer. Mike LaBelle is going to discuss our second quarter results and update our earnings outlook for the remainder of the year in a couple of minutes. But before we turn the call to him, I want to spend a few minutes discussing the state of our real estate markets, give you some comments on tenant demand and the credit markets, and how all these issues are impacting our business prospects.

As I make my remarks, keep in mind that Boston Properties' strategy, and we've said this before and we will say it again, is to operate at the top end of the real estate markets in select areas with barriers to supply. The location and the leasing composition of the portfolio really matters. And, while we do very well in good times, on a relative basis, we do even better in more challenging times.

We have been in the midst of a dramatic de-leveraging of the financial world for more than a year now. The crisis in the national housing markets and the corresponding dramatic markdown in housing values continually reinforce the magnitude of the leverage in our financial system.

The concerns surrounding the government-sponsored entities and the losses from residential lending at the regional banks are just the latest incarnation of the same problem that has existed for the last year.

The US consumer continues to be adversely impacted by higher fuel costs, higher food costs and in addition to seeing the statistics showing up in foreclosures, we are now seeing delinquencies in credit card loans, home equity loans and auto loans. We don't see any immediate catalyst for optimism.

In general, the challenges that the consumer is facing and the losses stemming from the financial crisis are having an effect on business profitability, growth and ultimately jobs. However, not all industries are being affected to the same degree and not all employment markets are going to feel the same kind of impacts.

Just last week, Microsoft, Google, IBM, and Nokia, all announced significant growth in top-line revenues. These are businesses with an international reach, and while there's no question that growth around the world has slowed as well, there is still global growth. Consistent with these trends, office demands in our Boston submarket, for instance, continue to be pretty strong, fueled in Waltham, for example, by strong demand from technology, biotech and life sciences companies. So over the past few months, Autodesk, Adobe, NameMedia, Constant Contact, National Grid, Shire, which is a biopharmaceutical company, and AMAG Pharmaceutical have each grown in the Waltham market.

We continue to respond to requests for proposals for large tenants. In fact, there are over 15 that are greater than 70,000 square feet that are active today in the market at our proposed developments in Waltham and Weston. And, in Cambridge, Google and EMC and VMware and Akamai and Microsoft have all expanded over the last few quarters, leaving a vacancy rate there of just under 8% in Kendall Square.

Now, in the Boston CBD, consolidation in the financial services sector over the past decade has really shielded Boston from the job losses stemming from the continued credit crisis. In fact, our biggest challenge in the Back Bay, where we have, in fact, seen overall availability increase but it hasn't been due to reductions in financial services companies, but rather changes from publishing companies, is accommodating the growth of our tenants in 111 Huntington Avenue, who have exhausted all of their contractual expansion rates.

While their leases don't expire until 2011 and 2012, the tenants' growth needs are driving much earlier decisions. And we will be the first to say that we have seen significant and this is the nomenclature that's being used of RIFs, or reduction in force, all over the major financial firms in New York City. The banks and investment banks are capital constrained, and with likely changes to the regulatory environment, the business models for these institutions are certainly in transition.

Some of these firms have put space on the sublet market. Lehman, for example, has recently offered 165,000 square feet at 399 Park; by the way, that has a 2016 lease expiration, and others are considering the same. This may be a slow-acting process that has yet to manifest a decline in pricing, or it may only affect a narrower subset of assets. But, pricing has remained firm.

One of our brokers has tracked about 20,000 job losses corresponding to about 1.4 million square feet of sublet space from those financial services firms, and we are certainly not immune to that. For example, Citibank is offering 250,000 square feet in Citigroup Center. But again, the nature of our assets really matters and we are in fact in discussions with a law firm to relocate and expand into all of the available Citibank space when they can make it available, which will probably not be until 2009, as well as taking an additional 60,000 square feet of our 2010 rollover.

Approximately 40% of the midtown market is controlled by the top 10 landlords. And if you narrow that to the top buildings, the market share is significantly higher. These landlords are very well capitalized, and the overall direct vacancy rate is still under 5%. And, as we have said before, new supply in midtown Manhattan has been and will be very limited in an overall market of about 220 million square feet.

Velocity is clearly down significantly, but we have only 200,000 square feet of rollover over the next 18 months in our 7.3 million square foot New York City portfolio, and that number includes 100% of the GM.

We are negotiating leases on about half of that space, and we are achieving rental rates in excess of what we achieved a year ago, with only slight up-ticks in concession packages, maybe $5 a square foot more of TIs or an additional month of free rent.

Our largest exposure is the new development at 250 West 55th Street. We continue to make progress with prospective tenants there, but we haven't signed any additional leases.

Our perspective on the D.C. market is really influenced by our portfolio composition. We are 98% leased, and our only significant exposure in 2009 is at 1301 New York Avenue, where we are in renewal discussions with the Department of Justice.

Our primary leasing focus is 2200 Pennsylvania Avenue, the 440,000-square foot development where construction began on the parking structure this quarter. Activity for leases that would commence in 2011 is very strong and we are in active negotiations with a number of tenants with triple net rents expected to be between $55 and $65.

In Montgomery County, activity inside the Beltway continues to be very strong and tenant demand has actually outstripped our availability at Wisconsin Place. So we're working with CapitalSource to recapture a portion of their premises at that building, which will be delivered at the middle of 2009. Construction is advancing, and we do expect to deliver that building sometime in the third quarter.

Outside the Beltway, however, at Tower Oaks, the story is a bit different. The market is narrower, and while we have signed leases for about 42,000 square feet of that 183,000-square foot building, the rest of the lease-up is going to be slow.

Rents are soft and in fact, if you look at our second generation statistics this quarter, all of the decline comes from second generation rents from this marketplace. At Fort Meade, our building for NSA contractors is expected to be accredited by the end of the third quarter, and we hope to have tenants in place beginning in the fourth quarter.

The Northern Virginia market in general has had little positive activity over the past few quarters. A combination of the slowdown of GSA related requirements during the presidential election year, and a wait-and-see attitude from significant concentrations of defense and security-related issuers; potential changes in administration or policy activities, and the overall slowdown in the economy have made short-term renewals the transactions of choice.

Yet at the same time, we've received a commitment for the remainder of our 235,000 square foot Democracy Tower, which is going to be delivered in the third quarter of next year.

We've finalized the leasing of much of our 85,000 square feet of retail space, leaving just 20,000 square feet remaining, and we've completed another 46,000 square feet of leases at South of Market, bringing the office leasing on that project to 84%.

While the Northern Virginia market struggles with a vacancy rate in excess of 12%, our Northern Virginia portfolio including these developments is 97% leased. Our major lease expiration in 2009 is in Reston. It's a 264,000 square foot building leased in its entirety to Lockheed Martin in our 700,000 square foot NGA campus, and we expect a renewal of that building.

Finally, let me touch on San Francisco. Activity in San Francisco in the CBD continues to be pretty slow. There are really no large users in the marketplace for new requirements. Absorption in the second quarter was slightly negative but with a direct vacancy rate of under 9% and overall vacancy under 10%, the market still remains very tight.

There has been really no change in asking rents, so it's our belief that the market for top space has settled out in the high 80s to low 90s. There continues to be modest organic growth from smaller firms, but there are no large requirements in the market other than those that are created by contractual lease expirations.

If you look at our occupancy statistics this quarter, you will see a reduction in occupancy in San Francisco. And that's really from contractual lease expirations on tenants that we moved that happened to be in space in the first quarter, in both EC3 and EC4, and in the second quarter, they have moved out of EC3, and so you saw a decline in occupancy in EC3 this quarter.

The new development at 555 Mission, which is about 550,000 square feet, is rumored to have completed one additional lease on the top floor of the tower, sort of giving you a sense of what the top end of the market is, with average rents in the mid 80s bringing its leasing to about 30%.

The Valley continues to show job growth in the computer electronics and manufacturing sectors, where most new space requirements are really in the 15,000 to 70,000 square-foot range, i.e., smaller users.

Large user activity has moderated from the pace of the last six months, though Google has committed to build another 1.2 million square foot campus in Mountain View at Moffett Field.

New speculative development has come online, and it has led to an increased vacancy this quarter. In particular, a building that Oracle owned from BEA Systems is now in the market in San Jose, and that adds about 350,000 square feet of availability this quarter.

Just about everyone is being cautious about making decisions, and rental rate growth has slowed, and in some cases it has probably dipped 5% to 10%. But there is still incremental new demand.

Now let me shift my focus and make some comments about the financing markets before I turn things over to Mike. Since they really are the key to understanding the acquisition market and individual asset pricing and where and when transactions can be accomplished.

In general, the credit markets continue to be very volatile, and access to secured mortgages greater than about $100 million continues to be very restricted. Since this is the source of debt for the vast majority of buyers, it really is the critical component in any sales process.

There are two primary markets for secured debt; the commercial bank market and then the traditional life insurance company market. The foreign banks are actually open to maturities over five years, but outside of five years you really do eliminate the domestic institutions.

And while loan-to-value matters, the primary driver to loan size and availability is now debt service coverage; and that includes amortization under either a 25 or a 30-year schedule as well as quality of sponsorship and quality of asset. Lenders are being very discriminating regarding the assets they are underwriting.

Sponsorship and relationships really matter today. Any asset with major rollover or vacancy is going to require significant equity and recourse from a well capitalized sponsor, assuming it still covers debt service. Rates for 60% loan-to-values are probably today between 240 basis points and 280 basis points over on a fixed-rate basis for high-quality assets. So that's somewhere in the 6.4% to 6.8% range.

If you take a 6.5% rate, for example, and you throw in a 25-year constant on that, a 25-year amortization schedule on that, you come up with a constant of about 8.2%. Now, if you need coverage, and today coverage is probably at a minimum 1.25, and probably is more normally 1.4 times initially, and you add a 1.25 coverage onto that 8.2 constant, then the necessary yield to cover debt jumps to over 10%.

So, while you might still be interested on people maybe pricing the assets at 5% cap rates, it's going to require an awful lot of equity in today's market to make those transactions work.

Assets with assumable medium to long term debt are clearly enjoying the most significant interest. And, while there are potential mezzanine lenders out there to sell a portion of the capital stack, that capital is being priced from probably a minimum of 450 basis points to well over 1200 over, depending upon coverage and value.

Many of the assets that were sold over the last few years came from opportunity funds that bought wholesale and were selling retail. These funds, whether they like it or not, and whether they have the management experience or not, are now owner-operators with a long-term perspective.

With the property markets slowing and increases in future cash flows slowing, and limits on availability of debt down, we don't expect to see any meaningful pickup in asset sales from these owners in the near term.

If high-quality properties are going to be sold, this is where you're going to see transactions, and I emphasize the word must be sold. As an investment grade issuer, Boston Properties has the financial flexibility to raise capital in the unsecured debt market, the bank market, the convertible market as well as the traditional secured markets.

These markets are available in size, and with access to capital, we can move quickly to complete transactions. So we have availability, we're anxious to put money to work, but we don't see a lot of potential transactions out there in the short-term.

With that, I'm going to turn the call over to Mike.

Mike LaBelle

Thank you, Doug. Good morning, everyone. Despite the economic headlines that Doug just discussed, to date we have not seen evidence of the economic slowdown in our reported results.

This quarter, our second generation leasing statistics showed a healthy 17.75% increase in second generation net rents, led by the Boston and San Francisco regions, and our transaction costs were slightly lower than our historical trends, averaging $22 per square foot.

Our mark-to-market grew significantly this quarter with the addition of the GM Building to $13.65 per square foot, and excluding the GM Building, stayed constant at $9.25 per square foot.

When we go through our projections in a few minutes, the one substantive change that we have made was to extend the lease-up of our expiring and vacating space. But with rollover for the remainder of 2008 of only 1.9%, the impact on our future estimates is minimal.

Since the General Motors Building is in our results this quarter, I thought I would spend a few minutes on a discussion of the various accounting impacts, and an explanation of how it will flow through our income statement and appear on the balance sheet.

The major accounting impact comes from the application of FASB 141, Fair-Value Accounting. FASB 141 requires us to allocate the value of an acquisition and its components, including the value of the leases, land, building, tenant improvements, leasing commissions and debt.

A significant component of this is the marking-to-market of each lease. With the average lease in the GM Building over $90 per square foot below today's market, the FASB 141 assessment results in a large mark-to-market adjustment of over $1 billion. This adjustment will have a substantial impact on our earnings, as it is amortized on a straight-line basis, and recorded as income over the life of each lease.

As always, we will clearly delineate our non-cash earnings in our supplemental financial reports. The magnitude of the mark-to-market at $90 per square foot was a critical factor in our decision to purchase the GM Building. Over time, we believe we will see growth in market rents and capture significant growth in current income and appreciation.

In the second quarter, the GM Building contributed FFO of $5.9 million, including a one-time deduction of $600,000 for joint venture formation costs, and FASB 141 revenue of $5.2 million. The GM Building is an unconsolidated joint venture, so the financial results of the property will come in under our net income from unconsolidated joint venture line, and the assets and liabilities will be located on the asset side of our balance sheet in investments and unconsolidated joint ventures.

Turning to our second quarter results, our second quarter FFO was $1.19 per share or $0.04 per share above our guidance. Excluding the impact of the GM acquisitions, our earnings would have been $1.16 per share, $0.01 above guidance.

The core portfolio performance was right in line with our expectations. There were a variety of positive and negative items within the portfolio, such as slightly better rental revenues due to some early rent commencements and percentage rent, the push-off of some of our operating expenses offset by a straight-line rent adjustment.

Our G&A for the quarter was $900,000 less than our budget. This was due to lower than projected legal costs and payroll tax savings owing to more limited stock option activity than normal. With overall negative results in the broad equity markets, we also experienced a loss in our deferred compensation plan resulting in savings of $400,000 in G&A that is directly offset by a reduction in interest income of $400,000.

Our fee income was higher by $1.2 million. This was the result of higher fees related to faster than projected development outflows at two of our joint venture development projects, construction management fees related to tenant improvements completed in the portfolio, and development fees of our 20 F Street third-party development that I'll discuss in more detail later. The GM Building contributed $270,000 to fee income this quarter.

Lastly, our net interest income was slightly higher, with interest income up $650,000 due to modestly higher investment rates, offset by $500,000 in lower capitalized interest related to slower than budgeted development outflows at some of our larger development projects.

In summary, the net of the positive and negative variances resulted in our exceeding our first quarter guidance by approximately $0.01 per share, excluding the impact of the GM acquisition. The GM transaction netted $0.03 per share.

As we discussed briefly on our last call, we closed on the sale of our land parcel at 20 F Street in Washington D.C. in April. We acquired this land six years ago for just $4.2 million. Our cash gain on this sale is $23.2 million, generating an IRR of nearly 30% over the hold period.

In addition, we're providing development and construction management services to the buyer for the construction of a 165,000 square foot office building. Due to our ongoing participation in the project, we will recognize fee income estimated to be $8.4 million and gain on sale of $22.3 million over the approximate 24 months term of the development as a percentage of completed costs.

We recognized a gain on the sale of $6.2 million and third party fee income of $600,000 in the second quarter. We do not include the gain on sale in FFO. However, the future fee income associated with the development of this building is built into our third party revenue guidance in FFO.

Now turning to our guidance for the remainder of 2008, given the uncertainty in the economy and the volatility in the financial markets, we have conservatively pushed out some of our leasing projections. With only 5% currently vacant in the portfolio, and only 2% of leases rolling for the remainder of '08, these more conservative leasing assumptions do not have a material impact on the remainder of 2008 and we expect portfolio occupancy to remain constant.

Third quarter 2008 NOI, excluding the GM Building should track closely with second quarter results with the fourth quarter up 2% sequentially. Looking at our 2008 over 2007 same store performance, we expect growth of 3% to 4% over 2007 on a GAAP basis, and 5% to 6% on a cash basis. Our more conservative posture with respect to lease-up of our vacant and expiring space has tempered the 2008 same store cash growth slightly.

Consistent with our practice, we're budgeting $1 million per quarter in termination income for the remainder of the year. The General Motors Building is projected to contribute approximately $51 million of FFO for the second half of 2008. This equates to $0.35 per share, and includes $0.28 per share of non-cash FASB 141 adjustments. In addition, we will earn approximately $2 million in management fees.

As discussed in our last call, we brought 70% of our South of Market phase one project and 21% of our 77 CityPoint project into service midway through the first quarter, and 20% of our One Preserve Parkway project in the second quarter.

We will deliver the rest of 77 CityPoint, another small portion of South of Market, and 20% of Annapolis Junction in December. The remainder of these projects and our other near term development completions at 701 Carnegie Center, Wisconsin Place and Democracy Tower, totaling approximately $280 million will deliver in mid to late 2009. A 9.5% return on cost continues to be a good approximation for the yield on these developments. The development pipeline hitting next year will positively impact 2009.

Included in the GAAP number for the aggregate of the in-service portfolio and development placed in service are straight line rents of approximately $20 million to $22 million for the remainder of 2008.

Our hotel is operating on budget so far this year, and is expected to contribute between $10.5 million and $11 million in 2008, up modestly from $10.1 million in 2007. Third party management and development fee income is projected to be up with the contribution of management fees associated with the GM Building, and development fees at our 20 F Street project. We expect fee income of $14 million to $15 million for the remainder of the year, for a total of between $26 million and $27 million for the full year.

G&A expense remains consistent with prior guidance and is anticipated to run between $18 million and $18.5 million per quarter. The increases in our staff to manage the additional New York City buildings will be at the building level, thus having no material impact on our G&A expenses. We utilized our cash balances to pay off our Prudential Center mortgage loan in April, and to complete the acquisition of the General Motors Building in early June.

Our cash balance at the end of the second quarter was approximately $112 million, and we anticipate utilizing this to fund a portion of our pending acquisitions. We expect to run the rest of the year with only moderate cash balances and are dropping our projection for interest income to $1 million to $2 million for the second half of 2008. This is a significant drop from our previous projection of $11 million to $12 million for the last three quarters of the year, as the prior projection assumed no acquisitions.

Our second quarter interest expense declined with the payoff of our Prudential Center loan. Interest expense will increase for the remainder of 2008, since we anticipate utilizing our line of credit more actively and expect to complete additional financings.

We're currently projecting $525 million of new financing in the third quarter with an interest rate of approximately 7.5%, including the non-cash amortization of the projected cost of our hedges. We anticipate capitalized interest to increase consistently, exceeding $10 million in the fourth quarter as we fund our development pipeline.

We expect to incur a one-time charge associated with our hedges of approximately $7 million in the third quarter, due to FASB 133 hedge accounting. This charge is associated with a pending mortgage financing with an eight year term. As our hedges were designed to lock in interest rates for 10 years, we expect to write-off two years of the hedged interest payment resulting in the charge.

It is important to note that we have not committed to these financings, so this charge may not occur, or we could write-off a much larger portion of our hedge liability, dependent upon our ultimate financing execution.

You will note in our supplemental package that our capital expenditure program was light this quarter. We budget $40 million per year in CapEx for the in-service portfolio. Through the end of the second quarter, we've only spent $9.4 million. We do expect to catch up and still project a budget approaching $40 million.

Projects such as our new lobby renovation and grand entrance way at Citigroup Center are just getting underway, and will have an impact on our reported capital expenditures in the second half.

Despite our more conservative approach to leasing velocity in our budgets, as Doug discussed, rental rates in our markets are holding, and overall fundamentals remain stable.

Including the effects of the GM Building and our FASB 133 charge, our third quarter FFO results are expected to range between $1.22 and $1.23 per share. We are increasing the range of our full year FFO guidance, due primarily to the impact of the GM acquisition to $4.86 to $4.92 per share.

Since the timing is up in the air, these estimates do not include the acquisition of the other macro assets. We anticipate acquiring a 60% joint venture interest in these buildings, consisting of 125 West 55th Street, 540 Madison Avenue and 2 Grand Central Tower, and expect to close during the third quarter.

The purchase price for the portfolio is $1.15 billion. We are in the process of assuming $574 million of existing debt with a weighted average interest rate of 5.68% and maturities ranging from 2010 to 2013. The un-leveraged annualized GAAP NOI yield on the portfolio should be approximately 7.5%.

Since the individual buildings may close at different times, we will update these results as appropriate. We expect to fund our portion of the equity required for these acquisitions with cash balances and our line of credit.

A review of our balance sheet and scheduled debt maturities over the next couple of years demonstrates that we maintain a very healthy capital position. We closed an increase on our line of credit, upping it to $1 billion this quarter and our current availability is over $700 million.

As mentioned previously, we also expect to raise approximately $525 million of additional capital later this year. Our only material pending debt maturity is a $273 million mortgage on Embarcadero Center One and Two, maturing in December of 2008. We expect to pay this loan off with either cash or availability under our line of credit.

Looking ahead to 2009, our debt maturities total only $270 million. Our $200 million construction loan on South of Market comprises the largest component of this and has two one year extensions available, should we elect to extend.

In summary, we currently have more than sufficient liquidity to pay off these financings with internal capital or access to capital for refinancing if we so choose.

We do anticipate raising construction financing in the next few months for some of our larger development projects like Russia Wharf and 2200 Pennsylvania Avenue. Given the pre-leasing at Russia Wharf and the strong leasing momentum achieved long before building construction commencement at 2200 Pennsylvania Avenue, we expect to be successful in raising competitive construction financing.

While many of the debt markets are more expensive from a spread perspective compared to historical terms, the lenders, including banks, insurance companies and bond investors, are still seeking to finance well structured and prudently leveraged projects and high-quality corporate credits like us. In fact, in many cases and as many of you have likely read in the media, they are only seeking to finance credits like ourselves.

We continue to proactively manage our capital position and work to strengthen our relationships with our credit providers, the result of the strong balance sheet and wide-ranging access to the markets.

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

Mort Zuckerman

Good morning. This is Mort Zuckerman. Thank you all for joining us at this particular time. As you have heard from both Doug and Mike, Boston Properties remains very well-positioned in the markets it is in, and in its place in the markets which is at the upper end of the commercial real estate market. And, just as the upper end of the commercial residential market is doing much better than the rest of that residential market, so too, can it be said of the commercial market, and, we have found this to be the case for literally decades, and this is why we have focused on this particular dimension of the market. And in markets were there are supply constraints.

So we are very comfortable with our market position and with our marketing position of the assets that we have, and have continued, we believe, to do well. For example, in occasions where there are tenants who want to sublease space, we have been able to work very effectively with them in finding sublease tenants.

And in terms of acquisitions, of course, we have made a major acquisition involving not just the General Motors Building, but three other buildings which we expect to close in the next 90 days, that we believe will position us for excellent growth in the years ahead.

These were buildings that were purchased at costs that are well below, well below replacement costs on a per square foot basis, and well below current market rents. And we believe, as these rents roll over, and you've heard the numbers on the General Motors Building itself, where they are estimated to be over $90 a foot under the current market, as these leases roll over, we believe we will continue to gain from that experience and from that result.

Now the real issue in the macroeconomic world that we all live in today is, how is this all going to affect not just the economy but the businesses that we are in, and in the real estate that we are in? And I think you have heard from both Doug and Ed, how we have fared fairly well. In fact, we believe this represents a major opportunity for the acquisitions of buildings. And just as we sold over $4 billion of real estate in the markets when we thought, including in New York I might add, where we sold two buildings; in markets where we thought the price has got to be extremely frothy, we now believe that we are in a series of markets where there are buying opportunities.

The most vivid example of that, of course was the General Motors Building, where we believe we bought it at dramatically under its replacement cost with rents that are very, very low in relation to the current market, and at a cash flow yield in its first year of 5%, which for those of you who follow these acquisitions represents a very attractive cap rate for a property which has dramatic appreciation built into the existing lease structure relative to the current market.

These are situations that we believe will come up over the next couple of years, and we intend to take advantage of that because we think this is going to be a buying opportunity for companies such as Boston Properties, which is very well positioned to make acquisitions, since it has the capital structure and the capital availability that is a reflection of that capital structure that will make us competitive in these markets.

We were able to close the General Motors and three other buildings we have in partnership with two other investment groups, basically representing Middle East investment funds. They have indicated that they wish to continue working with us. They are very pleased with the development of these investments to date, and they are looking for additional opportunities. And we intend to see if we can come up with such opportunities and continue to work with them. And that was a part of the rationale for our partnership with them.

We were able, because of our financial condition, to close or to agree to close, to sign the purchase and sale agreements without these partnerships, although we knew that we had interest. And we then did bring them into our partnership, not only because it diversified the ownership, but really because it was an opportunity to find a way to develop additional equity capital and magnify the opportunities that we believe will be uniquely available to a firm like Boston Properties over the next several years, where we see a continued downward pressure, particularly as mortgages come due in various buildings, particularly large mortgages and cannot be refinanced on attractive terms, that there will continue to be the opportunities to purchase buildings.

And this is something that has always been a part of our activity and will continue to be a part of our activity, along with the development portfolio, particularly when we think we can buy these assets in a market where the availability of capital and credibility in this market will make us a serious and continuing player.

With that, I think I will just end my comments, other than to say that we do believe that we are uniquely positioned to do very well over the next several years because of this dual role both in the development side and in the acquisition side. And with the capital availability to seek additional acquisitions, we think we can build-in the base for an even more dramatic growth pattern than we anticipated.

I will just end my comments and thank you all for joining us on this call.

Doug Linde

Okay. Operator, we've got quite a few people in the queue, so why don't you start the Q&A please.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Anthony Paolone with JPMorgan. Please go ahead.

Anthony Paolone - JPMorgan

Thank you, and good morning. Looking into the second half of the year, it seems like more than half of your expirations are in Boston. I was wondering if you could comment on how those leases are coming along in that market.

Doug Linde

Got to give me a second to look at my statistics here.

Anthony Paolone - JPMorgan

I think it was 250,000 of office expirations.

Doug Linde

There are, I would say, of the 250,000 square feet, the largest is a 50,000 square foot requirement that is in Waltham that we are expecting to do a renewal on. The second largest is two leases at the Prudential Tower that we have an agreement, we just haven't signed the lease yet. So they haven't rolled through our statistics. That is 40,000 square feet. And the third is with our building in Cambridge where we have the Massachusetts Institute of Technology in two floors and Nokia in one floor and we know Nokia wants to stay. We know MIT is probably going to leave, and we haven't quite decided whether or not we are going to try and free that building up for repositioning or we are going to sign a lease with Nokia on a longer-term basis.

So those are the three largest, and that makes up 120 of the 246. So the next after that is about 17,000 square feet, and I just don't have enough clarity on each individual deal.

Anthony Paolone - JPMorgan

Okay. Then, Doug, can you talk about the dip in occupancy in San Francisco again? I didn't quite understand the move out and where the tenants went, that sort of thing.

Doug Linde

So, last quarter, we had Marsh Mac in 180,000 square feet at EC3, as well as an 80,000 square feet in EC4, because they were physically occupied in both spaces. In the first quarter their lease expired, but they still remain in occupancy. In the second quarter, they are fully out of EC3. So at the end of the quarter, that space, which is about 100,000 square feet is now vacant, and they still remain in the EC4 space, which is really the primary driver of the occupancy decline.

Anthony Paolone - JPMorgan

Do they intend to move out of that as well?

Doug Linde

No. That was a new 10 year lease. In fact, what we did was we took two groups. We increased one of the groups, and one of the groups actually moved to another building. So, we had two separate groups that made up 100,000 square feet. One of the groups grew to 80,000 square feet, the other group actually left the portfolio.

Anthony Paolone - JPMorgan

Okay. And then just question on developments. Can you talk about how you look at starts over the next 12 months to 18 months and the likelihood of doing spec development and where it might be?

Doug Linde

I think that speculative development is highly unlikely in the next 12 months in this company's portfolio. If we have a tenant that's prepared to make a commitment, for example, in our property in Weston our property in Waltham, I think we would gladly start a new building, not with it being 100% leased but with it being 60% or 70% or 80% leased.

If Princeton University decided they wanted to do another building in Princeton, we would certainly start a new building for them. But, I think that doing something on a speculative basis in any of our other suburban markets is almost out of the question, and we certainly aren't going to start a new building in New York City, given where we are with 250 West 55th Street until that building is committed. And we are starting, and have started on a speculative basis 2200 Pennsylvania Avenue, but Ray can comment right now on the activity there. It's been pretty feverish. Ray?

Ray Ritchey

Yes. I would say that the interest we received on that building was probably the strongest we've ever received in any urban building, especially in the Washington area. We've got a letter of intent pending for about 200,000 square feet from a major law firm, and three or four other secondary leases anywhere between 40,000 and 80,000 square feet. All of this has taken place just within the last 60 days since breaking ground. We are very, very optimistic about both the long-term office and the retail leasing success there.

Anthony Paolone - JPMorgan

Okay. Thanks.

Operator

Thank you. Our next question comes from Michael Bilerman with Citi. Please go ahead.

Michael Bilerman - Citi

Good morning. Irwin Guzman is here with me as well. Doug, I wanted you to balance some of your comments, balancing sort your economic outlook, you are talking about topping out of rents, increases in sublease space, extending the lease-off, and juxtapose that, with what appears to be a much, much bigger appetite to go out and do deals.

I think you said you are very anxious to put out capital. Even Mort's comments, I think, would solidify that. And I know we're in a capital constrained environment and having the balance sheet to be able to do it, but I think there's a lot of equity players out there that have capital. Why be so aggressive and why be so anxious to go out and buy and not thinking that there may be a competitive environment that would drive prices higher?

Doug Linde

Mort, do you want to start with that?

Mort Zuckerman

Yes. You have to have enough confidence in yourself, as we do, frankly, in terms of our ability to make judgments as to where the long-term values will be in the markets that we are in. We may not win every deal that we go after, but there will be somewhere we will.

If you look at the whole situation with the General Motors Building, when virtually everybody who knew anything at all about real estate knew what a great building that was and, frankly, what a good buy it was, nevertheless, we were the ones who were able to go in there and hang in there and bring it to a close.

We are not going to win every one of the buildings that we go after; but we think, even though there are good players, but we have a lot of confidence in our ability not only to acquire buildings but to then manage them and manage them well, and maintain the opportunity to maximize their value. So we believe, we bring to the table a combination of both capital and experience and management skills that gives us a serious long-term advantage.

Now, others may feel the same way about their capacities, but so far, we have done very well in our acquisitions as well as very well in our developments. And we have that dual capacity to continue to build the company, and we have, we believe, as good a management group to handle both of these challenges over the long haul. And we challenge anybody to be our superior, and we're perfectly willing to be in that kind of competitive environment that's the nature of our economic system.

We just think that this is a unique opportunity, particularly to buy those assets where, if we manage them properly, will bring us great long-term returns. We've always been a long-term player in terms of buildings that we build and in the buildings that we buy, and the management of these buildings and the way we deal with our tenants, long-term values.

One of the things that was just mentioned here was the improvement to Citigroup Center. We are completely redoing the lobby of that building. Now, this is not something that we have to do. We are doing it because we believe it will add significantly to the long-term and indeed to the short-term value of that building, which, I can assure you, is basically a 100% leased. It is 99% plus leased, is my recollection.

So we don't have to do it, but we believe this will add to the value of this asset and add to the value of this building from the tenants' point of view. We look to all of our buildings to do this kind of work. So we welcome competition. We believe we will do well in that competition. We have done well in this competition in the past and we enjoy the process, and we particularly enjoy the results, and we hope our shareholders will enjoy the results.

Ed Linde

If I can just, it's Ed Linde, if I can just add one thing to that, to answer that question, which is I hope we didn't give the impression that, willy-nilly, we're going to go out and use our capital to buy anything that comes on the market. The key, of course, is to use that capital to buy the right assets that come on the market. And just as we did, and I hate to keep coming back to the GM Building as an example, but it is a good example. Just as we bought that building with a rent roll or a rental profile that minimized short-term exposure, we saw long-term value creation opportunity.

That's the kind of asset that we are going to use our capital to buy. An ordinary asset or an asset that has great exposure, unless it's priced significantly lower than maybe some of these sellers think they can get, we won't take a look at. So don't think that we're going to just run out there and buy everything in sight. I hope we didn't give that impression.

Michael Bilerman - Citi

Is there are things that you are working on today that are more pressing, or this is more of the next couple of years?

Ed Linde

Well, I don't think anything is pressing. We are not forced to use that capital. We want to be opportunistic in using that capital. And it will be in the next 12 months or the next 24 or the next 36, depending upon the circumstances.

Doug Linde

Michael, it's fair to say that our underwriting was pretty conservative over the past two to three years when we were looking at assets. If anything, it has become even more conservative, given what we are seeing in our own markets and what we prospectively believe to be a slowdown in overall business activity. And so, I do not think you are going to hear us saying that we are buying things based upon spikes in rents or significant changes in occupancy in any kind of an asset that is out in the marketplace today.

I think you can be confident that the same rather conservative perspective that we have taken on underwriting is going to remain, the core principle for anything that we look at going forward.

Michael Bilerman - Citi

Well, I think that is the worry, right? The worry is that there is so much going on in the economy and with fundamentals that at some point, going into these assets even with good embedded growth today, that there is some risk down the road. I just do not know if you were looking at it from an IRR perspective and how that has changed with the backdrop of increased credit cost, and increased risk, that you are certainly seeing on the fundamentals side and how you value that in looking at some of these assets.

Mort Zuckerman

Well, we do take that into account, and we did with the recent acquisitions, of course. We have been through a lot of these cycles in the past, and we believe we know how to deal with them in terms of assessing what we can buy, and what we should buy and how to assess their economics and their financing.

As I tried to say before, we have always been long-term players and we do not have to maximize our short-term earnings if we can see on an IRR basis the kind of returns that we really believe are attractive, because the long-term, sooner or later, or the medium-term, sooner or later, it turns out to be the short-term and we have got that approach since we've been in business, before we were a public company.

We think we have followed it since we were a public company to the benefit of our shareholders. We intend to follow the same basic standards and the same basic business philosophy that has, in a sense to energized our activities for the last 40 years.

You are raising the same critical points that we talk about all the time when we look at different assets. We look at what the financing costs are and what they will be. We look at what the rents are and what they might be. We look at what the replacement costs and what they might be. We look at what the short-term rollover is. We also have to make a judgment, for example, as to whether or not what we are in, in the way of an economic decline, and we have been in an unprecedented economic decline and macroeconomic condition, and we take that into account.

Now, nobody can be perfect in their judgment about the future. You have to allow for the various contingencies, but even within that context, when we looked at the IRRs at the General Motors Buildings and the other related assets, we came to the conclusion that we would be able to deal very well with whatever the contingencies were.

If anything, we believe that our numbers are conservative and that is to say, we intend to top them on the upside, but, we're very happy if we come out where we believe we would come out. Your points are very well taken, but believe me, we address those points constantly in our dialogue inter alia and it is an exchange that goes on all the time.

There are some people within our group who are very conservative about these things and they make sure that everybody knows what those points are. And some of those people indeed are on this phone call.

Irwin Guzman - Citi

Good morning. This is Irwin Guzman. Can I ask about the decision to own 60% of the macro portfolio versus your prior expectation to own up to 49%? It sounded like you were aiming at owning less of the other three assets. Can you talk about what changed and whether it was driven more by your desire to own more or by your partners' desire to own less?

Mort Zuckerman

It was driven entirely by our own desire to own more. And I do not think I am violating any confidentiality of our conversation with our partners if I tell you that they wanted to own more than they were ultimately permitted to buy. So, to be honest with you, if it were up to me, I frankly would have bought the whole bloody thing, 100% for Boston Properties. That's how good I think these assets are.

We have very good partners, and we think that we can use this as a platform to develop additional investments, co-investments with them. I believe they have the same view of it. However, it was entirely our decision and frankly, if I were to tell you all the conversations, I think my colleagues know that I wanted to go even further than that. However, we decided, based on the opportunity that we believe comes out of developing good long-term relationships, which has always been a pattern of our business practices, we thought we could do this with the co-investors that we have and that this, in the long run, would also be beneficial for Boston Properties.

So it was absolutely our decision. I can tell you that it was a decision that was not as well received by our partners, who would have liked to have a much bigger play, both of them would have liked to have a much bigger equity interest.

Irwin Guzman - Citi

Thank you for answering all the questions.

Operator

Thank you. Our next question is from the line of Ee Lin See with Credit Suisse. Please go ahead.

Ee Lin See - Credit Suisse

Hi, can you please explain a little bit more about the FASB 141? I see that in your projection you have $138 million for the fair value leased revenue. And my question is, does that assume that expiring leases will be renewing at current market rents, or does it mark-to-market even the leases that are not expiring? Or to ask it another way, to realize that number, do you just have to wait until the leases expire and then raised to the current market rent? Or, does it mean that you have to bring every single lease to the market rent, even if they are not expiring now?

Mike LaBelle

This is Mike LaBelle. It is a non-cash item.

Ee Lin See - Credit Suisse

Yes.

Mike LaBelle

FASB 141 dictates that you mark the leases to the current market and recognize the difference between what you are receiving and what the market rent is on an amortized basis over the life of that lease.

So, for each lease that we have, we are recognizing the difference between the actual rent on the lease and the market rent on the lease, when we are only collecting the actual rent on the lease.

Ee Lin See - Credit Suisse

So, even for the period where the lease is not expiring, you will

Mike LaBelle

That is correct.

Ee Lin See - Credit Suisse

Okay. So there is no way to actually realize that value?

Mike LaBelle

When the lease expires. Presumably, we will capture that growth then, plus whatever additional growth in rents we see over the term of those leases. So many of those leases are long-term in nature and that is stating what the current mark-to-market is and over the next five to eight to 10 years, we anticipate that rents will continue to grow in midtown Manhattan, and when those leases actually roll, we will be able to capture even more upside.

Ee Lin See - Credit Suisse

I understand that part about when the leases expire, you will be able to mark that to market, but, are you also measuring the difference between the rent even for the period where the lease is not expiring yet?

Ed Linde

Yes, when a lease is not expiring, we are recognizing the current market of those leases.

Ee Lin See - Credit Suisse

Okay, so you actually will not be able to realize that part unless you break that lease right now. Correct?

Ed Linde

That we are really recognizing currently.

Ee Lin See - Credit Suisse

Okay, thank you.

Doug Linde

We would not be able to recognize it in cash unless the lease were broken now.

Ee Lin See - Credit Suisse

Yes. Okay, thank you. That's all.

Operator

Thank you. Your next question is from Jay Habermann with Goldman Sachs. Please go ahead.

Jay Habermann - Goldman Sachs

Good morning, here with Slone as well. Just coming back to New York City, can you just comment, I know you gave a couple examples of space being sublet in your portfolio. But, I'm just trying to get a sense of how much additional sublet space we could see perhaps in the near-term and potential impact on either market rents or vacancies.

Doug Linde

Jay, so the example I gave was that, we had a conversation with one of the brokers that we work pretty closely within, we said, okay, so here is the list of the latest from the last call, 12 months of, at least publicly announced layoffs, RIFs, whatever you want to call them, in the financial services sector in New York City. Okay, so let's talk about all of those companies and what they've actually put on the market today, it was 20,000 jobs and approximately 1.4 million square feet. And that included a portion of the space that is being what is the right word, reconstituted or recombined with the JPMorgan and the Bear Stearns merger.

The question really is how much more there is going to be and how further those cuts are going to go, in terms of the sort of core businesses and those investment banks. That is a really hard question to answer.

I think the one thing that we have always recognized is that it takes capital for a large corporation to avail itself of excess space because they do not typically lay off departments, they lay off people within various areas of their institutions. So to bring people together and to restructure the way they are operating is not an insignificant capital expenditure. So many times, it is almost not worth putting the market into the sublet market in order to deal with what the costs associated with that activity are.

Now, the real issue is, those people are clearly not in the market for additional space and the lack of demand from the financial services players, I think, is almost more of an impact than what the sublet space that they are putting on the market is doing. Clearly, if JPMorgan puts space on Park Avenue on the market and they have 12 or 13 years left on a lease, and they want to get rid of it, and they discount the market by 10%, we are going to have to wait for that space to work its way through the market before we can realize the kind of rents that we anticipate, realizing in our portfolio.

And quite frankly, we think most of the landlords who, like us, have very little vacancy in their portfolios are going to be pretty hard-nosed about what they are asking for rents and how patient they are going to be about holding what current pricing looks like in the marketplace.

I think it is going to take some time, and clearly, everyone's expectations are always that as soon as things happen in one sector, there is an immediate reaction. This one has taken a long, long time, and it could take a long time for all of this to work its way out in terms of affecting the market in one way or another. However, we are not pollyannaish about it. We do expect there to be some softness in the midtown market, and we expect that, overall, the concessions will probably go up and rents will certainly not be going up. They may not go down much, but they are certainly susceptible to that.

Jay Habermann - Goldman Sachs

Right. And on West 55th, you mentioned briefly in your comments there was no additional leasing. However, can you just give us some updates in terms of just interest levels and are tenants simply just looking at other options now in the market?

Ed Linde

We are continuing with a negotiation with a large tenant for space in that building and there is great interest in that space. It is a complicated transaction, and it has not yet come to fruition, and it may or may not come to fruition. However, behind that tenant are several other large tenants who have also expressed interest and with whom we have been somewhat slow to deal with because of the fact that we would not have enough space.

If we make one deal, we do not have space to accommodate the second or third deal. However, there continues to be strong interest in that building, and it stems from the fact that, well, first of all, it stems from the fact that it is a great building. We are building a building that is totally consistent with what Boston Properties does. On top of that, if you look around, and we have said this before, there just is not a lot of new space in the midtown market and despite all the talks about subleased space, there is not a lot of space available in large blocks and there are tenants who are looking for new space in large blocks.

So, the interest remains strong. It is not a stampede, but we are very comfortable about the leasing prospects for that building, which will not become available until 2010.

Mort Zuckerman

Yes, this is Mort. Let me add one other comment to that. What operates in the marketplace, not exclusively, but particularly at this point? If you look in midtown New York, there are very, very few buildings that are going to be coming on stream over the next four years. There is really one in Time Square, and there is the building that we are doing, are really the only two buildings in the marketplace that you can really to and count on.

Now, you have a number of tenants, even though the market may be, in overall terms, somewhat weaker because of what we all know the world of finance is going through, nevertheless, you still have a number of tenants who are continuing to grow and who are in buildings where they have no expansion space. And the result is, they have to look for new big blocks of space. This is not something that you do overnight, people plan a year or two years ahead. And there are very few of those big blocks of space that they know can be tied up at this stage of the game.

Generally speaking, you often need new buildings to find that amount of space. If you need 500,000 square feet of space today, you had to look around, and find it, it would be very difficult to find. There are tenants who need that kind of space, and that is where we have, and in a sense, because we are, I think, by far and away the best building in terms of the building and the best building in terms of location that is coming on the market over the next three to four years.

We have the opportunity to get those tenants who need to move, and who need to plan in advance. We have already seen that with the first tenant, which is a 221,000 square foot tenant. They simply could not find the expansion space in the building they were in. They wanted to move to a good new building and they found one. This is the same thing that is happening for the other tenants that we have been talking to.

So that is what notwithstanding the overall market, not that it does not affect the atmosphere of the negotiation and it does have an effect in that way. We will and are as aware of that as anybody. However, you do have a real marketing advantage when you are basically the best new building coming on stream over the next four years.

Jay Habermann - Goldman Sachs

Right. And just to be clear on acquisition strategy, I know there were some questions earlier, but is it really the function of two items? Number one being, you expect cap rates could move higher. And number two, should we expect to see more acquisitions in the joint venture format, now that you have partnership, especially with this Middle East capital?

Mort Zuckerman

Yes, to both. Yes, we do anticipate that we are going to want to continue to develop this partnership, which is one of the reasons why we went ahead with them in the first place, and we think that they understand and know that we are very, very familiar with the markets that we are in and that we can manage the buildings well. We will be able to manage them to maximize their values and our values. So that is something that will undoubtedly affect everything.

However, believe me when I tell you this. We are going to remain committed only to the purchase of buildings that are in the very high end of the commercial office market in any one of the markets that we are in. We believe that those still remain the best long-term values, and we are going to focus on that.

Those opportunities are frankly going to be there simply because of the conditions that we have already covered and I am not saying we are going to be able to buy any of them or a lot of them, but we are certainly going to be in that marketplace.

Jay Habermann - Goldman Sachs

Great. Thank you.

Operator

Thank you. Your next question is from the line of Mitch Germain from Banc of America. Please go ahead.

Mitch Germain - Banc of America

Good morning guys. Ray, just circling back to D.C., I know there is a significant amount of supply expected in the near term. Can you just talk a little bit about the fundamental picture in terms of demand trends?

Ray Ritchey

Well, the D.C. market is like the majority of our markets. It is very much a project-by-project or a submarket-by-submarket analysis. If you look for the larger blocks in the CBD, there is really a very short supply. We made a presentation to a 200,000-square foot user last week who was looking at 2200 Penn, and that group was just shocked at the number of, or the lack of options that were available in the 2010-2011 timeframe for first-class office space. Whereas, if you go to a secondary market like Noma, there is abundance of options at a very low cost.

So, again, just the constant theme of the barrier of entry to the high-end, trophy level space in all of our markets is really the theme of the story today. That theme is evident out in Northern Virginia. I think, we talked extensively about Reston and the fact that we are approximately 90% committed on 900,000 square feet, in a market they are struggling, really speaks to the flight to quality by many of our tenants. So, Mitch, it is very hard to generalize across the board on what we are experiencing versus the experiences of others.

Mitch Germain - Banc of America

Great. And last question, Doug. Should I interpret from your comments you are taking a more measured approach to the second development in Manhattan, basically not going to start it without a pre-commitment at this point?

Doug Linde

I think that is a fairly accurate statement.

Ed Linde

Yes, but I'd also think that just the timing of that assemblage and putting all the pieces together and finalizing it we always knew it was going to be available after 250 West 55th Street. So I do not think there is anything unusual in that.

Mitch Germain - Banc of America

In terms of available from the start standpoint, or in terms of delivery standpoint?

Ed Linde

Exactly, exactly.

Mitch Germain - Banc of America

Okay. Thanks, guys.

Operator

Thank you. Our next question is from the line of Jordan Sadler with KeyBanc Capital Markets. Please go ahead.

Jordan Sadler - KeyBanc Capital Markets

Good morning. I just wanted to follow-up on one of Michael's questions earlier. I think he asked you if your IRR hurdle had changed and I hadn't heard if you said yes or no, or if you actually had given an IRR hurdle via non-investment.

Mike Labelle

The clear answer is, absolutely, it's changed. Given that there presumably is more risk associated with transactions today, given everything that we have just talked about, and the inputs into those IRR calculations clearly have changed as well. I can not tell you what the number is on any particular investment because there is really a summary of what the conditions of the particular asset are, what the leasing profile is, where it happens to be, what the cost per square foot is, vis-à-vis replacement cost.

A building like the GM Building may have an IRR of X, and a building that is being built in suburban D.C. that is fully leased to the GSA for 15 years, may have a different IRR associated with it. So, there is no single answer. All I can tell you, the numbers are certainly higher than what they would have been 12 months ago.

Jordan Sadler - KeyBanc Capital Markets

Also, what about from three months ago? Is GM the new benchmark, and are you raising your IRR hurdle, given that you have already put or committed $4 billion worth of your capital through the GM investment and the new developments you have started over the last couple of quarters?

Mike LaBelle

We are very satisfied with our projection of IRR and the GM Building, for example. If the GM Building came on market at the same price with the same IRR tomorrow, I suspect we'd buy it. In fact, I know we'd buy it. So, if that is your comparison you are looking for, I think that is the answer.

I also would point out that our IRR hurdle must have been not as low as a lot of other people's IRR hurdles during the time when there was a lot of trophy properties trading for prices that we considered to be too high. So, I do not think it is as dramatic change in IRR hurdle as it is a change in the marketplace and a change in the underwriting.

Mort Zuckerman

Also, I think that in fairness, we should point out that when we thought that the cap rates for the sale of buildings got to levels that, shall we say, represented what, to repeat a phrase, irrational exuberance, you will note that we were considerable sellers.

We sold over $4 billion of real estate because we thought the market was so frothy. At those prices we were sellers. At the prices that we think we can realize today, we're buyers. So there is going to be that kind of swing in the marketplace. If the marketplace ever gets to be the way it was a year and two years ago, we will undoubtedly look to sell some of our assets.

So we are not blind to the opportunities to sell as well as the opportunities to buy. I think we have put ourselves into a position, as a result of the sales that we did make, and the financings that we did make, to be potential buyers in what we think is an opportunistic environment today for people who have capital and have the management skills to run and lease these buildings.

Jordan Sadler - KeyBanc Capital Markets

What do you view as your window of opportunity to put capital to work right now? Do you think you are going to have another six months or three years or?

Mort Zuckerman

Oh, no. Who the heck can predict what is going to go on here? We think it will go on, if I had to make a judgment, we think it is going to go on for 18 months to two years. However, who knows? Anything could change the economy, I mean, if oil prices crack to below $100 a barrel, believe me, the view of the macroeconomic potential of the United States will change. And I do not know what hell though, I did not think that oil was going to get $140 a barrel, and I think its god damn insanity that we put ourselves in that kind of a position where we do not exploit our own natural resources, and are forced to send hundreds of billions of dollars abroad to pay for our oil prices. However, that is a whole other issue. You have to read the editorials in US News to find my views on that.

Now, I do think that by and large, I have to say that we have always been aware of the business cycle, and particularly the real estate cycle. That has been a big part of everything we have ever done, in terms of when we have done our financings, when we started buildings, when we started buildings on spec, when we have bought buildings, when we have sold buildings.

We think we have done a pretty damn good job of making the judgment as to what is the best time to buy and what is the best time to sell. I will say, if you look at the record over the past three years, I do not know of any other REIT that was as active in the sale of really good assets.

We sold the building in Time Square. We sold 280 Park, we sold a number of other buildings and we are very happy that we did. We're very happy that we are in the market now as buyers rather than as sellers because we think there is extraordinary long-term opportunities for people who have the capital, and we have the capital and understand what the hell we are doing in this whole thing.

So, all we can say is, we hope that our record justifies what we have done in the past and we hope that our record will be justified again by what we do in the future. We are still long-term players in the real estate business, and only in a certain segment of the real estate business.

We think we can continue to be very, very active players in the next short while, more in acquisition than in development, because of the nature of what's happened. However, we are still going to follow our basic business philosophy.

Jordan Sadler - KeyBanc Capital Markets

That is helpful. And then just lastly, Doug or Mike, it might have been you, I think in your commentary, you mentioned that the mark-to-market ex-GM, I think, it was flat sequentially at $9.25 a square foot.

Doug Linde

That is correct. It is $9.25 a foot.

Jordan Sadler - KeyBanc Capital Markets

Okay, I just wanted to confirm that. And so, is that in your expectation, leveled off here and so hit it something of an inflection point and will likely stay flat? Or, is this sort of a temporary, a function of something else that happened during the quarter?

Doug Linde

The way we do our mark-to-market is pretty simplistic, which is we look at what our existing in-service rents are and we have a, "this is where we think the mark-to-market would be on that space and so, to the extent that a piece of space rolls over, and it's been released at a" higher rent, it comes out of the mark-to-market, or the mark-to-market on that piece of space obviously declines.

And so', it is based very much on the portfolio composition. So, it changes on a quarter-to-quarter basis, based upon what is actually rolled over. However, we still think it is a pretty significant number.

Mike LaBelle

I think, getting back to what Doug said previously, given what is going on in the overall economy is we are not necessarily assuming that rents are going to be increasing in the near-term. We think they are going to stay relatively flat in the near-term.

Mort Zuckerman

Do not tell that to any of our tenants.

Jordan Sadler - KeyBanc Capital Markets

So this could level off as you continue to capture some of that rent growth through the renewals?

Mike LaBelle

Correct.

Jordan Sadler - KeyBanc Capital Markets

Thank you.

Operator

Thank you. Our next question is from Ian Weissman with Merrill Lynch. Please go ahead.

Ian Weissman - Merrill Lynch

Yes, good morning. I was wondering if you can help me reconcile something on the GM Building. Two weeks ago or a month ago rather, when you put out your initial press release, you said that the GAAP return was going to be about 7.7% in 08 at the midpoint. I think you said in-place rents were $85 billion to, or mark-to-market was $170. Today, in your release it says that the GAAP return is 10%, which would imply that in-place rents would go up an additional $30 a foot or so, so let's say almost $200 a foot on average for the building. What is the change in your GAAP return expectations from just over the last month?

Mike LaBelle

We actually did not change the expectation for what the market rents are, we just went through the analysis of the FASB 141. It has everything to do with the FASB 141 obviously, which is a very, very complicated, in-depth and thorough analysis that has to be done on a lease-by-lease basis.

With the additional time that we had to go through this analysis, worked very closely with Price Waterhouse Coopers, our auditors in determining what the right FASB 141 numbers were. We came up with a revised estimate, and we are very comfortable with the estimate that we have given today.

Ian Weissman - Merrill Lynch

So, if you said that market rents are going up, I think you said $90, what is sort of average in place today at the GM?

Mike LaBelle

The average in place at the GM is about $90. If you look at the supplemental, it says it is about $98 per square foot, but that is based upon the existing measurement of the space. Upon re-measurement of that space, if you look at each space and re-measure it, it is more like $90 a foot today.

Ian Weissman - Merrill Lynch

$90 going, so the mark-to-market would be $180 on average for the building?

Mike LaBelle

Yes.

Mort Zuckerman

Let me just make a point here about re-measurement of space. As you probably know, for those of you who live in New York, you probably notice every year as you look at the buildings that they get bigger by about 2% every number of years. It is quite an interesting diet that these buildings are on to help them grow. However, the fact is that the Real Estate Board of New York does measure space and there is a standard and the loss factor went up by 2% from 25% to 27%. And when we got into all of that that was an important thing in terms of being able to measure the difference in rent. Rent is not just rent, rent is rent times the number of rentable feet, and the number of rentable feet went up by 2%, which is not an insignificant amount.

Ian Weissman - Merrill Lynch

So the 200 basis points of return expectation, additional 200 basis points has more to do, or mostly to do with the re-measurement of the building, more than anything else?

Mike LaBelle

It has everything to do with the computation that was done, the calculation and the complicated nature of that calculation that we have just done a better job of analyzing and calculating that number and come to an agreement on that number with our auditors.

Ian Weissman - Merrill Lynch

And does it have anything to do with the retail space at all? Or this is all just focused on office?

Mike LaBelle

It does not. It is really the underlying calculations.

Doug Linde

And just so you understand, the percentage rent is not included in the FASB 141 because it is not contractual.

Ian Weissman - Merrill Lynch

Right. Okay. All right, thank you very much.

Doug Linde

Sure.

Operator

Thank you. Your next question is from John Guinee with Stifel Nicolaus. Please go ahead.

John Guinee - Stifel Nicolaus

Thank you. A couple of quick questions. Mike, is it appropriate to say going forward you're going to earn about $0.14 to $0.15 FFO per share from the FAS 141 each quarter?

Mike LaBelle

Let me just quickly do the math. So, our share of it is $20 million.

John Guinee - Stifel Nicolaus

Well, just take $138 million for 2009, times 60% divided by 142 million shares.

Mike LaBelle

That is about $0.14.

John Guinee - Stifel Nicolaus

Each quarter? Are you going to be reporting FAS or FFO, ex-FAS 141?

Mike LaBelle

No. What we do, and this is all to do about Securities and Exchange Commission and Reg G and FD, and every other different way that the SEC has handcuffed us is, FFO is a defined term based upon what NAREIT has defined as FFO. That is what we are going to report. We do a painstaking job of breaking out our non-cash items in our supplemental, each and every quarter and we will continue to do that on the whole portfolio and explicitly break out what is going on all of our joint ventures, which is also done in painstaking detail. However, what we are going to report is what we have to report, which is funds from operation as defined by the white paper.

John Guinee - Stifel Nicolaus

Okay. Two other quick questions. How do you think, given that NAV will become more important, given the issues with FFO that's been discussed for the last few minutes? How do you think we should look at your land position? Do you think its worth more or less than book value? Then, second, you halted the dividend increases for a couple of years while you sold $4 billion worth of assets. Do you have any thoughts on your dividend policy going forward?

Doug Linde

I will answer the first question, which is, we believe that our land position is worth and well in excess of what its book value is. We also think that company is worth a lot more than its total book value. So, what book value really means today is anybody's guess.

With regards to our dividend, the Board talks about the dividend periodically. We generally talked about it sometime in the second half of the year. We look at our capital needs. We look at our expectations on our payout ratios. We look at what our other opportunities for capital are and we do not have a stated specific policy on dividend increases.

John Guinee - Stifel Nicolaus

Great, thank you.

Mort Zuckerman

Let me make a comment too, about NAV, which tends to get into the world of generalities. I want to be very specific about it rather than anything else. Again, consistent with what we have stated and have performed on for all the years we have been a public company and, indeed, all the years we have been a private company, there is a difference in value for the prime properties that we own in the marketplace as compared to many other properties.

There is a difference between the General Motors Building and 599 Lex and 399 Park and the Prudential Center and the Embarcadero Center in terms of the way they are valued in the marketplace, in terms of the rates at which people will buy these properties that have a recognition of what we frankly have experienced, which is that they do much better in good markets and they do much better in bad markets or challenging markets, as the phrase goes.

I am not sure that the street recognizes that particular difference, but it is something that, frankly, we have experienced in everything that we have done. It is a relevant consideration in terms of the valuation in the marketplace of NAV for the kinds of assets that we have compared to the kinds of assets that many other firms owned.

John Guinee - Stifel Nicolaus

Okay, thank you.

Operator

Thank you. Our next question is from Lou Taylor with Deutsche Bank. Please go ahead.

Lou Taylor - Deutsche Bank

Thanks. Doug, you alluded to about $500 million of additional capital in the second half. What type of capital are you contemplating?

Mike LaBelle

This is Mike speaking. I talked a little bit about a mortgage loan that we are working on currently that is just under $400 million that we are working on for one of our Embarcadero Center assets, which is Embarcadero Center 4. So that would be a large chunk of that. We do expect to raise and have projected to raise another $150 million beyond that. It would also likely be term capital. So it could either be capital raised in the unsecured bond market, it could be capital raised in the convertible debt market, it could be capital raised in the mortgage market.

One other thing, just to note on the convertible market, that we did not talk about in our notes, was the accounting impact of the change to the convertible market that will take place next year and just to make sure that everybody's aware of it and we put it into our press release, is that there is an accounting pronouncement called APB 14-1 that affects the accounting for all convertible debt.

The result of this change, if it were to occur in 2008, would have been an additional $0.13 to $0.14 per share of GAAP interest expense, net of incremental capitalized interest, just to make sure everybody remembers and is aware of the effect of the convertible debt.

Lou Taylor - Deutsche Bank

Okay. And then second question, Mike. You had referenced some return figures for the three other New York assets that are the pending acquisitions. Can you just go over those numbers again?

Mike LaBelle

What I said was, the annualized GAAP NOI yield for the aggregate was expected to be approximately 7.5%.

Lou Taylor - Deutsche Bank

All right. Do you have a cash figure?

Mike LaBelle

We really can not give additional details on that at this time until after we close on the transaction.

Lou Taylor - Deutsche Bank

Okay. And then just what's the expected closing timeframe?

Mike LaBelle

We are working through actively, the assumption of the three loans that are associated with this. We would expect to have closed these properties sometime in August, I would say.

Operator

Lou Taylor - Deutsche Bank

Great. Thank you.

Thank you. Our next question is from Michael Bilerman with Citi. Please go ahead.

Irwin Guzman - Citi

Hi, it's Irwin Guzman here. Can you just let us know whether the partners on the other three buildings from the Embarcadero portfolio will be the same as the ones in the GM?

Doug Linde

They will be. It is an identical structure.

Irwin Guzman - Citi

Thank you.

Operator

Thank you. Our next question is from Michael Knott with Green Street Advisors. Please go ahead.

Matt Wocash - Green Street Advisors

Good morning, this is actually [Matt Wocash]. I am just curious on the financing side. If there was an assumable debt on GM, what kind of interest rate would you have expected to pay on the debt?

Doug Linde

That is one that we probably are not the most appropriate answeree. The challenges associated with answering that question are the fact that there is no commercial mortgage-backed securities market functioning today, and you are talking about a $1.6 billion mortgage. The theoretical answer is simple, because you basically say, well, a normal mortgage with a, "debt service coverage ratio of blank priced in that current environment with regards to how life insurance company lenders might look at this or how the foreign banks might look at this on a swap rate basis gets you to a number, but the real challenge is that that market is not deep enough to do a transaction of that size, subject to not having" the deal completed already.

Now, Deutsche Bank is in the process of selling its notes, or Deutsche Bank, Wachovia, Lehman Brothers and UBS are in the process of selling the notes on the loan. And when they sell those notes and they complete that transaction, I think we will have a better sense of where the market is today. However, that, again, the transaction closed in June and the sponsorship associated with the transaction prior to June was very different than the sponsorship today. So that, in itself, has a very meaningful impact on how the pricing of the transaction might actually be effectuated in today's market.

Mike LaBelle

We did do an analysis of the debt valuation as part of our FASB 141, and as Doug said, the size of the loan creates some issues. However, we looked at what we were seeing in the marketplace for similar senior financings and for similar mezzanine financings. For those estimates, we estimated roughly 6.5%, which is approximately 250 over for the senior portion of that loan. Then, the mezzanine portion of that loan we used roughly 7.5% to value that for our FASB 141.

Matt Wocash - Green Street Advisors

Thank you for your speculations.

Operator

Thank you. And at this time we have no further questions.

Doug Linde

Okay. Thank you all for being patient enough to listen to all the questions. We realized that there were not any other calls that were occurring at the same time, so you obviously had a little more time to get to us than you might otherwise. And we appreciate your forbearance there.

We will speak to you again. We will put information out as quickly as we can when we get to the closing table on the other assets in Manhattan and update our guidance based upon those transactions at that appropriate time. Have a nice summer, and we will speak to you again in the fall. Thanks.

Operator

Ladies and gentlemen, this concludes the Boston Properties' second quarter earnings conference call. You may now disconnect. Thank you for using ACT Conferencing.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Boston Properties Inc. Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts