Boston Properties Inc (BXP) — Q2 2018 Earnings Call Transcript

Thank you. Good morning and welcome to Boston Properties second quarter earnings conference call. The press release and supplemental package were distributed last night, as well as furnished on Form 8-K. In the supplemental package, the Company has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Reg G requirements. If you did not receive a copy, these documents are available in the Investor Relations section of our 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 that expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be attained. Factors and risks that could cause actual results to differ materially from those expressed or implied by forward-looking statements were detailed in Tuesday’s press release and from time to time in the Company’s filings with the SEC. The Company does not undertake a duty to update any forward-looking statements. Having said that, I’d like to welcome Owen Thomas, Chief Executive Officer; Doug Linde, President; and Mike LaBelle, Chief Financial Officer to the call. During the question-and-answer portion of our call, Ray Ritchey, Senior Executive Vice President and our regional management teams will also be available to address any questions. And now, I’d like to turn the call over to Owen Thomas for his formal remarks.

Thank you, Sara, and welcome to Boston Properties. Sara joined us last week as Vice President and Head of Investor Relations and comes with a wealth of experience in the field. We are delighted that you are here. Good morning, everyone. Second quarter marked another strong period of wins in leasing and new investments, and we continue to complete major steps towards achieving our growth goals. In this last quarter, we generated FFO per share which is $0.04 above our guidance, $0.02 above street consensus and increased the midpoint of our full-year 2018 FFO guidance by $0.07. We leased 1.7 million square feet, which is well above our long-term quarterly average for the period. This brings us to almost 4 million square feet leased in the first half of the year, and we achieved several important leasing wins on key in-service assets, which Doug will review. And just this past July, we secured Verizon as anchor tenant to develop a 627,000 square-foot office tower in Boston as the last phase of our Hub on Causeway project with Delaware North. We closed the acquisition of Santa Monica Business Park in West LA with CPPIB as a capital partner, and we closed a joint venture with the Moinian Group for the future development of 3 Hudson Boulevard, a large-scale office property in the Hudson Yards. So, overall, Q2 was a strong quarter for Boston Properties with activity in leasing, development and acquisitions continuing in July. We continue to experience a positive environment for commercial real estate, including high-quality office assets in gateway cities which is our focus with several economic and market tailwinds. First, overall economic conditions continue to be quite favorable and have if anything improved since last quarter. Though impacted by timing of new trade tariffs, second quarter U.S. GDP growth was 4.1% and is projected to be 2.8% for all of 2018. Job creation remains steady with 630,000 jobs created in the second quarter and the unemployment rate stable at 4%. Though the prospects of trade wars and political turmoil is unsettling and economic downturn does not seem imminent to us. On capital markets, though the Fed increased rates 25 basis points in June and is signaling additional increases in 2018, the 10-year treasury rate actually as of morning is trading roughly flat to the level that it traded on our last earnings call. Obviously, the yield curve is flattening, given low inflation in global market forces. We don’t see significant long-term interest rate increases as a major risk factor to our business at this time. Given this economic backdrop and the fact that the supply and demand of office space remain in general equilibrium, leasing activity is healthy across most of our geographic markets and with customers in numerous industries. In the private real estate market, transaction volume growth has turned positive. Specifically, U.S. large asset transaction volume in the second quarter increased 9% from the first quarter and 15% over the second quarter of ‘17. Office represented 31% of the transaction volume for the quarter and increased 4% from the first quarter of 2018. Investor appetite and as a result cap rates remain healthy in our core markets. There were once again numerous significant asset transactions this quarter with cap rates in the 4s and prices per square foot above replacement cost. Starting in Boston, Pier 4 in the Seaport is selling for a low 4s cap rate and just under $1,200 a foot to a domestic pension advisor. This building is 370,000 square feet and 93% leased. In New York, a 20% interest in 10 Hudson Yards sold to a domestic pension fund at a 4% cap rate and just over $1,200 a foot. The building is new, comprises 1,000,008 square feet and is fully leased. In San Francisco, 345 Brannan in the SoMa district is under agreement to sell for a San Francisco record price of $1,326 a square foot and a 5 cap rate to a REIT. Property is 110,000 feet and is 100% leased to Dropbox. And finally, in Washington DC, 2099 Pennsylvania Avenue located across the street from our future development at 2100 Pennsylvania Avenue is under agreement to sell for $1,054 a square foot and a 4% cap rate to a domestic pension advisor. This building is a little over 2,000 feet and is 98% leased. Moving to Boston Properties capital activities, we’re having an active year selling non-core assets and will likely exceed our $300 million disposition target this year. We recently closed the sale of 91 Hartwell Avenue in Lexington, Mass for $22 million. With this sale, we’ve completed nearly $150 million in dispositions year-to-date. We are marketing for sale 1333 New Hampshire Avenue located near Dupont Circle in Washington DC. This 320,000 square foot property will be fully vacated by Akin Gump in 2019. We are executing many new developments in DC and the lighter renovation of this asset justified by market conditions is not a good fit with our ongoing strategy. We are considering recapitalization options for our 634,000 square foot build-to-suit for the TSA in Springfield, Virginia, in order to free up capital for our growing development pipeline. If completed, we will refund our invested capital to date, avoid future development draws and generate development fees as well as a return on our invested capital. And we continue to explore additional sales of select non-core assets throughout the portfolio. Moving to acquisitions. Last week, we announced the closing of our Santa Monica Business Park acquisition in LA. We did enter into a joint venture with Canada Pension Plan Investment Board who will own 45% of the project and the venture completed $300 million of acquisitions financing. Boston Properties resultant equity investment in the property is approximately $180 million. On returns, our initial unleveraged cash yield is nearly 4% and is expected to be over 6% in five years due to market roll-ups and must-take space from Snap, a major tenant. Most of the property is encumbered by ground lease with an above-market coupon and a market purchase option in 10 years. The coupon on the ground rent is above the stabilized cash yield of the asset. So, the future purchase of the land will be accretive to annual returns. We are excited and honored to form this first partnership with CPPIB, which both of us hope and expect will lead to future joint investments. We’re also very pleased with our increased presence in the Los Angeles market, which doubled with this deal and our critical mass in Santa Monica. Development continues to be our primary strategy for creating value. We remain very active, pursuing both new pre-lease projects and sites for future projects. Specifically, we announced last week that Boston Properties has entered into a partnership with the Moinian Group to purchase a 25% stake in 3 Hudson Boulevard, one of the most attractive, large tenant sites in New York City. The site supports a 2 million square foot office building and is located adjacent to the nearly completed 7 train entrance. Boston Properties will assume operational control of the co-development, and construction and the foundation for the tower is already underway. We were able to acquire the site at an attractive price and minimize our capital outlay. We invested $46 million at closing and have a commitment to fund an additional $62 million in future capital if needed by the venture. We believe the purchase price for the land approximates $360 per FAR square foot and significantly less on a rentable square foot basis. When you factor in the initial FAR purchase, option prices for the remaining FAR and funding today on the foundations and below-grade base building components. We also provided $80 million of financing to replace an existing land loan. Our focus now is securing a significant anchor tenant, which is a precondition of commencing vertical construction. With the closing of the 3 Hudson Boulevard joint venture and our previously described development at 343 Madison Avenue, we now have two major sites in New York for future growth. Continuing the theme of conserving our public equity capital, we are also working toward bringing in a capital partner for the project at 343 Madison Avenue, currently in the pre-development phase. In Boston, we announced yesterday that we executed a lease agreement with Verizon Communications for approximately 440,000 square feet to anchor a 100 Causeway, a 627,000 square foot 31-story office tower. This is the last phase of the Hub on Causeway, our 1.4 million square foot multi-phase development located adjacent to North Station and the TD Garden. The first two phases of the project are underway and include a hotel and residential tower on top of the mixed-use podium. We are developing the site as part of a 50-50 joint venture with Delaware North. 100 Causeway is 70% preleased, and we are in tenant discussions to lease the balance of the building. Our future invested capital is estimated to be $260 million, and projected initial cash yields are consistent with our development hurdles, approaching 7%. Also in Boston, we’re in discussions with an existing tenant at Kendall Center to redevelop an office property for their expansion. And lastly, this quarter, in Reston, we delivered into service our 508-unit Signature residential project which is in the early phases of lease-up. Our current development and redevelopment pipeline stands at 13 office and residential projects comprising 6 million square feet and $3.3 billion of investment for our share. Most of the pipeline is well underway, and we have $1.1 billion remaining to fund. The commercial component of this portfolio is 83% preleased and aggregate projected cash yields approximate 7%. These figures exclude the $1.4 billion in new developments we have described in this and previous calls where we have anchor lease commitments but have not commenced the project including 2,100 Pennsylvania Avenue, Reston Gateway and 100 Causeway. These projects will all commence in 2018 and 2019. Our capital strategy remains unchanged. Our best use of capital today is launching new preleased development and making select value-add acquisitions for which the yields are higher than both stabilized property acquisitions and the inferred cap rate and repurchasing our shares, notwithstanding their material discount to NAV. Our best and cheapest source of capital is debt financing, which we can utilize without materially changing our credit profile due to the new debt capacity provided by the income from our development deliveries. We have and will continue to select non-core assets, which raises marginal capital. The sale of larger core assets is a less efficient funding source, given significant embedded tax gains and resulting special dividend requirements. We can accomplish our growth plan without accessing public equity capital, given the debt capacity and delivered developments, and if needed, access the plentiful private equity capital. This has been another significant quarter of wins for Boston Properties, both in the new investments I described and in leasing, which Doug is about to discuss. Our outlook and future growth plan continue to be strong and viable. We remain confident with our plan to materially increase our NOI starting in 2019 through development deliveries and leasing up our existing assets from approximately 90% to 93%. And continuing growth in 2020 and 2021 is now becoming more clear and likely, given all the new developments we’ve added and expect to add to our pipeline. Let me turn it over to Doug.

Thank you, Owen. Good morning, everybody. Last quarter, I began my comments by saying that we were as busy as we’ve ever been. We are actually busier today. Owen’s comments focused on a string of additional investments that we have moved from pursuit into the active pipeline. We’ve been communicating these opportunities for a number of quarters. In the case of 100 Causeway Street, which will be an immediate development start, once again, we found another anchor customer that matches with our fundamental strategy of creating great places where tenants can best attract and retain talent. You can’t lose track of the labor availability, employment picture in our market. The unemployment rate for people with a degree from a college, BS or BA is about 2% across the board. Finding an engaged, high-quality workforce is a critical issue for our tenants, and we believe our new and rejuvenated portfolio is a huge advantage. This is our value proposition. Last October, we had our investor conference in Boston, and we described our development activities, the major capital refreshment that was underway, our vacancy and our leasing exposure in ‘18 and ‘19. The conclusion was that the portfolio was in a really good shape, with the exception of 159 East 53rd St. and 399 Park Avenue where we had a lot to do. Those two assets with the combined availability of over 700,000 square feet have the potential to contribute $55 million of annualized first-year revenue. Remember, we only own 55% of 159 East 53rd. We explicitly stated that it was the most important operational challenge we had in front of us in ‘18. I’m pleased to report that we’ve made a lot of progress. We had 480,000 square feet of availability last October at 399 Park Avenue. If you picture our stacking plan moving from the top to the bottom, floors 39 and 38 have been leased 50,000 square feet; floors 26 and 25 have been leased 50,000 square feet. We are negotiating a lease for floors 18, 19, and 20, 70,000 square feet. The 14th floor has been leased for 40,000 square feet. We recently signed an LOI and are negotiating a lease for floors 7, 8, 9, and 10, totaling 250,000 square feet. If my math is correct, that totals 460,000 square feet of leases, 140,000 square feet which are signed. We have two tenants that are competing for the last first floor available, the 21st floor about 23,000 square feet. And just to top up this activity, this week, we expect to sign a 30-year lease commitment for the entirety of the office space at 159 East 53rd St., a total of 195,326 square feet. In total, those signed leases and leases in negotiation represent just over $55 million of revenue. The timing of the revenue recognition of the leases is consistent with our previous expectations and significantly weighted to the fourth quarter of 2019. We can control when the leases get signed. We can’t control when the tenants build out their space. In the second quarter, we completed 420,000 square feet of leasing in our Midtown portfolio that included 300,000 square feet of expansions and extensions at 601 Lex and 599 Lex, and included 75,000 square feet of what I describe as 399. Overall activity in the Midtown market continues to be strong, and the brokers we work with confirm that the activity we are seeing is consistent with the overall market. The result has been a change in mood and affirming of lease economics. The leasing activity continues to be led by the buyer sector which continues to enjoy the advantages of what Midtown Manhattan offers. Base building construction at Dock 72 is winding down, and we are building out the amenity space offerings. WeWork has commenced construction of its tenant work with an expected completion by early 2019. We have a few ongoing dialogues, which is a slight improvement from last quarter. For Brooklyn, large tenant activity has been light and tenants have more of a just-in-time perspective. So, we don’t expect much leasing until the amenity spaces are closer to completed at the end of this year. Market fundamentals continue to improve in San Francisco. There is no new product for lease in 2018, 2019, 2020, or 2021, now that a single user has leased the entire 755,000 square feet of Park Tower. The next new product to deliver will be a first admission in 2022 or beyond, and 270,000 square foot rehab expansion that just commenced at 633 Fulton. The large blocks of contiguous available sublet space stemming from tenants that are moving to new construction are disappearing. The Dropbox sublet space, 300,000-plus square feet has been leased and we believe the Salesforce sublet at Rincon Center and 405 Howard which are about 200,000 square feet each are also committed. As we move into the back half of ‘18 and ‘19, our CBD activities in Embarcadero Center where we’ve commenced our major refresh of the public areas and amenities. This quarter, we completed 109,000 square feet of office leasing in DC, including 60,000 square feet of the space made available from bank consultants moving to Salesforce Tower. We have four non-contiguous full floors at EC4 and may have the opportunity for the 60,000 square foot 3-foot block at the top of EC4 together next year. Full floor financial or business service demand isn’t as robust as the tech-led growth, but it is feeling the pressure from the lack of availability, which should lead to very favorable pricing. There has been a reduction in inventory of traditional space as landlords, including Boston Properties, speculatively build more creative office in existing traditional buildings. There have been significant increases in rents for large block availability geared toward tech tenants since they’ve been based on new construction economics. Rent growth in older towers which are traditional build-outs are also higher but at rates that are still lower than a new construction inventory. It’s a great value. Silicon Valley has also seen a pickup in activity. There have been over 4 million square feet of deals in the first half of the year from leases in excess of 100,000 square feet, the majority of which has been growth. The existing Class A inventory is being absorbed. The latest megadeal being a 1 million square foot lease at Moffett Tower in Sunnyvale for buildings that will be delivered in 2019. We did another 80,000 square feet of leasing this quarter at our single-story product in Mountain View where the average rents increased more than 100%, and starting rents are in the mid-50s, triple net. We are also responding to a multi-building build-to-suit opportunity at the station on North First. While we didn’t sign another development deal build-to-suit in DC this quarter, we did complete 650,000 square feet of leasing. The activity is concentrated in Reston where we signed 435,000 square feet, and we continue to see strong, growing demand from our incumbent tenants. Today, we have 500,000 square feet of additional leases in negotiation. In the second quarter, we completed a 235,000 square-foot renewal at Democracy Tower, which included a tenant recapturing 76,000 square feet of previously subleased space. We had a cybersecurity company sign a 50,000 square-foot lease including 15,000 square feet of expansion and an internet analytics company renewed on 84,000 square feet. We’re working on new leases and renewals with software and web services companies as well as defense contractors and engineering firms. Owen mentioned our second residential project in Reston, which came on line this quarter. We’ve leased about 178 of the 508 units, while at the same time improving the year-over-year occupancy of the 359-unit Avant project right around the corner, which ended the quarter at 95% occupancy with a 1.5% increase in year-to-year rents in the face of trying to lease 508 other units. In the district, we completed an expansion and an extension with WeWork at Met Square, our 20%-80% JV with Blackstone. Our other CBD activity was limited in the portfolio. It continues to be a very competitive Class A market, and we actually expect the potential buyer of 1333 New Hampshire to renovate and operate the building at a more moderately priced position. This is not an area of the market in which we at Boston Properties concentrate, hence the decision to exit the asset. 1333 New Hampshire, you’ll remember, was the one asset that we identified at our investor conference that we were considering for a gut renovation at major project where the only remaining component of the building was going to be its structure. This is obviously a change in plan. Owen described our expansion into the Santa Monica Business Park. The last few quarters, the corporate M&A deals surrounding HBO, Disney, Fox, Comcast, Hulu changes in ownership have really been weighing on deal activities. Nonetheless, there has been and continues to be large block activity. The shared office companies have been very active. We’re tracking over 500,000 square feet of transactions that are either completed or underway at six individual assets on the West Side. At Colorado Center, we completed a 130,000 square-foot extension with one of our tenants during the quarter. And last week, we leased the remaining large block of space at Colorado Center, 58,000 square feet at Bird, the scooter company, or the motorized scooter company, which brings our occupancy there to 98%. The tightest market in our portfolio continues to be Boston. The percentage leased in our Boston regional office assets is the strongest at 95% in total. We do not have a single vacant floor in our Boston CBD portfolio. When we started the quarter, we had one floor left at 888 Boylston. We signed one lease and expect the second to be executed this week, which will leave us with a whopping 3,300 square feet in the building. You’ll note that our leasing percentage is now 88% at the Hub on Causeway, and next quarter, you’ll see that 100 Causeway is included in our statistics at 70% leased. Our largest negotiation in the region right now involves this piece of space that’s expiring in 2022. Demand for space in Boston from growing technology tenants is as strong as we have ever seen. This quarter, the Back Bay had major absorption with a 400,000 square-foot expansion by Wayfair and a 100,000 square-foot lease with DraftKings. In addition, Amazon is expanding by taking a 430,000 square-foot building in the Seaport, a little less than the 440,000 square-foot building that Bryan is building over at The Hub. In Cambridge, where we have limited availability, our activity is centered at the Proto apartment building. We opened up the Proto 45 days ago in Cambridge. We’ve leased 82 out of 244 market rate units and 8 of 36 affordable units. Even as many tenants are attracted to the center cities of Boston and Cambridge, there continues to be significant demand in our Waltham, Lexington suburban areas. We signed the lease for the entire availability at Reservoir North, 73,000 square feet with a tenant that is upgrading out of a 30,000 square-foot B building owned by a local developer, and we are in negotiations with two tenants for 70,000 square feet of the remaining 100,000 at 20 CityPoint. Our active construction projects, including the recent delivery of the Signature, total about $3.5 billion. We’ve signed construction contracts at fixed cost for all of those projects. With the 100 Causeway Street announcement, we have another $1.4 billion of development that is in design and will be bid in the next 12 months. Changes in tariff rates and other headwinds in the construction industry are things we are mindful of when we give our budget and agree to future fixed leases for these new projects. Our budgets include, both contingencies and cost escalation estimates to manage these types of events. While we have seen an impact on certain components of our projects, our allowances are sized to manage these risks, and they are all component of the total investing estimates that we provided in our disclosure in our supplemental package that we haven’t covered. I’m going to conclude my remarks with some comments about the same-store statistics for the quarter. Boston and San Francisco had very strong rollup, 44% and 35% net respectively across their portfolios on about 335,000 square feet. New York City is down on a very small pool, mostly from leases at 599 Lex. And Washington DC is down from the 230,000 square-foot renewal we did at Democracy Tower in Reston where the initial market rents are usurped by the effect of the 3% annual rent bumps in operating expense escalations that are embedded in the prior 10-year lease. On an earnings basis, the rent is about the same. I’ll stop there and turn it over to Mike.

Thanks, Doug. Good morning, everybody. With all the transactions we completed this quarter, Owen and Doug had a lot of ground to cover. I’m going to try to describe the financial impact and talk about the quarter. So, we had a solid second quarter as we exceeded our earnings guidance, and we are raising our full-year 2018 estimates. Our second quarter funds from operations came in at $1.58 per share that’s $0.04 per share above the midpoint and $0.02 per share above the high-end of our prior guidance range. Our portfolio exceeded our estimate by $4 million, about $0.02 per share, and it was primarily related to lower operating expenses for the quarter. The majority of these expenses were repair and maintenance items that now will be incurred later this year and will not represent savings to the full year. Our development fee income also exceeded our budget for the quarter by about a penny or $1.5 million. The majority of the increase is from earning leasing commissions from our joint venture portfolio that included deals closed at Colorado Center, Metropolitan Square, and the Hub on Causeway. And lastly, our interest expense was slightly lower than our assumption due to higher capitalized interest on our development pipeline and major capital projects. As you can see in our supplemental report, our second quarter same-property NOI was down 3.3% on a cash basis compared to the second quarter of 2017. This performance was as we expected and it was in line with our prior same-property guidance and it’s primarily due to the move-outs at 399 Park Avenue in the third quarter of 2017 that we have discussed. We project our cash same-property results will improve in the back half of the year as the income from this space is fully out of the prior year period. And as Doug described, we are well on our way to re-leasing the space. As we look at the rest of 2018, we are seeing solid leasing activity in the portfolio, which we expect to result in higher top-line revenues than our prior projection. This includes several renewals in Embarcadero Center and our Mountain View portfolio, with increases in rents that will start to flow through our numbers this year. In New York City, we signed a two-floor expansion at 601 Lexington Avenue for space that expires in the fourth quarter that we had expected to be vacant. In Reston Town Center, Doug described the renewal and expansion activity we’ve achieved. And in Santa Monica, we’ve had similar success, completing a 130,000 square-foot early renewal with a large rent increase and leasing an incremental 60,000 square feet which is nearly all of our vacancy at Colorado Center. These deals will start to hit our revenues later this year and primarily impact our straight-line rents due to pre-rent periods and being early renewals where the cash rent increase comes at natural expiration. We’ve increased our assumptions for straight-line rents in 2018. However, we’ve not changed our assumptions for 2018 same-property NOI growth as we expect we will still end up within the current ranges. So, despite giving back most of our second quarter outperformance from deferring operating expenses into the second half of the year, we anticipate our full-year portfolio NOI will be a penny per share higher than our previous assumptions from higher revenues. In our non-same-property portfolio, we closed on the $627 million acquisition of Santa Monica Business Park in July. As Owen described, we completed our capital structure by bringing in CPP as a 45% partner and closing $300 million of mortgage financing at a fixed rate of just over 4%. A portion of the property is subject to a ground lease that we have accounted for as a capital lease due to our right to purchase the land in 10 years. The net contribution to our 2018 FFO is approximately $0.02 per share, including the impact of the ground lease expense and the mortgage interest expense. We also closed on the sale of 91 Hartwell Avenue, a fully leased suburban office building located in Lexington, Massachusetts. The lost income from selling 91 Hartwell costs us about $1 million of NOI in 2018. We have increased our assumptions for development and management services income in 2018 by $6 million to a new range of $37 million to $42 million for the year. In addition to exceeding our second quarter budget, we have two additional one-time leasing commissions we expect to book later this year. And we also start recognizing fee income from Santa Monica Business Park in the second half of the year. As part of our investment in 3 Hudson Boulevard, we originated an $80 million loan to refinance an existing land loan secured by the site. This is an opportunistic low leverage secured loan that will generate interest income at a positive spread to our corporate debt cost and reduce our overall carrying cost in the investment. We have modified our 2018 net interest assumptions, partially to account for the interest income for the loan. Our new range for 2018, net interest expense is $363 million to $375 million, representing a reduction of $3.5 million at the midpoint. So, for the full year 2018, we are raising our guidance range for funds from operation to $6.36 to $6.41 per share, an increase of $0.07 per share at the midpoint. The increase in our guidance is from $0.03 per share of higher projected portfolio NOI which includes Santa Monica Business Park, $0.03 per share of higher fee income, and $0.02 per share from lower net interest expense offset by the loss of a $0.01 per share from the sale of 91 Hartwell Avenue. Our guidance does not assume any additional acquisitions or dispositions. We are in the market to sell 1333 New Hampshire in Washington, and if we’re successful, we will likely close later this year. The property currently contributes approximately $10 million to our annual FFO. So, if we were to close on the sale at the end of the third quarter 2018, it will reduce FFO by less than $0.02 per share and 2019 FFO by about $0.06 per share. Looking out to 2019, we anticipate strong FFO growth with a sizable component of our development pipeline delivering during the year. We still anticipate that all of the revenue from the leasing at Salesforce Tower will commence by the end of the third quarter of 2019. Both 145 Broadway in Cambridge and the Hub on Causeway podium development will deliver in the back half of 2019, and we project incremental growth from the lease-up of our two residential developments that delivered this year. Doug described in detail the activity on the leasing front in the portfolio, with a significant driver of growth over the next two years being the lease-up of 399 Park Avenue where we currently have 480,000 square feet of high-value vacancy. We have signed leases or letters of intent on nearly all of this space. As a reminder, the majority of the income will not commence until later in 2019 as the space becomes occupied. However, we’ve made great progress in achieving our goal of having all of this space leased in 2018. The projected growth in our property NOI will be partially offset by higher interest expense in 2019. The capitalized interest for our developments delivering will drop off, and although we continue to add new projects to the pipeline, they will be funded primarily with incremental debt which will offset the capitalized interest related to the development funding. In addition, 100% of the capitalized interest associated with Salesforce Tower will stop at the end of 2018, even though revenues from that project will not stabilize until the third quarter of 2019. We will also have interest expense for our new investments including Santa Monica Business Park, 3 Hudson Yards, and the anticipated acquisition of Hines 5% interest in Salesforce Tower. We have started discussions with Hines and expect to close sometime in late 2018 or early 2019. So, while we will not be giving detailed 2019 guidance until next quarter, we want to stress that we’re delivering on all of the growth opportunities that we have been describing over the past year. And we remain confident in our plan to materially increase our NOI starting in 2019. That completes what we wanted to cover formally. Operator, if you could open up the line for questions, that would be great.

Hey. Good morning, everyone. I wondered, Doug, you discussed two sort of potential big projects in New York, one on Madison and the other in Hudson Yards, both of which required big pre-leasing before you go vertical. Can you tell us about the discussions with tenants on both those projects, maybe the type of tenants and their desire to be at one or the other and how those projects will differ?

Yes, good morning Manny. This is Owen. First, the projects are on different timelines. 3 Hudson Boulevard is fully entitled and ready to proceed, and we're currently working on the foundation to expedite our market entry. On the other hand, 343 Madison is still in the entitlement process and won't be available for new development or tenant discussions for a while. That's the first point. Secondly, we are actively marketing 3 Hudson Boulevard and, as I mentioned earlier, we're looking for a major tenant to kick off the project. We have JLL working with us to support these efforts, and we are engaged in those discussions. John, do you have anything additional to add? John Powers is on the line. John, can you hear us?

Sorry. So, the MTA site is in the future, as you said, that has to go through the unit process. And we have some issues between the city and the state regarding the taxes that have to get sorted out first. So, as you said, that’s very much in the future. And we just signed up 3 Hudson Boulevard, and we are very excited with JLL, and we’re starting to meet with tenants now.

Great. And then, switching to the West Coast, I think it’s new to us that you’re buying out the Hines, Salesforce Tower. Can you tell us is there a contractual deal there or why you sort of try to buy that small stake in the building?

Sure. So, when we set the deal up originally, we gave Hines the ability to effectively sell their interest upon stabilization. And they’ve indicated that that’s something they would like us to consider doing. And so, we are entering into a thoughtful dialogue with them about what the value of their interest is, and they haven’t promoted their position based upon the performance of the property. And we will come to some sort of a successful conclusion, hopefully in the next couple of months.

Just curious on 3 Hudson. You gave the comp at 10 Hudson. I’m just curious where you think your all-in costs and development return comes in 3 Hudson relative to kind of the stabilized value at 10 Hudson?

Okay. I don’t know a thing about what the stabilized value is for 10 Hudson other than what the purchase price was. So, it’s hard to comment on that. We believe that at the appropriate time with the appropriate tenant, we are going to be able to generate a return somewhere near what we’ve been executing on all of our other developments. The amount of space that we have to lease and the amount of speculative risk that we have to take will be obviously a key determinant in what goes on there. And we are in a position where we believe it will cost somewhere between $1,300 and $1,400 a square foot to build that building based upon the sort of market comps for our cost for construction, for TIs, for interest carry. When we start the building and what the escalation of those costs are going to be will obviously impact those numbers. Where rents will be will also impact those numbers. So, we’re not in a position today to say the cost is going to be x dollars per square foot and the return is going to be x percent because there are too many unknowns from a timing perspective.

And given how far along you guys are on the foundation, what do you think, if you guys were to get a significant pre-lease, kind of the delivery time would be from here?

So, the schedule that we have right now is somewhere between 36 and 40 months from the construction go date, once the foundation has completed to having a tenant physically in the building.

And then, just last one for me. Just curious your updated thoughts here on WeWork and exposure to kind of coworking in general as this tenant in particular kind of branches out into other areas of the real estate spectrum. Does that at all change your view on more exposure to this tenant or kind of how do you look at them as a tenant versus competitor at this point?

WeWork is an important customer of Boston Properties. In the supplemental, you’ll see they’re 14th on the sheet now in terms of their size; they’re about 0.9% of income. And we are selectively talking to them about additional stores that they would put in our buildings. As Doug described, we’re getting pretty full. So, there are fewer of those opportunities today. But for the right building and for the right situation, we would certainly consider expanding our relationship with WeWork.

Owen, great quarter. You mentioned the importance of conserving public equity capital. Does that imply you wouldn't issue equity at any price since it increases the denominator too significantly and makes it challenging to make progress, or is there a specific price at which you would prefer to issue common stock and use joint venture equity?

John, in light of the current stock price, which we believe reflects a significant discount to the true value of our assets and is yielding a rough breakeven in the low-5, we don’t view this as an appealing market for raising capital right now. The most effective approach for us at this moment is debt financing, as we are increasing our debt capacity with our ongoing developments, and the cost of debt is considerably lower than that of issuing public equity. Additionally, I want to emphasize that we don't want to increase the company's leverage. If we find ourselves needing more capital, we would definitely look to the private equity market for real estate, as evidenced by our recent Santa Monica deal, which highlights our strong access to that market and our solid partnerships. Therefore, we are prioritizing other options over public equity for raising capital.

Great, okay. And then, Mike LaBelle, your midpoint for 3Q is about $1.62, your implied midpoint for 4Q is about $1.70. Can you talk about how you get from $1.62 to $1.70? And then second. Is $1.70 a good floor when I think about quarter by quarter for 2019.

One thing to consider is that there are some one-time leasing commissions and one-time development fees in the latter half of this year. Therefore, I'm uncertain if we will achieve the same level of development fee income and leasing commissions next year, as this may not happen again. As we progress, our development will continue to contribute incrementally each quarter. We're increasing occupancy at Salesforce Tower each quarter, and once tenants move in and occupy their space, we can begin to recognize revenue. Even though we've been receiving cash from these tenants for months, we can't recognize the revenue until their spaces are completed. Additionally, we have two residential properties that will also be coming online. Another difference between the third and fourth quarters is that the summer months incur higher expenses where we operate, particularly for utilities. Thus, you will see some benefit from that in the fourth quarter.

Last question, if I may. You mentioned something interesting, Owen. You said your land at 2 Hudson or 3 Hudson was $360 per FAR, but significantly less on a net rentable square foot basis. Can you briefly explain the difference between FAR and net rentable square foot for a building like that?

John, it’s related to the ratio between the rentable square foot and the usable square feet and how the ultimate configuration of the building is. And the latter part of that is yet to be determined. But the price per rentable square foot is lower than $360.

Just two questions. First, Mike LaBelle, as we look to 2019, I want to clarify two items. One, it seems like the sale of 1333 New Hampshire is something new that we should incorporate into our models for next year. And second, regarding all the leasing that Doug mentioned at 399 and 159, and the expectation that this will significantly impact the fourth quarter of next year, is that in line with what you previously outlined at the Investor Day and earlier this year at NAREIT, or has some of that timing for revenue recognition been pushed back?

The timing regarding the New York City leasing aligns with our expectations and discussions from before. We are on track with our plan concerning the deals we are approaching and when we anticipate those will contribute to our revenue. Most of the space has been demolished and will need to be rebuilt. It typically takes tenants about 9 to 12 months to move into that space, and some have lease expirations that mean they aren’t in a hurry. For instance, a tenant may sign a lease in the third quarter of 2018, but their lease doesn’t expire until the end of 2019, allowing them to proceed slowly with their plans. We are aligned with our expectations in this regard. Additionally, concerning the development pipeline, we have provided guidance on what we expect to deliver in the coming years, and we are on track to meet those expectations for delivering spaces and starting to generate rental income. We do not foresee any changes to that. As for 1333, we have previously indicated we would consider selling it, and it is now on the market as we engage with potential buyers. It appears we are much more likely to successfully sell that asset now compared to last quarter, which is a noticeable change. We have not factored it into our guidance yet since we wait until it is finalized, but I wanted to emphasize that it seems more probable to occur.

Yes. Thanks, Alex. I think the FBI is still very much in question about whether they go forward or not. Our President has made it one of his personal agendas. And given everything else he faces, I don’t think it’s, like number one on his target to get started. In terms of GSA leasing in general, when you have something along the lines of 26 million square feet of lease expirations the next three to four years, something’s got to be done. However, it is still priced at a point that makes new development very, very challenging. So, we tend to see, I think, a lot of renewals, a lot of short-term extensions to keep the government in place with no major moves, I think on the GSA side, but certainly not the downturn we’ve seen in past cycles.

Doug, great to hear about all the activity at 399 and 159. So, can you just frame out how much of that $55 million incremental NOI is under contract versus under negotiation or LOI? And maybe handicap the possibility of any of those leases that are outside walking away at this point?

So, there are 700,000 square feet; 140,000 of it is signed. I expect that there is another 200,000 that will get signed before Friday. So, that will get to that 340,000 square feet or just about half of it. And the other two major leases are actively being negotiated. And I think our expectation is they are going to get done.

I think it’s going to move up but it’s mostly going to be in the fourth quarter. The 399 space was not all out of the portfolio until midway through the third quarter, I guess last year. So that’s still going to be in there for a part of next quarter. So, I think that it will be better than it was this quarter, and then the fourth quarter will be even better than that to achieve within the range that we provided in our supplemental.

Yes, I will summarize what I mentioned earlier. Starting with a straightforward update, we have successfully leased out Colorado Center, contributing to a slight increase in our revenue for this year. Currently, we are 98% leased, so there isn’t much to address there. At Embarcadero Center, I previously mentioned the bank consulting space, which became available when one tenant moved to Salesforce Tower. There’s a bit of tenant movement, but we have potential interest from another tenant outside the project. Additionally, we are converting two of the four floors at Embarcadero Center 4 into more tech-focused creative office spaces. We believe we will successfully lease those, with construction set to begin before the end of this year, aiming for completion before the end of the first quarter of 2019, which is when we have significant availability there. In Boston, I noted that we are 95% leased, so there is little to do there. At 611 Gateway, we are currently leasing approximately 50,000 square feet a year, with a goal of reaching about 80,000 square feet in 2018, leaving around 40,000 to 50,000 square feet that will be rented at about $42 per square foot, yielding $4 million or $1.6 million in additional revenue, which is not substantial. Overall, the rest of the portfolio is performing well. We do have some high-value spaces in New York City at the General Motors building, where we have a lease pending for the majority of one of the floors that we expect to finalize this calendar quarter. This will likely result in revenue recognition in late 2019, as it is high-revenue space. Overall, the portfolio is doing very well. Looking back to 2016 regarding our revenue bridge, we are very close to completing the goals associated with the $160 million in revenue.

Can you provide an update on the leasing progress for some of the other properties besides 399, which is progressing well? Specifically, can you discuss the timing for lease-up at 611 Gateway, Colorado Center, and Embarcadero, especially regarding the potential for an additional 70 million or 80 million in revenue?

Yes. So, I would say, we’re generally very bullish on our remaining projects and where we are with them. We definitely see a lot of good activity happening. We continue to see leasing velocity. And we believe that we’re able to achieve the parameters we have set out with very good quality buildings across our holdings.

Owen can add more on this topic as well. One reason we are acquiring properties like the Santa Monica Business Park is due to the significant barriers to entry in West LA, which are the toughest in the country. Therefore, when an opportunity arises to purchase over 40 acres in Santa Monica, we will definitely take it. The success we've experienced at Colorado Center, where we bought the property two years ago at 65% occupancy and are now nearly 100% leased, reinforces both the rarity of available sites and the incredible demand for tech space in that area.

My final question is at Signature at Reston, it’s now fully placed in service as far as multifamily, retail. You’ve done some leasing progress there. But how are the effective rents and lease-up periods compared to your underwriting, just given the amount of supply in the potential market in multifamily?

So, John, I guess, I tried to describe what I think is going on, by basically saying that the existing apartment building across the street is actually at 95% occupied with an increase in rents year to year when the Signature was not open. My implication to that was that we are well in line with our pro forma rents. The leasing is progressing. I would say if you put a lie detector on me, I would say that we would have liked to have been slightly higher leased. But the fact of the matter is that we just opened up the retail at the base of the building. And when we started the building and did our pro forma, we didn’t anticipate having signed a lease with an adjacent development for 270,000 building across the street where there is a whole on the ground and a little bit of noise and construction activities. So, there is a little bit of self-inflicted slowdown in the lease-up that we had to get through, but we’re actively moving through it.