Boston Properties Inc (BXP) — Q4 2017 Earnings Call Transcript

Good morning and welcome to Boston Properties fourth 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 of these documents, they 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. 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 Owen Thomas for his formal remarks.

Thank you, Arista. Good morning, everyone. We have been very active over the last few months winning important new business and in the process delivered another strong quarter which I would summarize as follows. Delivered FFO per share $0.04 above street consensus and $0.04 above our prior forecast excluding the impact of the financing we did last quarter due to operational improvements, increase in midpoint of our full-year 2018 guidance by $0.07 after an adjustment for recent property sale. Increased our quarterly dividend by $0.05 or 7%, leased 2.4 million square feet which is significantly above our long-term quarterly average for the period, increased office portfolio occupancy by 50 basis points to 90.7%, completed an $850 million unsecured refinancing on very favorable terms, signed enhancement lease commitment and development of 20 CityPoint. Commenced development of the Hub on Causeway residential project, signed an anchor lease commitment for 66% of the office space in our 2100 Pennsylvania Avenue development. And in January, signed a lease with Leidos to develop our new headquarters at 1750 President, the last remaining site in the core of Reston Town Center. Clearly we have been having a busy and productive period. Let me first move to the macro environment. The prospects for global and U.S. growth are healthy and stable. The global economy outperformed consensus forecast last year with growth projected to be just over 3% in 2018. Though U.S. economic growth slowed in the fourth quarter of 2017 to 2.6%, growth is projected to remain at a comparable level for 2018. And we believe recent federal Tax Reform will likely provide a boost and prolong our economic recovery. Job creation also remains steady and favorable with nearly 150,000 jobs created in December and unemployment is at 4.1% at the lowest level since well before the global financial crisis. On financial markets, fears of inflation and resultant higher interest rates permeate the press and consensus thinking. Facts are, the 10 year U.S. treasury has risen only around 30 basis points this year and inflation remains fairly steady and muted at 2.1%. Though we believe, the fed is committed to further rate hikes in 2018, Interest rates continue to be low globally and we remain skeptical of a significant upward move in long-term rates in the U.S. in the near and medium-term. We think the impacts to Boston Properties of recent federal Tax Reform is clearly favorable certainly for the foreseeable future. Many of the features of the U.S. tax codes that are important to us and the real estate industry such as REIT status, like-kind exchanges, deductibility of interest, and depreciation of structures remain intact. Further, our customer base, generally taxpaying entities will have increased earnings which should spur investments and leasing activity. The office markets and sub-markets where we operate remain in general equilibrium. However, new deliveries of office space outpaced net absorption in 2017. Doug will provide more specific leasing color, but the statistics for our size major markets, our net absorption for 2017 was 2.4 million square feet or about 0.4% of occupied space while deliveries were 4.8 million feet or 0.7% of stock. Vacancy increased modestly 40 basis points to 8.4% while rents grew 3.3%. Leasing activity remains healthy with broad-based activity in both the technology and traditional industry segments. In the private real estate equity market, office transaction volume ended 2017 down 25% from 2016 levels, primarily due to less product available in the market. Though cap rates remain reasonably stable for leased assets in our core markets, many domestic and international investors have significant capital targeting commercial real estate and we foresee healthy transaction volumes and steady pricing in 2018. There once again were numerous significant asset transactions in our markets this past quarter, a few in Washington DC; 1440 New York Avenue sold for nearly $1,200 a square foot and a mid-4s cap rate to a European institution, this is a 2,000 foot building that’s fully leased. Also in Washington, a smaller 114,000 square foot building 900 G Street sold for over $1,300 a foot, a low-4s cap rate to a European high-net-worth buyer. This deal represents a new record price per square foot for the Washington DC market. In downtown Santa Monica, 520 Broadway sold for $1,036 a square foot and a 3.9% cap rate, the stabilized cap rate upon lease-up will be over 5%. In El Segundo, Campus 2100 sold for $574 per square foot in the high-4s cap rate to a domestic pension advisor. Lastly, in New York the sale of a minority interest in 1515 Broadway is under agreement at a valuation of over $1,000 a foot and a low-4s cap rate. This is a 1.8 million square foot building. It’s fully leased and it’s being recapped with a European institution. Now I will move to our capital activities. Last year, we sold $31 million in non-core assets and just completed the sale of 500 E Street in Washington DC for $128 million or around a 6% cap rate when incorporating capital required for existing tenant obligation assumed by the purchaser. In 2018, we will continue to prune non-core assets and as a result upgrade our portfolio and expect to sell approximately $200 million to $300 million of property including the 500 E Street sale. We do not anticipate a particularly active year in acquisitions, though we are always in the market reviewing deals, we would prefer to develop to 6% to 7% yields than purchase assets at a yield which is generally 200 basis points lower. Assets that require repositioning to meet our criteria and we continue to have ambition to carefully grow our footprint in LA. Development will remain our key strategy to create value for shareholders and our development activity remains very active with many new pre-leased projects either committed or under pursuit. As mentioned, this quarter, we added 20 CityPoint to the active pipeline. It’s a 211,000 square foot mirror building with 10 CityPoint in Waltham which we completed in 2015. The property is 52% pre-leased and the anchor tenant is projected to occupy in the third quarter of 2019. We added the next phase of our mixed-use Hub on Causeway development in Boston which is a 440 unit high-rise residential building. We own this in a joint venture with the Delaware North Company and our share of the project cost is $154 million. The project will deliver its first units in late 2019. With these additions, our current development pipeline stands at 12 office and residential development and redevelopments comprising 6.2 million - $3.4 billion of development. Most of the pipeline is well underway and we have $1.5 billion remaining to fund. The commercial component of this portfolio is 81% pre-leased, up from 75% last quarter and aggregate projected cash yields are approximately 7% in total. Further, we have committed to but have not yet commenced in our active pipeline 2100 Pennsylvania Avenue in Washington DC and 1750 Presidents for Leidos in Reston together representing 744,000 square feet and $520 million in investment. These projects are collectively 76% pre-leased. Lastly, we have four different tenant negotiations underway in Cambridge, Boston, Washington DC, and Reston to anchor four significant and largely pre-leased new office developments representing 2.5 million square feet of additional starts in 2018 and 2019. The pace of our new development activity has clearly accelerated over the past few quarters. This is solely due to our success in winning mandates with important customers, not due to our willingness to accept lower yields and higher levels of risk. All other projects we have recently launched and hope to start in the next few quarters are substantially pre-leased. New developments such as the Salesforce Tower will come into service over the next few quarters and dramatically increase our operating cash flow. As a result, we will be able to fund our new development pipeline using debt without materially increasing our leverage profile. If however, we elect to seek equity to fund the portion of the pipelines, it will be raised through the sale and/or joint venture of select assets or development, not through issuing equity at our current share price. To conclude, we are increasingly confident about achieving our clearly communicated plan to materially increase our NOI starting in 2019 through development deliveries and leasing up our existing assets. And growth beyond 2020 is now becoming more clear and likely given all the developments we have added and expect to add to our pipeline. I will turn it over to Doug.

Thanks Owen, good morning everybody, happy new year. I want to pick up on Owen’s economic commentary as it relates to office demand in our markets. As evidenced by their actions, our primary customers, which are larger real estate users, whether public, private, startups, or established companies are exhibiting renewed confidence by making the decision to either upgrade and consolidate their space and in some cases expand. As Owen suggested, as we begin 2018 we are as busy as we have ever been with new development investments on a pre-leased office portfolio. We also have three residential projects, Owen described the most recent and two of those are opening this year. In fact, one of them is opened as we speak and we are taking leasing in Reston. 20 CityPoint was leased to an engineering firm, and 1750 in Reston Town Center is leased to Leidos, which is a science, engineering and technology government contractor, also known as a defense contractor. They are currently in 170,000 square feet and two of our other buildings in Reston Town Center and as part of the consolidation, they are taking 100% to 175,000 square feet of this new building. While we continue to see the bulk of new incremental office demand from technology and life science businesses, there is also robust demand for new space from traditional industries. For example, if you look at the leasing activity in Manhattan in 2017, the finance, insurance, and real estate sectors led the way. I think there are some articles recently about two banks that look like they were expanding and/or consolidating in Midtown, and there are a number of recent law firms announcements that will be coming to take new space in Midtown Manhattan. One of the topics that we are being queried about recently, our expectations for market growth, rental growth in our markets. The first thing you have to consider is that we have seen significant market rental growth over the last few years from the lease-up and delivery of all of the new construction in our market. New construction rents are higher in most cases than current rents. This is true in New York City, in Boston, in San Francisco and Washington DC. Now the impact on existing inventory, which makes up the bulk of the availability in all the markets is not quite as simple to delineate. But in general, we would say that overall taking rent for existing space in 2018 are probably going to be pretty flat versus 2017. Now this excludes some of the exceptional sub-markets like Cambridge or the leasing at newer buildings south of market in San Francisco. This will also come with rising tenant improvement contributions. Now you have heard me say this before, and it bears repeating, higher concessions of the product have two factors; one is increased supply; and the second is dramatically higher construction costs when building out tenant improvement. We increased our TI contribution as we completed the last round of deals at Salesforce Tower along with significantly increasing our rental rates and our annual escalations. On the other hand, we have also had to increase our contribution in New York City as supply has become more of a factor. Now as you know, the increasing market rent is a much less important determinant of our revenue growth than the mark-to-market of our inspiring leases and changes in occupancy. This quarter the mark-to-market on our leases that have an economic impact was pretty flat overall, but varied widely by market. In Boston, we were up about 6%, so 98% of the portfolio that hit the numbers this quarter was in our suburban assets. In New York City, we were actually down just under 4%, but this was because of the big ticket relax that we had done at 399 Park Avenue and they are pretty close to the forecast that we have talked about over the last few years. The base of that building is going to be pretty flat; the high rise in the building is going to be up. In DC, we were down 6% due to a 22,000 square foot lease in our last suburban Montgomery County asset where rents have rolled out significantly. And in San Francisco we were up 62% on a small portfolio of about 50,000 square feet, which was concentrated in our Mountain View single-storey product. I’m going to start my regional comment with Salesforce Tower in San Francisco and I suspect this is the last call where we’ll have much to say about leasing activity there. During the quarter, we leased an additional 205,000 square feet including leases with a law firm, a private equity firm, an investment manager, and a co-working company. As of today, we are 97% leased and the first tenants have moved into the building. Every lease we have signed, we are negotiating, and is scheduled to commence by the third quarter of 2019. The only new construction with remaining availability in the city of San Francisco today is Park Tower, a 750,000 square foot building which will likely be available in late 2018. The next building to be delivered first in Mission is probably 2022 or beyond. Large blocks of contiguous available space are going to become in the form of sub-lets from tenants that are moving to the new construction or business failure. This quarter, our 56,000 square foot tenant at 50 Hawthorne exited the market and they entered into an as-is sub-let for their entire space with a nine-year term remaining at a mid-80s starting rent. They were paying $64 gross with a share in the subway product. As we move into 2018 our Bay Area activity is going to be centered around the 80,000 square foot block we are getting back from the one tenant, the only tenant that is relocating from Embarcadero Center to Salesforce Tower and four available floors at EC4 though they are not contiguous. Along with a whole host of early renewals that are underway. In the fourth quarter, we completed about 100,000 square feet of office leasing at Embarcadero Center. As of Monday, we have three offers on the block that we are getting back from 80,000 square feet and EC1. There will also be some rollover in Mountain View where we continue to be delighted by the strength of that market. The bulk of our portfolio increase in our 2018 estimates outlined in the press release is a direct result of the strong leasing occupancy gains from the Boston region. In Boston we completed another 66,000 square feet of leasing at 200 Clarendon during the quarter bringing our total leasing to 350,000 square feet in 2017, and we currently have another 25,000 square feet that were done this quarter and we are negotiating a deal for our last currently vacant floor 30,000 square feet. We completed our lease negotiations at the Hub on Causeway for 147,000 square feet of the 180,000 square feet of podium office space that builds as Owen said is going to be opening in the third quarter of 2019. We have reached agreement with the retail users for 36,000 square feet which will get us 95% of the retail space committed and 89% of that total project. Demand for space in Boston from growing technology tenants is as strong as we have ever seen it. Hence our discussions with another tenant possibly for the Tower at the Hub on Causeway. A year ago, I described the possible opportunity to recapture the Microsoft lease at 455 Main Street in Cambridge. This has in fact happened; we took it back on the 31st of December and we have signed a lease; we have re-let 90,000 square feet of the 105,000 square feet block. The roll-up on the 90,000 square feet is the 122% on a net basis that will hit our statistics next quarter. In our Waltham, Lexington suburban portfolio, we completed 395,000 square feet this quarter including another 71,000 at our 191 Spring Street redevelopment that’s now 88% leased and saw its first occupancy earlier this month. Last quarter we foreshadowed starting a new building and when we said we hit the goal of 20 CityPoint. And we have active interest for the remainder of that building. As we said at our investor conference the most significant opportunity for high contribution occupancy improvement is in our New York City portfolio. At 399 Park, we are in active discussions with a tenant that could take the entire low-rise block of 250,000 square feet and we have an active pipeline of tenants of between 65,000 square feet to 150,000 square feet for the low-rise space if that field doesn't happen and a number of tenants for the high-rise floors. In fact, we have in excess of 700,000 square feet of proposals outstanding at that building. At 159 East 53rd Street discussions are even further along with a tenant that will take the entire 195,000 square foot block. Tier 2 activity is significantly higher than it was at the end of the third quarter and we have multiple proposals outstanding. These deals are in line with our original rental assumption of mid to high 80s starting rents in the low rise, but our tenant improvement contribution will be higher than what our expectations were two years ago. At the top of 399, we have a full floor lease under negotiation where rents are in the $120 a square foot area. Given the condition of the space and the build-out requirements, future executed leases for these buildings will not run through our 2018 numbers, but they will be part of 2019. We completed a lot of leasing during the fourth quarter in New York City, 622,000 square feet and it was centered around long-term renewals. I previously mentioned in the previous quarter the early lease extensions that we were working on with Ann Taylor at Time Square Tower for their 2020 expirations. We have also completed a 70,000 square foot law firm renewal at Time Square Tower, a 90,000 square foot law firm expansion at 601 Lexington Avenue and on 767 Fifth, General Motors building, one of our anchor tenants has exercised an expansion rate and will be adding the 77,000 square foot of swing space that we recaptured last year. If you remember that termination income we discussed, as part of these premises, when it renews and extends in 2022, we have another anchor tenant that expanded by 39,000 square feet. Big quarter in New York on the renewal and extension perspective. Finally, our view on the high end in New York which is defined as over $100 a square foot, in 2017 is as follows. There were a lot of deals done over $100 a square foot. The most since 2008 based on total square footage. Seven of the top 10 were new constructions which tells you tenants will pay a premium for new product and on the other hand there is more competition for existing high-end space. As we look into 2018 the new buildings on the west side with space priced over $100 are significantly leased. And the next step is not going to come online until 2021 and beyond. We expect that deals completed during 2018 at over $100 a square foot are going to drift back to the existing product or the new product on the east side which has a much higher price point. Finally, DC. Last quarter, I broke our DC activities into three themes. The pattern holds true for the fourth quarter. First, matching space and tenants together to launch new development. Last quarter with Marriott and TSA, this quarter it’s 2100 Penn and 1750 in Reston. The second theme is the strength of Reston Town Center as a magnet for private sector contractors and technology tenants. This quarter we completed seven transactions for 205,000 square feet of office leasing and are working on more than 300,000 square feet of additional deals at our existing Town Center properties predominantly future of lease expirations. Finally, the CBD Class A market remains highly competitive with more availability coming online. The good news is that we don’t have a lot of space. The challenge is that there are lots and lots of options for smaller tenants. I will stop there and let Mike to continue on.

Thank you, Doug. Good morning. I’m going to start by describing our activity in the bond market last quarter. We actively monitor the market and we saw a window late in the quarter where the bond market was feeling very strong combined with a relatively stable rate environment. This was an opportunity for us to take some financing risk off the table, lock in future interest savings and refinance our 2018 debt maturities. So in December, we elected to redeem $850 million of unsecured bonds that carried a 3.85% all-in interest rate and they were scheduled to mature in November of 2018. We funded the redemption with a new seven-year deal, also $850 million with an all-in yield of 3.35%. We recorded a charge on the early redemption of $13.9 million or $0.08 per share that was not included in our prior earnings guidance. We also locked in approximately 50 basis points of interest savings or about $0.03 per share through 2018. Given the recent sell off in treasury it looks like a good decision today, but we will have to wait until late 2018 to know for sure. Turning to our earnings, our fourth quarter funds from operations came in at $1.49 per share excluding the impact of our debt redemption. Our FFO exceeded our guidance from last quarter by about $7 million or $0.04 per share. The majority of the increase came from higher than projected NOI from the portfolio that beat our budget by about $5 million. Largest contributors were the expansion by existing tenants in New York City and in Boston that occurred earlier than anticipated. About half the improvement was due to operating expenses coming in lower than our budget. Lastly, we recorded approximately $2 million of higher than projected fee income across the portfolio. Overall, 2017 was a solid year for us. We increased our dividend by 7%, we grew our FFO per share by over 3%, and we grew our share of same property NOI by 2.6% despite dealing with a significant amount of lease rollover in New York City. We also delivered developments that added approximately $17 million of incremental NOI and we are positioned to add substantially more going forward. Additionally, we completed $6 billion of debt transactions extending our maturities and reducing our overall borrowing cost by over 50 basis points. Looking at 2018, the major changes to our earnings projections come from asset sales, interest expense, and portfolio leasing assumptions. As Owen mentioned, we sold 500 East Street in Washington DC during the first week of January. 500 East Street was built in the 1980s and it was one of the first buildings we developed in Washington. We had recently extended anchor GSA lease with a long-term flat extension for the property and had minimal NOI growth going forward. The sale is not included in our prior projections and reduces our projected 2018 FFO by approximately $0.05 per share. In the portfolio as Doug described, we have strong activity on some of our vacant space particularly in Boston, New York City, and San Francisco. In Boston, we have now leased Bay Colony to over 90%. We project 200 Clarendon Street to reach 98% leased this year and we just signed a 90,000 square foot lease Doug mentioned to backfill the space vacated by Microsoft in Cambridge at a big roll up in rent. In New York City, we project 250 West 55th Street to reach near 100% occupancy this year in fact selling all of the states we got back from Al Jazeera’s termination. As Doug mentioned we have good leasing activity at 399 Park Avenue, but we don't expect any meaningful impact to our 2018 earnings due to the timing of occupancy. In San Francisco, we are seeing a steady stream of activity and expect to continue to gain occupancy as we fill the small vacancies complete renewals and work on backfilling of the tenant base that comes back to us in early 2018. Overall, we are keeping our guidance for 2018 same property NOI growth steady. It’s a little ironic that the improvement in our fourth quarter 2017 run rate mutes the impact of the improvement in our 2018 leasing assumptions. We still assume growth in our share of same property NOI for 2018 over 2017 to be within a range of 0.5% to 2.5%, but from a higher starting point. However, we are increasing our guidance for straight-line rents by $5 million at the midpoint to a range of $55 million to $75 million and we project our occupancy will improve throughout 2018, approaching 92% by year-end. Our guidance for the incremental contribution to 2018 NOI from our development is unchanged at $40 million to $50 million. We plan to deliver two residential projects in the first half of 2018, one in Cambridge and one in Reston, but their NOI contribution for the year is projected to be nominal during the lease-up period and is expected to pick up in 2019. The two largest contributors to 2018 NOI are 888 Boylston Street which is now 93% leased, and Salesforce Tower which just commenced occupancy at the end of 2017. Salesforce Tower now 97% leased is projected to generate less than 20% of its full run rate in 2018. We project it to generate its full contribution upon stabilization in the third quarter of 2019. Our net interest expense assumptions have changed as a result of our refinancing activity and the increase in development with the addition of 20 CityPoint, the Hub on Causeway Residential and 1750 President Street to the pipeline. We project net interest expense for 2018 to be between $350 million and $380 million, which is about $7 million less than our prior expectation. After accounting for the reduction in earnings from asset sales, we are increasing our guidance at the midpoint by $0.07 per share for FFO. The changes from our prior guidance includes the loss of $0.05 per share from asset sales, improvement in the NOI contribution from the portfolio of $0.03 per share, and lower interest expense of $0.04 per share. Our guidance range for 2018 FFO is $6.23 to $6.36 per share. As both Doug and Owen described, the most significant growth driver for us going forward is from delivering our existing developments and adding new developments to the pipeline. This quarter we succeeded in both of these areas by increasing the pipeline to 81% pre-leased for commercial space, adding two new projects to the pipeline and advancing several of our other opportunities through the predevelopment phase. These activities build on the already strong growth we project over the next few years. That completes our formal remarks. Operator, if you could open up the line for questions that would be great.

It’s Michael Bilerman here with Manny. Owen, in your opening remarks you talked about the increase in development that you are seeing driven a lot by the tenants and build-to-suit opportunities that you are not aggressively going out and seeking additional risk. And I’m just curious if you flip the coin over and you think the amount of tenants that are seeking new space either in existing development that have come out of the ground or in these built-to-suit opportunities, how does that position the existing stock of office buildings in your core markets that may need substantial CapEx to keep them relevant for tenants? I know you have certainly spent a lot of capital the last couple of years in your buildings, but how do you sort of think about the trajectory going forward of that existing stock, and are you more likely to try to buy some of these buildings and put the CapEx in and use your skill set, or are you more likely to look at your portfolio and sell into it and sell off that capital need?

Well I think Michael that if you go through the development activity that we are doing, it’s a combination of factors that our customers are seeking new space. I mean obviously some of it is relocation, some of it is consolidation from multiple locations and some of it is actual growth. So it’s not all zero sum. So it’s baked out at the offset. And then second as it relates to our existing portfolio, we clearly spend a lot of time assessing each of our buildings and keeping a close watch on those buildings that we think are the most competitive and the least competitive. As we discussed at our investor conference last year, we selected quite a few of our existing assets and we have embarked upon pretty significant refresh projects, not sure I will go through all those on this call right now, but whether be it 53rd in Lex, what we have done in the suburbs of Boston, there have been a number of assets that we think are long-term viable and interesting to customers. I mean Doug talked about the work we are doing at 53rd in Lex and the leasing activity that we are seeing at 399 and 159 is very, very active. So yes, we are making those investments on assets that we think are long-term competitive; we are seeing good results from that. Lastly, we have been selectively taking assets that we don't think are going to be as competitive for the long-term and we have been pruning them. This has been a smaller activity over the last few years, but I think we fairly consistently sold between $100 million and $300 million of assets over the last two or three years.

So Michael, if you look at the four markets that we are in, and we hopefully will be significantly in Los Angeles at some point in the near future. The Boston market has primarily been driven by tenants coming into the market from outside of the market so there has been very little sort of musical chairs that are going on which has just driven the majority of the new construction, a lot of it is from the suburbs. I mean San Francisco as you are aware, the vast majority of the new construction has been taken up by growing technology tenants and so again there has been very little inventory that’s been leftover. In Washington DC there is a problem, Owen and I have referred to it as the muffin top issue which is there are a lot of people who are building new buildings and they are leasing the tops of these buildings for law firms and they are struggling with the rest of their phase and then that is a much more musical chairs market. And then you are well aware of some of your conversations with other public REITs about the issues associated with the supply in Manhattan and the issues that those buildings that are not recapitalizing themselves are going to have real issues and there is going to be a significant demarcation in the availability of space in those buildings versus new constructions and buildings that have made the leaper phase and put new capital in. 1271 is a best example of a really tired building that said they get the bullet and they put $300 million of new capital in literally redoing the systems in addition to the lobby and they are being very successful leasing space. So I think you are seeing what is actually going on in real time in these various markets.

Hey guys. Doug, if you could help clarify on Leidos just to understand correctly, how much space are they coming out of in your existing assets and when is that going to happen?

So they are coming out of 170,000 square feet, they are in two separate buildings. One of the problems just in their own prediction in Reston is that they were not all consolidated in one building and they also did a major acquisition. And so they are going into 275,000 square feet and it will happen in probably the second quarter of 2020.

Hey guys congratulations on a busy leasing quarter. You talked about the renewed confidence from tenants and obviously reported a lot of activity past quarter. I mean would you describe there it as being a really noticeable shift in tenant activity just in this last quarter from Tax Reform changes and other maybe sort of optimism from other areas? And then based on what you are seeing on the ground do you believe that net absorption of rent growth could accelerate in your markets in the next year or two?

I think Jed, maybe I will take the first part and Doug can take the second part. I think it’s a combination of factors; I don’t think a switch got slipped when Tax Reform came out and all of a sudden the leasing activity went up. But I do think it’s a positive boost, companies that pay taxes being more profitable and therefore more willing to invest. I think that is clearly a plus. I think the one thing that also is shifting is the breadth of the leasing activity. We have talked quarter after quarter about the importance of technology and life sciences and that clearly still is growing and is important, but we are also announcing growth and net absorption activity from financials, even law firms are moving in, in some cases taking more space. I think the breadth of the demand has also been very helpful.

Regarding where we think rental rates are going to go, again the challenge in these markets is that it’s a supply problem not a demand problem. To the extent that there is continued supply, I think you are going to see pressure on the economics of the existing inventory. I don’t think you are going to see pressure on the economics of the new supply. What is going on is that there is a big premium associated with the new supply relative to where tenants are moving out. The confidence is what I think is driving them to be in a position where they are prepared to make those decisions. So the best example in our portfolio most recently has been that this firm that took the space at 20 CityPoint. I mean that’s a firm, an engineering company that was located in the market. They were in a tertiary building, a not traditional high-quality office building. Based upon their business and quite frankly overall employment trends in these marketplaces and the desire and the needs to recruit and retain power, they said it’s time for us to step it up and go into a different kind of a facility. And so they are paying significantly different kinds of rent than they were paying in their previous premises. I think that story is going on, and on, and on in all of this new construction that’s occurring across our markets predominantly with these traditional tenants. We are not necessarily looking at this as simply a growth opportunity, but really a change in the way they are managing their businesses from a real estate facilities perspective.

So you don’t see the growth in concessions that you referred to, you don’t see that abating anytime soon either?

I don’t, I think that as part of the new construction and the higher rent, the market has been conditioned to a higher concession level and I think that’s across the board, across the country. I mean even on the last couple of spaces we have at Salesforce Tower, I think we literally have 30,000 square feet, we are still prepared to give $100 a square foot on a 10 to 15-year deal. But the rent has gone up a lot, I mean the rent when we originally performed at the top of that building was in the high 60s to low 70s and then high 80s to low 90s now. And the increase was 2% to 2.5% and now it’s 3% plus. So we’re getting paid for it.

We think development is more accretive for shareholders. As I mentioned, we are launching these projects; our existing development portfolio is generating about a 7% cash yield. And depending on how you look at it, we think our stock is trading in the low-5s on a cap rate basis. So we clearly think it trades at a discount to NAV but the yield is very different from where the dollars are that we are investing in development.

Thank you. Turning a little bit, you guys have been pretty active in the multifamily development business, a very different business for you; low on leasing cost, low on CapEx on the second generation. How much do you like that business going forward and do you think that’s going to become a more important integral part of your business?

John, we like it. We started in the business as you know by developing on a mix-use sites where we would acquire the site and/or entitle the site, and it would have a multifamily component. In the far past history of Boston Properties, these sites were generally sold, but we started developing them ourselves. We were successful. We have made money on it, not just on paper; we sold the Avenue in Washington DC for a very significant profit for Boston Property’s shareholders. So I think we demonstrated the ability to do it and as we run across and we come across sites that we believe and we think we can generate the kinds of yields that we have been talking about, we are going to continue to grow it.

So for the most part, it's both the what I referred was life science companies and they are coming from out of state as well as the suburbs. There are some technology companies, and they are coming predominantly from the suburban locations and those are locations in the greater 128 area. So Lexington and Waltham and places like that. Interestingly, there are other growing tenants in those same submarkets that are grabbing the space that’s coming available. There is incremental net organic demand and new business activity in the suburban Boston, the deal where you were starting that is absorbing the state as these other tenants are moving into the city.

Hi guys. Owen, maybe just going back to your commentary about the ability to fund new development with debt at this point not really impacting leverage. I'm just curious at this point in the cycle, maybe what is the high end of your target range on debt-to-EBITDA versus looking to accelerate asset sales or joint ventures?

So right now our debt-to-EBITDA is in the mid-6s and our targeted range is somewhere plus or minus seven based upon the delivery of the development that we have going on and when the NOI comes on, it’s going to reduce our net debt-to-EBITDA to six times or even maybe below six times. As we look out at this development that we have planned plus adding some more that might happen. We feel very comfortable that we can stay below seven the entire time. There may be blips like for example in the first quarter of 2018 we are likely to blip above seven because we are not going to get any income from Salesforce Tower and all the money is going to be out. But then it’s going to come right back down through 2018. So we think that we have the ability to use debt to fund the foreseeable pipeline that we have without needing to raise any equity.

I’m going to be honest with you, I think it’s already happening. There were two institutions on the financial side, two banks that took additional space and what I refer to as traditional midtown, not the far west side. There are three or four major other transactions that we expect will happen in the first quarter. People will say, 'jeez, I guess the east side hasn’t quite lost its cluster.' Quite frankly the fact of the matter is that there is no real estate in the Hudson Yards any longer, it’s all new construction. The next buildings are coming online until 2022 plus there is available space downtown in the buildings that are currently under construction or recently completed. People are feeling really good still about midtown Manhattan and there is a significant amount of traditional tenancy that still values the grand central station and the east side amenity. We are pretty confident and again the amount of activity that we have seen in the last quarter or so at 399 now that we are showing a finished product predominantly and 159 where the skin is on and people can walk around and they can feel what we are doing and they are seeing what the likely common areas are going to look like. We are getting a great reaction and people are encouraged, a lot of this is growth.

Good morning. Thanks for taking the question. Owen in your opening remarks and then Doug later on, both made reference to obviously smartly expanding your presence in LA. And Doug you used the term near future. I was just wondering if you guys could elaborate on that. Is there anything specific that you are working on? And then I have a quick follow-up if there is time.

Yes, we are always working on new business in LA. Jon Lange is on the phone as well and we are thrilled to have Jon in the company, he has really helped us to have some boots on the ground and eyes on the ground. So we have ambition, but I have said many times we are going to do it in a profitable manner. We are not going to grow for the sake of growth. We have what we think is a nice profit in the Colorado Center acquisition and we are going to similarly seek to make profitable investments in LA. We are looking at some development things. We are looking at some existing acquisitions. It’s not an easy time to do this. I talked about a deal that sold in El Segundo for a mid to high-4s cap rate and nearly $600 a square foot. So it’s not an easy time to buy existing products, but we are hopeful through development and perhaps repositioning that we will continue to grow in LA.

Great, thanks Owen. And then on the follow-up for just kind of shifting a little bit to 399 Park. This might be a kind of hard question to answer. But in your guys’ internal planning, what probability do you guys or what timing do you guys ascribe to either all or more likely some subset of the proposals that are currently changing hands? And if those leases hit your targets, when should investors think about cash NOI or cash rents starting to hit your P&L?

The third or fourth quarter of 2019 for when the cash is going to hit the majority of it, and then our full run rate basis obviously in 2020. Right, so because you are going to get part of the year. We feel really good about our prospects. I don’t like to sort of give a probability number out there, but we are in lease discussions, actively lease discussions which means that we have letters of intent that are being pushed back and forth multiple times. We have lots of interest in the building; there are literally more than two or three tours a week on the low rise of that space and we could have lightning in a bottle and have a handshake with somebody in two days or it could take us till two months. I just can't give a good approximation on that.

Yes, this is Jon. The building is looking really good now, the side work is about 80% done, the storefront is done. We are going to finish off the entrance in the next month or two, the city is out, we demolished some of the floors so there is a reason why it's all happening now.

Great, thanks. I'm just hoping to get your latest thoughts on consolidation and just space per employee where do you think we are in that part of the cycle as you are seeing REIT leasing pickup in your market?

This is going to sound like a little bit of a cant answer. It depends on the industry group. We continue to see on a marginal basis major law firms who haven't had a lease that was “struck” in the last decade continue to reduce their square footage. I mean the lease that we signed in 2100 Pennsylvania Avenue is a significant reduction in the overall footprint of the tenants that are moving into that building. These things are going to continue to occur. On the technology and the life science side, I would say that the densities have gotten about as low as they are going to get. People are starting to sort of push back on that. We have described sort of the issues that there our major tenants in San Francisco salesforce.com thinks about in terms of how they are building out their space. They are exceedingly focused on collaboration areas which means that there are more areas that are devoted to gathering and left the areas that we devoted to “either” a desktop or an office or tabletop. So we don’t think there is much in the way of compression that is going to be going on in those locations. Businesses are expanding, they are hiring new people, you look at the unemployment rates across our major markets and you see a dearth of available labor and so people are clearly grabbing every employee that’s around. So that means that they are expanding which means that they are taking additional space.

Yes, I will give it a shot. Well this is crystal ball time. I'm not sure how valuable this will be. Look, this is related to economic growth. The job creation is going to be related to GDP growth and there are lots of experts out there that predict whenever sessions going to occur I'm not sure we are exactly able to do that. I did provide some data at the Investor Conference last year that showed we are long in this cycle from a timing standpoint, but we are not long in this cycle from a net job creation standpoint. I also talked in my remarks about the Tax Reform and what impact that will have on the economy. So Jamie, I wish I could be more specific with you; I don’t think we know exactly when the next recession is going to occur. We don’t think it’s near-term and I think job creation will follow that. In the markets that are in, we believe magnets for employment. So when younger people graduate from a university with a PhD or a masters or a BA, they are going to markets where there are the most opportunities for jobs and job growth, and those happen to be the markets that we are in and the universities are trying to make sure that they are providing the right skill sets for these types of workers. I mean clearly I’m surprised no one has asked about it, but I will bring it up. I mean Amazon is saying that they are going to go to a new city and hire 50,000 people over a 10-year period. That’s a lot of people. When you have a 2% or 2.5% or 3% unemployment rate, you wonder where those people are going to come from and presumably they are going to come from certain companies that are no longer viable, that are going to have an exit. Then also migration from other parts of the country into those markets where the jobs are most plentiful. I mean that’s I think we’re seeing happening in the markets like San Francisco.

Hi, thanks. I was just hoping to get an update on the NOI bridge, how far along are you now on a leased percentage and where might you end 2018?

So this is like a torture question, right. I purposely didn’t bring up that word because I was hoping that we would never have to talk about it again. So big picture if you really care. So the numbers are $155 million; there is $86 million that’s signed; there is $10 million that’s pretty close; the incremental contribution from 399 is between $40 million and $45 million. The rest of it is from EC, Gateway, General Motors building and Colorado Center and that gets you to a $155 million. All of it is going to show up in our same-store result and our occupancy, and that’s hopefully the way we’re going to sort of address it on a going-forward basis.

Okay. So you are not going to give where you are on the leased percentage right now?

I can’t tell you on a square footage basis because we never sort of think about that way, we think about it on a revenue basis. I mean you can ask me the question every quarter and if I have the numbers I’m happy to give them to you, but we are moving into sort of saying okay we have given you a 2018 number we have given you a 2019 number. We told you when all this stuff is going to come online. You will know when we do a lease at 399 because we’ll tell you I promise. That will be the biggest contribution to getting us really close to the ultimate objective.

Hi good morning. Just two quick questions. First, for Michael about the dispositions that you guys talked about which includes the one that already closed in DC; the $200 million of $300 million. Does that mean there is roughly sort of another $0.05 of loss on an annualized basis that’s not in guidance or is there some sort of adjustment already reflected in guidance for what Owen outlined?

I mean we don’t have anything else in our guidance for assumed sales. We haven’t determined what assets they are; some of them might be land, and we do have some excess land that we already have kind of under agreement where it might be being re-entitled or some other things might be happening that we expect to close this year. That would have almost no impact on our FFO other than the carrying cost of insurance and taxes which is nominal. There might be a couple of non-core suburban type of assets as well that might have a moderate impact. But at this point we haven't identified and we are still working on kind of determining what assets those might be. It’s too early to say what the impact might be.

We do get cash money for those sales you know.

I know that. The second question is Owen, you mentioned that year-end you expect to get to 92%, it sounds like if you got all the city space backfill that’s another 100 basis points that gets you to 93.

What is going on. I'm sorry operator we still have the question going on.

Okay, great. So on the occupancy side, Owen, I think you said you expect to get to year-end 92% if you backfill City that gets you another 100 basis points next year to 93%. Do you think that you guys could get towards 95% or there are structural things about the portfolio meaning tenants always moving in and moving out that probably like that 93-ish may be sort of your max versus getting closer to 95% given all the demand in the market right now?

I think that we should be able to get to 94% to 95% on a run rate basis. Most of that is the availability we have in Manhattan. So that you add a 200,000 square feet we have at 159 and you add 500,000 plus square feet we have at 399 which should be leased on a long-term basis. Overall, expiration schedule that we are looking at for - and I showed you just when we did our Investor Conference, so if you look at those slides you can see it; for 2019 through 2020 it’s pretty light. So we should get there by the end of next year.

Hey. Good morning, Owen. Just going back to development conversation, obviously a lot of success in leasing there, adding a few more projects. But I was just curious; and we’re hearing a lot about labor shortages as well as rising construction costs, I haven’t heard you guys really change your development yield expectations recently. So I’m just curious I guess the implications that rent growth is keeping up with construction, but curious if you can comment on what kind of construction cost increases you have seen over the past year and then also what you are seeing from just availability of labor on the construction side?

I think I made a comment earlier on one of the reasons the tenant improvements are going up is because it’s just costing a lot more to build out space, which is I think a statement that we see significant inflation in the construction industry. When we do our base buildings, when we are making a bid on a project, sometimes we are actually bidding on the formula basis, so the tenant is paying a percentage of a factor on what the actual costs are, so it sort of moves. But in most cases, when we bid a building and we provide a rent to somebody, what we have done is we have built in cost escalation into our construction component in our development budget. Over the last three or four years, we have been building in anywhere from 3% to 6% depending upon the marketplace on an annual basis for that component of the project cost.

Okay. And then in terms of just overall availability, are you running into issues finding enough labor?

Yes, so honestly, that’s the reason for the escalation for the most part is labor shortages. So you have contractors who are working with subcontractors who are bidding to lose. In fact we are saying while we will do the job by. One of the advantages that Boston Properties has is that we are a perpetual user of labor in our markets with our contractors and with our subcontractors, and we have an impeccable reputation with regards to making payments on time, treating our subcontractors well, dealing with change orders appropriately. Because of that, I don’t want to say we get preferential pricing, but we certainly get preferential access to the subs who want to do work and know that if they do work with us in a good market, they are also going to be able to do work with us in a bad market. So we have not had a procurement problem on any of our jobs.

Okay, got it. And then I know you guys have been pretty clear that you are not going to use equity to fund any of the development needs here, but just curious in 2018 I know the development pipeline shows $1.4 billion of remaining funding needs but that obviously goes up with some of these projects that you have recently added or will be added shortly. Curious what the total CapEx budget is for 2018, how much do you actually think you will spend in 2018?

So this is capital on the existing portfolio as opposed to development spend?

No, no development spend specifically.

2018, something around $800 million.

$800 million. Okay and then just maybe one last one. Owen, you mentioned you are not concerned about a material increase in rates in 2018. But I guess what you consider material increase? I mean I guess is 3% still within that limit or how much - can you provide some color on that?

Yes. Predicting rates is obviously difficult, but I think material would be something significantly over 3%.

Okay, thank you for your time and attention and interest in Boston Properties. That concludes the call.

Thanks everyone.

Thank you.