Boston Properties Inc (BXP) — Q2 2017 Earnings Call Transcript

Good morning, and welcome to Boston Properties’ second quarter earnings conference call. The press release and supplemental package were distributed last night, as well as furnished on Form 8-K. In the supplemental package, the company has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Reg G requirement. 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 would like to welcome Owen Thomas, Chief Executive Officer; Doug Linde, President; and Mike LaBelle, Chief Financial Officer. During the question-and-answer portion of our call, Ray Ritchey, Senior Executive Vice President, and our regional management teams will be available to address any questions. I would now like to turn the call over to Owen Thomas for his formal remarks.

Thank you, Arista, and good morning to everyone. On current results, our FFO per share for the quarter was $0.05 above our prior forecast and $0.05 above Street consensus, due primarily to operational outperformance. We also increased the midpoint of our full-year guidance by $0.04. We’ve leased approximately 2.8 million square feet year-to-date in our portfolio. This includes 926,000 square feet in the second quarter and approximately 1.3 million square feet of leasing already in the third quarter, including a renewal of Estee Lauder at the General Motors Building, as well as a lease with Marriott, which commences the development of their new headquarters. Our in-service office portfolio occupancy increased to 90.8%, up 40 basis points from the end of the first quarter. We had another quarter of strongly positive rent roll-ups in our leasing activity with rental rates on leases that commenced in the second quarter up 18% on a gross and 28% on a net basis compared to the prior lease. Lastly, year-to-date, we’ve raised significant new capital and either commenced or secured nearly $1 billion in new developments, the office components of which are fully leased. So moving to the economic environment, the tepid yet consistent growth of the U.S. economy continues and serves as a constructive force for our business. U.S. GDP growth picked up in the second quarter, with current estimates at 2.6%. The employment picture also continues to be healthy with 222,000 jobs created in June, and the unemployment rate steady at 4.4%. Though the Fed has hiked rates three times since December and continues to signal more is coming, the capital markets are diverging as the ten-year U.S. Treasury remained low at 2.3% and has dropped approximately 15 basis points year-to-date, and 10 basis points since the end of the first quarter. Given continued muted growth, low inflation, and the uncertainty associated with Federal stimulus and tax cuts, we are not overly concerned about a sharp rise in long-term interest rates and anticipate for now a continuation of reasonably healthy operating and financial market conditions. Given the growth in the U.S. economy, the office markets where we operate have positive demand and healthy activity, but are in relative equilibrium given additions to supply. Job creation in our five markets grew 2.1% over the last year versus the national average of 1%. In the CBDs of our four core markets and West L.A., net absorption year-to-date is 1.3 million square feet or 0.2% of stock, while additions to supply year-to-date have been 2.2 million square feet or 0.3% of stock. Asking rents rose 2.6% in the first half of 2017, while vacancy stayed flat at 8.1%. Our leasing activity remains active with pockets of strength, though concessions are rising in specific markets. In the private real estate capital market, our commercial real estate transactions year-to-date through July are down 20%, and a little less for office, but there continues to be a strong bid from both domestic and non-U.S. investors in size for high-quality office assets in our core markets, and the international sources of capital continue to rotate geographically. Cap rates have remained stable for high-quality office buildings in our portfolio, generally in the low 4% range for stabilized properties. Once again, this past quarter, several significant office transactions were completed above replacement costs. Some examples include Santa Monica's Arboretum Courtyard, a 147,000 square foot office building under contract for $1,030 a square foot and a 4% cap to a domestic real estate advisor. Also in LA, 9665 Wilshire Boulevard is a 171,000 square foot office building located in Beverly Hills, sold for $1,035 a square foot and a 4.1% cap rate to a domestic REIT partnered with non-U.S. capital. Moving to Boston, 75 Arlington and 10 St James in the Back Bay, which collectively comprise 825,000 square feet, were sold for $816 a foot and a 4.3% cap rate to a Japanese investment firm marking its first U.S. real estate investment. Lastly, in Washington DC, 900 16th Street and 1101 New York Avenue were sold for $1,150 a square foot and around a 4% cap rate on a blended basis to a partnership of non-U.S. investors. The pricing for 900 16th Street is $1,254 a square foot, which represents a new high in pricing for Washington DC. So let me bring all this together and discuss our current capital allocation posture. On the positive side, economic growth, job creation, and leasing demand are steady with no visible catalyst for correction, and interest rates appear benign at least in the near-term. Additionally, private capital demand remains strong for high-quality office assets in our market. On the risk side, supply is increasing in a handful of our markets with rising tenant concessions, and there's the continuing backdrop of macro risk, including global hotspots and unpredictable outcomes from federal legislators. We therefore remain cautiously constructive and will continue to invest capital selectively in new development and existing assets that we can improve. However, the risk tolerance bar continues to be raised; we are requiring material preleasing for new development and keeping our leverage relatively low in the event of a correction and a resultant more robust opportunity set. Disposition decisions are driven by achieving attractive pricing for non-core assets. Moving to the execution of our capital strategy and starting with acquisitions, we completed a small 96,000 square foot bolt-on purchase for $16 million of one of the few office buildings we don’t own at Carnegie Center at an attractive price and something that we can efficiently manage. We are looking for new investments in all four of our core markets as well as LA, given our desire to build on our presence in that market. As another point on acquisitions, Mike will talk about a financing we’re completing on Colorado Center, which was appraised for $1.2 billion as part of the financing process. We bought a 50% interest in the property at a valuation of $1 billion just over a year ago. On dispositions, this past quarter we sold the building and related site on Shattuck Road in Andover, Massachusetts, in two transactions for total proceeds of $17 million. This asset is non-core and has a remote location relative to our suburban Boston portfolio. We have a small number of non-core assets either in the market or planned for sale in the Washington DC region and suburban Boston; our target for dispositions for 2017 remains at approximately $200 million. Our development activity remains robust; we delivered Reservoir Place, a north of 73,000 square foot redevelopment in Waltham, Massachusetts, where we have a letter of intent with a full building user. We commenced 145 Broadway, Akamai’s 485,000 square foot headquarters at Kendall Square in Cambridge, and MacArthur Transit Village, a 402 unit residential high-rise located adjacent to the MacArthur BART station in Oakland, California. Last week, we signed a 720,000 square foot lease with Marriott to commence their new headquarters in Bethesda, Maryland. We own 50% of this project with a local landowner. These three deals alone represent $815 million in new investment for us at a projected cash yield of approximately 7%, and the commercial component is essentially fully preleased. Further, we’ve made significant progress advancing a 300,000 square foot anchor lease commitment for our 2100 Pennsylvania Avenue development in Washington DC and are working on multiple build-to-suit lease opportunities precisely in Northern Virginia. These transactions could add over 1 million square feet of leasing for 2017 and several significant investments to our development pipeline if completed. At the end of the second quarter, our development pipeline consists of eight new projects and two redevelopments, totaling 4.7 million square feet and $2.9 billion in our share of projected costs, of which $1.5 billion has been funded through the end of the second quarter. Our projected cash NOI yield for these developments remains in excess of 7%, and the preleasing of the commercial component increased 12% during the quarter to 66%. To conclude, we continue to be confident about our prospects for growth and our ability to create shareholder value in the quarters and years ahead. We’re making good progress on our clearly communicated and achievable plan to increase our NOI by 20% to 25% by the year 2020 through new development and leasing up our existing assets from approximately 90% to 93%. This growth excludes our recent new business wins and potential new investments for which we have significant capacity. So let me turn it over to Doug.

Thank you, Owen. Good morning, everybody. I’m going to start with a little bit of color on our same-store statistics. We had a pretty healthy increase as Owen described in that same-store portfolio. Remember, those are the leases that commenced this quarter; those are not necessarily leases that were signed this quarter. So let me just give you some color on that pool. In Boston, there was about 370,000 square feet in the same-store from the Putnam transaction, which we completed over a year ago at 100 Federal Street, finally coming into play. Again, it’s an example of repositioning where we talked about leases that were signed, and we had to be patient about when that revenue was going to come in, but the revenue is there. In San Francisco, there’s about 230,000 square feet from Embarcadero Center; it’s really just a continuation of all the renewals and relocations that we’ve executed over the past 12 plus months, where we’re seeing roll-ups of between 40% to 50% on a gross basis and in excess of 60% on a net basis. In New York City, there’s about 300,000 square feet including a deal that we did back in 2014 at 601 Lexington Avenue with a major law firm, which again had a big increase and it's showing up this quarter. Washington DC is on the negative side; there’s about 127,000 square feet of space in Northern Virginia, and the biggest deal there was a law firm renewal done in the beginning of 2016, which resulted in a small downtick of about $0.65 a square foot, and that lease had 2.5% escalators and it’s for 12 years. Remember, all of these numbers are the first year rent versus the last year rent on a cash basis. To the extent that there are GAAP increases, which there are in virtually every one of our leases, those are not reflected in these same-store numbers. If you look at our TI numbers, they popped up a little bit this quarter too. And I think that’s the trend we’ve been seeing. The construction industry continues to be very busy in all of our markets, resulting in increases in base building as we accurately budget those costs. It’s also impacting tenant improvement installations. Tenants are investing more capital on their improvements, and we are investing more capital in their spaces. This is a reality across the board in San Francisco, Boston, New York City, DC, and Los Angeles. It’s urban and suburban. It’s a result of three factors: first, higher production costs, which are up because people are busy; second, there are increased code-related issues, Title 24 in San Francisco being the easiest one to describe; and third, we’re competing in all our second-generation spaces with new construction, which typically offers significant tenant improvement packages. In some cases, we’re increasing our allowances. Sometimes we’re prebuilding space, as we’ve described to you before, and in other cases, we’re providing turnkey installations. Rents and other concessions have been steady over the past number of quarters. I'm going to start my regional comments this morning with San Francisco with Salesforce Tower. Last quarter, we announced 100,000 square feet of leasing, and I discussed active proposals we were discussing with a number of tenants. In the second quarter, we leased another 175,000 square feet, bringing us to 1.135 million square feet leased, which is 82%, and we are in lease negotiations on five more floors totaling another 116,000 square feet. Last week, we received an offer for another 4.5. Current discussions involve law firms, co-working firms, private equity firms, hedge funds, private foundations, and venture capital firms, with some sovereign wealth advisors. If we complete the deal in lease negotiations, we will be left with two 10,000 square foot spaces on floors 51 through 56 totaling a combined 130,000 square feet; it will be over 90% leased. The available space is priced at over $100 gross. In spite of all the talk over the past year about the overhang of new construction in San Francisco, the overall market continues to improve. While there haven’t been any blockbuster deals, Amazon took another 175,000 square feet this quarter, Cloudera took 55,000 square feet, and Airbnb expanded again, bringing their net absorption just this year to 250,000 square feet. We are aware of five active requirements in excess of 100,000 square feet in the market, and they are all focusing on new construction as it’s the only large block option. The sublet space inventory has shrunk. The top 25 sublet spaces make up about 625,000 square feet, and there are only two spaces above 50,000 square feet, compared to 1 million square feet in Q2 of 2016, representing a significant reduction. We’ve tracked more than 20 deals with rent over $80 a square foot gross this quarter, and the new construction pricing is in the high 80s gross and up. Last quarter, I said that the story to follow in San Francisco CBD would be the continued demand growth and how tenants respond to the pricing of new construction. Tenants are accepting the higher pricing in the market. We completed nine deals for 73,000 square feet of office leasing at Estee this quarter and we have three more full floor deals in negotiation alongside active proposals for another six floors, including the space set to expire in 2018 from Bain Capital or Bain Consulting, moving over to Salesforce Tower by the end of this year. We completed a 62,000 square foot deal at Colorado Center this quarter, bringing our committed space to 93%. We have proposals ongoing for the last piece of space there, and our view of the overall leasing velocity in the LA market, particularly in the West LA market, has moderated. Very few large deals were completed in the second quarter, and the same tenants remain in the market with the same available spaces in play. Our repositioning plans are near completion, and we are working with local permitting authorities with a goal of commencing construction on the amenities work by the end of this year. Shifting to the other side of the country in Boston, we’ve made significant progress on our availability at 120 St. James and 200 Clarendon. In the second quarter, we signed 83,000 square feet of leases, and since the beginning of July, we’ve signed another 51,000 square feet and have 54,000 under negotiation. All of the space at 120 St. James is committed. We have executed our first prebuilt at 200 Clarendon on the 45th floor, which will be completed in the third quarter, and we are in lease with a second user. Down the street at 888 Boylston Street, during the quarter, we completed leasing on all of the remaining retail space, totaling 17,000 square feet, alongside additional leasing in the office tower, leaving us with 30,000 square feet in this 417,000 square foot project, nine months after opening, at 92.8% leased. While there aren’t many large exploration driven requirements in the Boston CBD at the moment, we are seeing growth activity picking up. Amazon grew by 150,000 square feet in July in the Seaport, while we are in active dialogue with six tenants, four from the technology industry ranging from 30,000 square feet to 175,000 square feet for the 175,000 square foot space at the Hub on Causeway that we’ll deliver in the first half of 2019. Overall, in the CBD market, rents are stable; however, depending on the condition of the space, the landlord’s contributions to tenant improvements have increased as I said at the outset of my comments. In our Waltham suburban portfolio, our largest executed transaction involved the recapturing and releasing of 40,000 square feet at our Reservoir Place asset. Additionally, as Owen mentioned, we have a lease under negotiation with a tenant for the entirety of 73,000 square feet at Reservoir Place North. We continue to see growth from life science companies; we actually completed another 25,000 square foot expansion at Bay Colony with an organization that has grown from 13,000 square feet in sublet space in 2001 to 150,000 square feet of direct space today. We responded to two additional build-to-suit proposals at our CityPoint landholdings, though as Owen stated, our leasing thresholds are very high. If we can secure a major lease commitment, this would add to our investment pipeline for 2020 and beyond. If any of these projects move forward, rents will be in excess of $50 a square foot gross. We’ve commenced marketing of that 100,000 square feet of space earlier this year. Our 2.4 million square foot portfolio, which is 100% leased, is dominated by large users. We’ve received strong interest from co-working operators that find us located on top of the Kendall Square T station to be an ideal spot for small tenant opportunities, which are lacking in Cambridge. We are exploring this option for a portion of the space. This space also has its own dedicated entrance if a user is interested in expressing its brand. The Cambridge office and lab markets continue to be tight and expensive, forcing tenants to consider alternative locations like The Hub on Causeway project. Last quarter, I commented that our large tenant at the General Motors Building with a 2020 lease expiration had been actively evaluating their alternatives. As Owen stated, Estee Lauder has made a long-term commitment to the building. In addition to the location and view, the building infrastructure, we believe one of the strong selling points for Estee Lauder was our ability to provide flexibility as they move forward with rebuilding and replanning their space, facilitated by the use of two swing floors. They are currently in 295,000 square feet and have committed to 220,000 square feet with rights to expand. This was an important transaction for the building as it is a great tenant and limits available space for some time. As I mentioned previously, the issue with the high-end market is not pricing; it’s the depth of the market, and there is more high-end space entering the market as we speak. This quarter, we were encouraged as there were more relocations over $100 per square foot than there have been in recent memory. This is due directly to the new construction on the west side at Hudson Yards and 1 Manhattan Place – excuse me, 1 Manhattan West. During the first half of 2017, so the first six months, there were 30 deals at 19 distinct buildings with starting rent above $100 per square foot, and the average deal size increased to 20,000 square feet. There were five deals between 40,000 square feet and 90,000 square feet. The size of the deals remains the issue. With the execution of our renewal at the General Motors Building, our biggest exposure in New York City is at 399 Park Avenue and 159 East 53rd Street. Activity at 399 Park is good; we have leases in negotiation right now for 66,000 square feet and are in discussions with three medium-sized financial service organizations between 150,000 and 250,000 square feet of our low-rise space, which encompasses 250,000 square feet. Obviously, we can complete all those deals. We have a steady stream of tours and proposals on the individual tower floors that begin on the 18th floor and go up to the 35th floor. Our low-rise space on Park Avenue is priced in the mid-$80s to the low-$90s. Repeating what we conveyed last quarter, in 2017, we’ll be collecting $31 million from the expiring tenants at 399 Park. We’re going to get the space back during the third quarter. We’ll be making proposals, and we’ll lease the space consistent with the economics I just described, but in every case, we’re going to have to demolish the existing improvements, and occupancy will not be until 2019. This will show as a decline in our same-store growth. Just to reiterate from last quarter, at 159 East 53rd Street, which is currently under renovation, the new curtain wall is being hung as we speak. We’ve made a number of proposals on 195,000 square feet of office space that is being rebuilt and will be delivered in early 2018. We’re optimistic that we will have signed leases in place contemporaneously with the base building completion, and revenue recognition will be in 2019. We are marketing a new building with a great new enhanced window line, mechanical plant, and tremendous outdoor space on each floor at a relative great value. Often during the summer, we describe a hiatus in activity as vacations impact individual transactions. This year, we have pushed through this pause in San Francisco, New York, and Boston. So the summer slowdown seems to have impacted the DC spot market, particularly in the CBD. The DC CBD leasing market continues to be a challenge with significant available inventory in existing assets and as a number of brokerage reports have pointed out, availability from new construction of partially leased buildings. Concessions remain generous, and additional GSA, contractor, law firm, or other private sector demand has yet to pick up in DC. Nonetheless, this quarter, we had a lot of activity in DC. The majority of it on the operating front was focused on Capital Gallery, which is a 99% leased building where we completed six renewals totaling 53,000 square feet. In Northern Virginia, we completed 120,000 square feet, including a full building user of 63,000 square feet in our VA 95 Park and in Reston Town Center, we have 45,000 square feet of leases under negotiation on vacant space, and Discovery Square, which expired in June, is under negotiation as well; all of which would bring us to 98% leased, and there are a number of technology companies looking to expand in Reston Town Center, just as the defense contractors have begun to retreat. This quarter, our progress with the Marriott lease, the development of 2100 Penn with a 300,000 square foot lead tenant as Owen described, and a recent build-to-suit requirement in excess of 600,000 square feet that we are aggressively pursuing in Reston Town Center, showcases that our new transaction activity is as robust as it has been in our history and involves very little speculative space. I want to conclude my remarks this morning with a portfolio comment. We’ve been conducting major capital reposition activities across the portfolio that have impacted the availability of significant spaces, including 399 Park, 601 Lexington Avenue, the General Motors retail, the Prudential Center retail, 120 St. James, Reservoir Place North, and 181 Spring Street in Suburban Boston at 100 Federal Street. These assets are all part of the revenue bridge, operating or development, and we’ve discussed them over the last 18 months on a continual basis. Moving forward, the only buildings in the portfolio planned for future repositioning, but not actively underway, where our activities could impact tenant space are at Metropolitan Square, where we own 20%, and 1333 New Hampshire. Both of these buildings are in Washington, DC and have known 2019 lease expirations. Our current share of the annualized NOI impact from future rollovers in lease assets is $13.8 million, which is fairly modest. We will continue to make other capital investments across the portfolio as we rebuild generators, elevator controls, lobby finishes, put new roofs on, and enhance all other types of building systems. Still, there are no building projects in the portfolio where we expect tenant spaces to be impacted. At the end of the quarter, we’ve completed leases that we expect will add $69 million to our goal of $160 million, which includes all the leasing at 399 Park, resulting in a net growth of $111 million in annualized in-service NOI, our revenue bridge. Finally, we’ve added 350 basis points to our development pipeline, where 70.6% anticipates a 2020 annualized incremental NOI of $242 million stabilized versus year-end 2015. With that, I will turn the call over to Mike.

All right, thanks, Doug. I’m going to start with a discussion of our results for the quarter. Our top-line revenue growth was strong this quarter and is reflected in a net operating income increase from the portfolio of $14 million, net of termination income. We gained 40 basis points of occupancy, which included significant gains at 100 Federal Street and 200 Clarendon Street in Boston, 601 Lexington Avenue in New York City, and our Suburban Washington, DC Portfolio, mostly from leases that were signed in previous quarters and what revenue has now commenced. This also shows up in our same-store results for the quarter, with our share of same property NOI up nicely at 3.9% versus last year. In June, we closed our $2.3 billion 10-year refinancing of the GM Building at a GAAP interest rate of 3.64%. The repayment of the existing debt resulted in a noncash gain on debt extinguishment this quarter of $14.6 million. This was outlined in our guidance and I spoke about it last quarter. It is from the acceleration of fair value interest and is now cleaned up and will not recur. Since it relates to a consolidated joint venture, our share is $9 million with the offset in our non-controlling interest line. As I mentioned last quarter, the loss of noncash fair value interest will increase our interest expense going forward. In 2018, we project our interest expense to be between $390 million and $410 million compared to our 2017 guidance of $355 million to $368 million. This represents an increase in interest expense of $38 million, or $0.22 per share in 2018 at the midpoint, which should be reflected in your models. For our earnings, we had a solid quarter and reported funds from operations of $0.67 per share. This was $8.5 million, or $0.05 per share above the midpoint of our guidance. $0.02 per share of this improvement is due to expenses that were deferred to later in the year, so we anticipate only $0.03 per share will flow into our full-year results. The remaining $0.03 was comprised of $0.02 per share from earlier-than-projected leasing, primarily in Boston and San Francisco. At 200 Clarendon Street in Boston, we continue to see an uptick in activity and are successfully converting proposals to signed leases and getting tenants in occupancy as quickly as we can. Similarly, at Embarcadero Center, we gained occupancy again this quarter and executed another full-floor renewal with a strong rental increase. In Mountain View, we signed a lease with a tenant for immediate occupancy at a 70% increase in net rent over the prior lease. None of the outperformance in the portfolio this quarter comes from termination income. We recorded $11.5 million in termination income this quarter, primarily from terminations at 399 Park Avenue and the GM Building that we discussed last quarter, which were already in our guidance. The other increase to our anticipated results this quarter was in development and management services fee income, where we recorded revenue approximately $0.01 ahead of our expectations. The variance was mostly in-service income and development fees. Based on the leasing that we completed this quarter and that we project for the remainder of the year, we’re increasing our assumptions for 2017 same-property NOI growth by 25 basis points at the midpoint to between 2% and 3% compared to 2016. Most of the improvement is coming from leasing velocity in San Francisco, Boston, as well as in New York, where we completed our early renewal with Estee Lauder. Although our current same-property growth pace exceeds 3%, as Doug described, we expect our growth will decelerate in the back half of 2017 due to lower occupancy from lease expirations at 399 Park Avenue. Most of our second-quarter uptick in leasing came from new leases with free rent periods and early renewals with rent increases, which flow into our straight-line rent. This is reflected in our new guidance for straight-line rent and fair value rental income of $75 million to $85 million for 2017, representing an increase of $5 million at the midpoint from last quarter. We’re also increasing our guidance for development and management service income based upon the results of the second quarter, and we now project $30 million to $33 million in fee income for 2017. We have not changed our guidance range for interest expense, though the financing of Colorado Center this quarter is dilutive to our 2017 earnings, and will reduce our income from joint ventures by about $4 million. The anticipated net loss to our budget is about $0.01 per share. So in summary, we are increasing our guidance for 2017 funds from operations to $6.20 to $6.25 per share. This is an increase of $0.04 per share at the midpoint, that represents an increase of $0.04 per share from improvement in portfolio NOI. That’s $0.01 per share from management and development services income, offset by a reduction of $0.01 per share from our financing activities. As Owen mentioned, we added three additional developments to our pipeline totaling nearly $815 million of new investment, and I want to make a few comments on our funding capacity and plans. Our development pipeline now totals $3.1 billion and has additional funding of approximately $1.5 billion remaining. At quarter-end, we had a cash position of approximately $500 million, and we have full availability under our bank line of credit and term loan facilities totaling $2 billion. Last week, we closed a 10-year fixed rate mortgage on our Colorado Center property located in Santa Monica. The loan in the amount of $550 million bears interest at a fixed rate of 3.56%. The property is held in a 50-50 joint venture, it was previously unencumbered, and we received a distribution of $250 million, adding to our liquidity. Since acquiring Colorado Center in the third quarter of last year, we have leased more than 300,000 square feet, bringing the leasing up from 65% to 93%. Our LA team has done a phenomenal job and we’re significantly exceeding our original underwriting projections both in terms of lease-up timing and stabilized projected income contribution. Upon full lease-up and stabilization, we project an unleveraged cash return of approximately 5.8%, and after rolling up existing below-market leases, we expect to achieve mid-6% returns. With long-term financing at 3.56%, the equity returns are even stronger. We have now accessed over $4.8 billion in the debt markets in 2017, demonstrating strong support we have in those capital markets. We also expect to raise approximately $225 million of construction financing, representing our share to finance a portion of the costs of The Hub on Causeway and Marriott developments. Overall, we have plenty of resources in the form of liquidity and debt facilities to fund our pipeline. As we’ve discussed in the past, our balance sheet is strong with relatively low leverage, providing more than sufficient capacity to fund these as well as additional investments without raising common equity. Lastly, I just want to remind everyone that we’re having our investor conference this fall. The date is October 4, and it will be in Boston with a formal presentation starting at 8:00 AM. We will also be doing property tours on the afternoon of October 3, and hosting a cocktail party that evening. You should have already received a save-the-date, and a formal invitation will come out soon. We look forward to seeing you all there, and as always, we appreciate your support. That completes our formal remarks. Operator, you can open up the line.

Hey, good morning, guys. You described a lot of good recent and pending leasing activity at Salesforce Tower. Just curious if you can explain briefly the drivers behind pushing that stabilization date out a couple of quarters?

So, on the stabilization, we have gotten information from Salesforce on their planned phasing in. As the building gets closer to completion, it’s going to complete at the end of this year. Salesforce has essentially six phases of work that they are putting into place, and we can start revenue recognition on the space when they complete their tenant improvements. They’ll begin moving into the building at the beginning of 2018 and, over six quarters, will phase into these six phases. The last quarter of their move-in is at the beginning of the third quarter of 2019. They will be paying us cash rent before physically occupying the space because the lease states specific dates when they must start paying cash rent. So we’ll be deferring revenue on our balance sheet as they pay cash rent before they occupy, because we can’t recognize the revenue until they occupy each phase.

Okay, that’s helpful. Thanks. And you mentioned that pre-leasing requirements have increased recently for developments. I was just wondering if you can quantify where you’d peg that today versus, say, a year or two ago?

Jed, it’s hard to give you an exact number; it depends on a lot of factors. What's the size of the building, how active is the current market, and the kinds of leasing dialogues we’ve had. But, as an example, several years ago, we launched 535 Mission in San Francisco on a speculative basis, and we probably wouldn’t do something like that today. Most of the transactions we’re doing today are substantially if not fully pre-let, as we’ve recently announced with Akamai’s headquarters and Marriott’s headquarters; we’re trying to secure a 300,000 square foot anchor commitment at 2100 Pennsylvania. It’s hard to give you an exact number; it depends on many factors but we want significant pre-letting in our new developments.

I’ll give you a real-life example. The tenant that Owen and I described is looking at Reservoir Place North at 72,000 square feet. They asked us for proposals for the next building at City Place, and we said we weren’t going to give them a proposal because 73,000, 80,000, or even a 200,000 square-foot building was not enough for us to deem it appropriate to start that building.

Thanks. Just turning to the Estee Lauder renewal. Could you just explain when the shrinkage of this space happens and what year? And your comfort level in taking back 75,000 square feet of space along with what type of package you have to offer to keep the tenant rather than have him go somewhere else. Let’s start with that. Thanks.

Let me start, and I’ll let John Powers chime in. Estee Lauder has a lease through the beginning to middle of 2020, and that lease is remaining in place. They signed an extension on 220,000 square feet and we will begin to provide them with some swing space sometime towards the end or middle of 2018, so they can start their work. I’ll let John keep going from there.

I don’t have much to add. They may, in fact, increase their square footage over the next period of time. We don’t know that. They have flexibility to take significantly more space.

Okay. As far as the rents, I mean, is this rolls down on rents flat? How should we think about that?

You should think about it as follows. When we bought the building back in 2008, there were two leases that were very, very billable market, and one of them was Wild and the other one was Aramis, Estee Lauder. We were able to keep both those tenants in the building, and we will be able to offer, I believe, those tenants really attractive lease rates lower than what we would charge a tenant that was taking 15,000 square feet or 20,000 square feet or 30,000 square feet in the building. So it’s a win-win situation for both parties.

Okay, that’s helpful. Just last question, you talked about some of the activity at 399 Park and the low rise of 601 Lex. Sounds like the activity there is pretty good. How do you feel about getting leases announced before year-end for the bulk of the space for both buildings?

John, you want to take that one?

We have some good prospects. We’re trading papers, so we’re optimistic we could have it done by year-end, but maybe it will drift into the first quarter. These are big leases, and after you have a term sheet, it’s typically 90 days to get them signed. We do have good interest on the three prospects Doug mentioned; they’re all on different time frames. One of them probably could certainly be done by the end of the year; the others will probably slip into the first quarter.

Thank you. So I just wanted to dig in a bit into your comments around the high-end of the market. You mentioned pricing is not an issue, but the depth, and maybe just private tenancies. Can you give a little bit more color on what you’ve seen with some of the higher-end spaces, maybe at 399 Park and some of the tenants that are looking at some of the floors in the GM Building?

Do you want to start with that one, John, and then I’ll add some color?

Sure. I think we have good activity at the GM Building. The funding in the market is, as Doug said, pretty flat in terms of the pricing today, but there’s still pressure on tenant improvement dollars, but there’s a lot of activity. We have a floor and part of a floor available, and we have two or three tenants looking at that at GM. We had two or three tenants looking at the four floors or more than four floors in the tower at 399.

Again, just this is sort of my market commentary. There are lots of tenants that are prepared to pay in excess of $100 per square foot to be in what I described as the 19 buildings that made deals this quarter. The challenge in Manhattan’s market is that the tenants that are paying these rates are typically smaller; thus it’s a question of the size of that pool relative to the amount of square footage that is coming into the market over time. That is where the rubber meets the road. We expect to see a lot of single-floor and two-floor deals at 30, 40, or 50,000 square feet, but it’s hard to imagine there being hundreds of thousands of square feet of leases from single tenants in excess of $100 per square foot in the current environment.

Okay, and just to clarify on the GM and Estee Lauder space, you mentioned that there will be some swing space. Are they taking some lower floors while you redevelop? Can you walk us through how that will work?

Sure. Go ahead, John.

Yes. You noticed I think it was last quarter, we took some termination income at GM. We did that to provide swing space for Estee Lauder to transition through the building. They need at least two floors to rebuild. This process will take them about three years to do, and they’ll make decisions on which brands to keep there and which to move.

Okay, great. So thank you.

Good morning, everyone. Let’s turn to LA for a second, a market where you’ve had some successful leasing at Colorado. What do you see in terms of other opportunities there? Would you stay in the West LA submarket, or would you go a little broader?

We’ve been growing LA; it is a priority for us. We’ve had initial success with Colorado Center, and we want to build on our presence there. We’ve been looking at numerous new investments, some offered by intermediaries and some through private discussions; some of them are acquisitions, while others are development and redevelopment. We’re continuing to track roughly half a dozen opportunities. The perimeter aligns with what we discussed: more West LA, Santa Monica, Beverly Hills, Hollywood, and El Segundo, as opposed to downtown. We’re not trying to grow just for growth’s sake; we want to build shareholder value, and Colorado Center has set that bar.

Great. And then maybe, Mike or Doug, if we turn back to your slides that you presented at NAREIT, has anything changed in terms of timing on the contributions from the developments or your expectations of when NOI kicks in from the projects outlined there?

Honestly, Manny, the only thing that’s changed is the developments have gone up slightly; I think it was 241, not 242 or 243. So it’s gone up a little bit because, honestly, we’re achieving more income from Salesforce Tower than we originally projected. However, we remain very cautious about timing for when these will be put in service because the first question this morning addressed the timing for the largest tenant at Salesforce Tower; it’s not within our discretion. We know when the cash is coming in, but we can not determine when the revenue recognitions will take place.

Got it. And final one for me: could you share your thoughts on your street retail? It’s been a big topic of discussion, especially as you’re leasing up at 399 and other locations?

I’ll make one comment, and then I'll let John respond. Our street retail in NYC includes a relatively small amount of square footage, although it holds significant value. We have a couple of spaces on Madison Avenue, and we’re engaged in constructive conversations with a few tenants there. The bulk of our retail in Manhattan is centered around food and lifestyle choices. For example, we're enhancing the retail at 601 Lexington Avenue with the development of a food hall and are actively seeking a master retailer to run this food hall for us. The market for retail in Manhattan, as Doug said earlier, is very challenging in many areas.

Thanks, guys, good morning. Just curious about your commentary regarding TIs going up while rents are staying stable. Can you talk about how this dovetails with the type of yield you’re expecting on some of these build-to-suit developments? Where should we expect those returns to come in compared to 12 to 18 months ago?

We mentioned in our remarks that the new developments being added are expected to yield roughly 7% cash yield for the company; that has remained our target for commercial development. We’ve typically gone through fluctuations, but frankly, we’ve achieved better than that. Overall yields have stayed relatively constant; the bar for new development has gone up, particularly in terms of preleasing requirements, which we discussed. For residential projects, yields are probably 100 basis points lower generally when we look at new development.

That’s helpful. And just turning to co-working space, you mentioned WeWork, and your plans to explore the market up in Boston. Just curious how much exposure you’re aiming for in that vertical from a tenant perspective?

Let me describe the answer to your question in two ways. We believe that co-working, and the aggregation of small tenant users is good for the market and our properties. We have been accommodating and receptive to these types of users. There are a host of these organizations; some won’t be successful, but some will thrive. We are in a position with WeWork; however, we do not have ownership stakes in WeWork as an equity owner. We have been prudent in maintaining modest amounts of tenant improvement exposure and high-quality secure deposits in the form of LCs and guarantees from their parent company. We will be thoughtful about this exposure; there are clear limits just as with other tenant types that are in early stages versus appearing as stable and established.

Great, thank you, and good morning. Owen, I want to go back to your comments on the capital markets. You mentioned that bids are rotating geographically. Could you talk about that rotation, especially concerning China, which has been in the news recently about pulling back capital? Thanks.

Jamie, this is hard to quantify; it's largely anecdotal. But a couple of things: the bid for the kinds of assets we own remains strong. I provided numerous examples of trades this quarter with low 4% cap rates, many trading to non-U.S. investors. In discussing rotation, we’re observing adjustments over the last quarter. There's certainly an uptick in Korean investors today as well as Japanese investors compared to a year ago. Some like Canadian investors appear slightly less active— although there are still numerous examples of transactions completed by every group. Regarding Chinese investors, I recognize that specific examples of capital controls have impacted some investors, and I also see many Chinese corporations and sovereign funds making significant investments in the U.S. and globally over the last quarter. Thus, I don’t think there’s a generalized wall that’s been built around China that has cut off outbound capital. In fact, we’re seeing continued robust Chinese capital inflow in the last quarter.

Okay, that’s helpful. Just recently, is there a change in that?

I can’t say there’s been a change in regulation in China that’s stopped capital flows, but I can appreciate specific cases where some investors suddenly have exited the market. However, I know there are definitely other Chinese investors actively pursuing transactions not only in the U.S. but around the world. That capital continues to flow.

I appreciate the color on interest expense for next year. You guys seem like you’re trending ahead of your core guidance, so what does your core outlook look like for next year in terms of same-store, and do you believe the better-than-expected trend from this quarter and the rest of the year will assist? I don’t think anything significantly changed from last quarter regarding same-store. Our challenge is that 399 Park has a drop of 250 basis points; thus we’ll see growth in the rest of same-store. The question is how much and how far it can cover that 2.5% drop. I believed it would be positive and overcome that. I’ll refrain from being more specific because there’s a lot of time between now and then, and we won’t provide guidance until next quarter.

Hey, guys. I think most of my questions have been answered, but I just have a quick one on the guidance. Given the beat in the quarter versus your expectations and excluding the deferred expenses, I’m wondering why it seems like roughly $0.02 upside from 2Q expectations wouldn’t have perhaps flowed through a little more, leading to slightly more upside? Or was some of that just earlier-than-expected leasing?

Most of it was indeed due to earlier timing on our part. We project that our renewals will happen, but if something is executed 45 days before expected last quarter, it starts impacting straight-lining earlier than anticipated. Similar for new leases getting completed slightly earlier than projected also lead to cash flow being recognized sooner. So at the core, this is mostly timing.

Okay, thanks. Did you provide the cap rate for the Carnegie acquisition?

We didn’t provide that detail, although I can say it was competitive with a historically attractive cap rate.

I would like to speak off the top of my head because I don’t remember the specifics. The building is around 80% leased and it was in the mid-7s. Our stabilized number is somewhere close to 8.5% to 9% once we complete the leasing.

Okay, thank you.

Good morning. Doug, can we go back to Midtown versus the far west side? You’ve spoken about the price point and the value spaces that existing buildings provide versus new construction. But clearly, if tenants are looking for efficiencies or modern spaces, the new constructions are better. But the existing buildings are still winning tenants. So, are there other things that existing Midtown buildings offer apart from just value space that keeps tenants coming back versus going for the more efficient floor plates?

Every tenant is different; they have unique characteristics. We’re dealing with tenants now that have no interest in going to the West Side at all. We’ve had other tenants in our portfolio that went to the West Side. Midtown core remains stable—it’s most sought after by many tenants, and the core of Midtown is very healthy. Tenants looking for larger spaces often find themselves limited by the size they require.

Okay, that makes sense. Then the second question, given the recent news around MTA and its infrastructure needs, do you foresee other opportunities where public-private partnerships would allow you to leverage capital for development sites or redevelopments?

There’s nothing identifiable we’re actively working on, although we’ve engaged in multiple successful projects working alongside transportation authorities on state-of-the-art buildings. A classic example is the Back Bay development working with MassDOT; don’t forget Salesforce Tower's inception involved the Transbay authority building a major transit hub in San Francisco. Public-private partnerships are a prevalent theme across our portfolio and will likely continue into the future.

Okay, thank you, Owen.

Hey, guys, good morning. Thanks for taking the question. A lot of mine have already been answered, but just on Colorado Center quickly: I read a couple of months ago that HBO is planning to vacate about 130,000 square feet in 2019. Can you comment on that? And Mike, you cited mid-6% as a stabilized yield; does that expiration impact that yield?

HBO does have a lease expiration in the beginning of 2019; however, we are not aware that they’ve made any conclusive plans to leave. There are a lot of recent articles detailing their interest in another development that has yet to commence. So, I think it will be hard for a new building, which hasn't yet begun development, to be available to them by 2019. I wouldn’t be quick to jump to conclusions based on information available.

To add, if HBO does vacate, we have strong internal demand within Colorado Center that would backfill their space, with a substantial uptick in the current rental rates HBO is paying. We're not concerned as the HBO space is among the best in Colorado Center, priced 30% to 50% below market.

Thanks a lot, guys; this is really helpful.

Hi, good afternoon, guys. So Erin Aslakson here for John. Quick question on the Estee Lauder lease. Would you anticipate rent to increase significantly when that lease commences in 2020? Can you quantify that?

I don’t want to be snarky; we’re not in a position to divulge specific details about tenant agreements. What I can state is that rent will increase from today's levels, but you will see the impact in our broader portfolio statistics and same-store tallies.

Thanks. Just one for me, probably for Doug. I appreciate the color on the rent spreads on the 1.3 million square feet of commenced leases during the quarter, but that’s backward-looking. What can you say about the spreads on leases that were executed in the quarter and whether we should expect any trend, up or down, for spreads in the coming quarters and into 2018?

I don’t have a list in front of me, but the majority of leasing at 200 Clarendon Street Building has shown dramatic rent upticks. We took space back between $35 and $45 per square foot, and we’re now achieving rents between $55 and $80 per square foot. The Embarcadero Center leasing remains consistent, typically yielding roll-ups of around 40% and 50% on a gross basis. At both 601 and 399, we’re in more of a steady pace. Our stance moving forward is focused on over $105 per square foot in rent, and that’s how we intend to approach leasing when that time arises.

Thanks. Looks like we’re about a year away from the initial occupancy of Dock72. Can you just provide an update on leasing prospects there?

We’ve leased 12 out of 16 floors on the East side and on the West. You are correct; we are about a year away from occupancy, but we have no specific deals in play yet. We’re bringing brokers out next week, and I believe that interest will grow as prospective tenants view the space firsthand. Our lack of land costs gives us an advantageous position.

Is transportation the main concern in terms of getting tenants comfortable?

There are many factors involved. Being in Brooklyn poses unique challenges, specifically concerning transportation, but now that the ferry is functioning, it’s seen as a positive advancement.

Okay. And you provided the appraised value for Colorado Center; I was wondering if you had done the same for GM Building?

We didn’t—probably in the ballpark of $4.8 billion.

Thanks for sticking with us. Doug, regarding your comment on the bridge and that you only have two remaining tenant-disruptive redevelopments planned that haven’t commenced yet, I’m curious whether we should view this as an indication that this intense pace is truly going to decline in regards to redevelopment. How important is it for BXP as a publicly traded company with investors and analysts waiting to see this incremental activity decrease over the next three years, thereby allowing the full cash flow potential of the company to materialize?

That’s a good question. I apologize for making you wait. This development pace is crucial to our success. We’ve managed to reposition the portfolio for a long time. You don't typically reposition buildings like the ones we’re doing at 399 Park Avenue and the General Motors Building every 10, 15, or 20 years; you do this every 30 or 40 years. We strategically chose to reposition our buildings now, largely due to lease expirations. Buildings like the 120,000 square feet potentially expiring at Colorado Center require basic tenant improvement projects—not a redevelopment. We are amenitizing the site while minimizing disruption to tenants. We feel good about our long-term positioning going forward.

Okay, if you would just allow me one more question. It was mentioned that the West Side is now fully leased, but many tenants haven't made their physical move yet. Is there a risk that Manhattan’s office vacancy rates could appear lower even though significant tenant moves are impending?

We keep a careful eye on lease statistics so we can gauge the timing of new supply in terms of net absorption. Overall, we anticipate that if net absorption continues as it has over the past several years, the current new construction in New York can be absorbed. Tenants may relocate to new districts, and this may create pockets of strength and weakness as we noted, but we believe the market can accommodate. The broader concern is whether net absorption continues, especially in the event of an economic downturn, as this will hinder the market in light of the impending new supply.

Right, and I guess it’s just right now, tenants are in two places—pre-leased numbers in the West Side and existing leases on the East. That’s my question. Lastly, for Princeton investment, while small this may seem in the grand scheme of things, does it present itself as more marketable? Will you ultimately consider Princeton as a larger portfolio sale candidate down the line, or are you committed to it for the long haul?

You have to treat Princeton as two distinct assets: Carnegie Center and Tower Center. Carnegie is doing well; it's maintained very high occupancy, while Tower Center is more challenging. We’re committed to Carnegie Center and engaging in prudent investments in the property to improve its overall performance.

This acquisition is opportunistic; Mack Cali is the only landlord remaining in this marketplace. We have only a few buildings still to acquire in this area. Making significant investments in Carnegie enables us to elevate the asset and ensure that it remains competitive.

Hey, guys. Just one or two follow-ups. It looks like Midtown East rezoning is expected to finalize in the next week or two. Could you share your thoughts on what this signifies for the market, and also touch on your 343 Madison development rights and the current stages of those plans?

Regarding Midtown East rezoning, it has been pending for quite some time; I don’t foresee it having dramatic impacts in the short term. Few properties are positioned to be torn down and rebuilt under the new FAR. The majority of Midtown has only been constructed under existing codes. We’re moving slowly with the MTA site and hope to have that move forward sometime early next year.

What timeline should we consider for potentially commencing that project?

It would be quite some time; we’d have to navigate through the entire city approvals process, so you’re likely looking at several years.

Okay, thanks.

That concludes all our questions. Thank you for your time and attention. We look forward to seeing everyone at our Investor Conference in early October. Thank you.