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BXP > SEC Filings for BXP > Form 10-Q on 9-May-2014All Recent SEC Filings

Show all filings for BOSTON PROPERTIES INC



Quarterly Report

ITEM 2-Management's Discussion and Analysis of Financial Condition and Results of Operations

As used herein, the terms "we," "us," "our" and the "Company" refer to Boston Properties, Inc., a Delaware corporation organized in 1997, individually or together with its subsidiaries, including Boston Properties Limited Partnership, a Delaware limited partnership, and our predecessors.

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. We caution investors that any forward-looking statements presented in this report, or which management may make orally or in writing from time to time, are based on beliefs and assumptions made by, and information currently available to, management. When used, the words "anticipate," "believe," "estimate," "expect," "intend," "may," "might," "plan," "project," "result," "should," "will" and similar expressions which do not relate solely to historical matters are intended to identify forward-looking statements. Such statements are subject to risks, uncertainties and assumptions and are not guarantees of future performance, which may be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected by the forward-looking statements. We caution you that while forward-looking statements reflect our good-faith beliefs when we make them, they are not guarantees of future performance and are impacted by actual events when they occur after we make such statements. Accordingly, investors should use caution in relying on forward-looking statements, which are based on results and trends at the time they are made, to anticipate future results or trends.

Some of the risks and uncertainties that may cause our actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include, among others, the following:

the continuing impacts of high unemployment and other macroeconomic trends, which are having and may continue to have a negative effect on the following, among other things:

the fundamentals of our business, including overall market occupancy, tenant space utilization, and rental rates;

the financial condition of our tenants, many of which are financial, legal and other professional firms, our lenders, counterparties to our derivative financial instruments and institutions that hold our cash balances and short-term investments, which may expose us to increased risks of default by these parties; and

the value of our real estate assets, which may limit our ability to dispose of assets at attractive prices or obtain or maintain debt financing secured by our properties or on an unsecured basis;

general risks affecting the real estate industry (including, without limitation, the inability to enter into or renew leases, tenant space utilization, dependence on tenants' financial condition, and competition from other developers, owners and operators of real estate);

failure to manage effectively our growth and expansion into new markets and sub-markets or to integrate acquisitions and developments successfully;

the ability of our joint venture partners to satisfy their obligations;

risks and uncertainties affecting property development and construction (including, without limitation, construction delays, cost overruns, inability to obtain necessary permits, tenant accounting considerations that may result in negotiated lease provisions that limit a tenant's liability during construction, and public opposition to such activities);

risks associated with the availability and terms of financing and the use of debt to fund acquisitions and developments, including the impact of higher interest rates on the cost and/or availability of financing;

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risks associated with forward interest rate contracts and the effectiveness of such arrangements;

risks associated with downturns in the national and local economies, increases in interest rates, and volatility in the securities markets;

risks associated with actual or threatened terrorist attacks;

costs of compliance with the Americans with Disabilities Act and other similar laws;

potential liability for uninsured losses and environmental contamination;

risks associated with our potential failure to qualify as a REIT under the Internal Revenue Code of 1986, as amended;

possible adverse changes in tax and environmental laws;

the impact of newly adopted accounting principles on our accounting policies and on period-to-period comparisons of financial results;

risks associated with possible state and local tax audits;

risks associated with our dependence on key personnel whose continued service is not guaranteed; and

the other risk factors identified in our most recently filed Annual Report on Form 10-K, including those described under the caption "Risk Factors."

The risks set forth above are not exhaustive. Other sections of this report may include additional factors that could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all risk factors, nor can it assess the impact of all risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. Investors should also refer to our most recent Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q for future periods and Current Reports on Form 8-K as we file them with the SEC, and to other materials we may furnish to the public from time to time through Forms 8-K or otherwise, for a discussion of risks and uncertainties that may cause actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements. We expressly disclaim any responsibility to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events, or otherwise, and you should not rely upon these forward-looking statements after the date of this report.


We are a fully integrated self-administered and self-managed REIT and one of the largest owners and developers of Class A office properties in the United States. Our properties are concentrated in four markets-Boston, New York, San Francisco and Washington, DC. We generate revenue and cash primarily by leasing Class A office space to our tenants. Factors we consider when we lease space include the creditworthiness of the tenant, the length of the lease, the rental rate to be paid at inception and throughout the lease term, the costs of tenant improvements and other landlord concessions, current and anticipated operating costs and real estate taxes, our current and anticipated vacancy, current and anticipated future demand for office space and general economic factors. From time to time, we also generate cash through the sale of assets.

Our core strategy has always been to own, operate and develop properties in supply-constrained markets with high barriers to entry and to focus on executing long-term leases with financially strong tenants. Historically, this combination has tended to reduce our exposure in down cycles and enhance revenues as market conditions improve. To be successful in the current leasing environment, we believe all aspects of the tenant-landlord relationship must be considered. In this regard, we believe that our understanding of tenants' short- and long-term space utilization and amenity needs in the local markets in which we operate, our relationships with

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local brokers, our reputation as a premier owner and operator of Class A office properties, our financial strength and our ability to maintain high building standards provide us with a competitive advantage. We expect tenants in our markets to continue to take advantage of the ability to upgrade to high-quality space in Class A properties like ours, particularly those tenants who value our operational expertise and financial stability when making their leasing decisions.

Leasing activity has continued to improve in our submarkets in which demand is driven primarily by growth in the technology and life sciences industries. This is particularly true in the San Francisco Central Business District ("CBD"), Silicon Valley, Cambridge, Massachusetts and suburban Boston submarkets, and we remain optimistic about the long-term operating fundamentals in all of our markets. Our portfolio is concentrated in markets and submarkets where businesses are oriented on new ideas, such as technology, advertising, media and information distribution (often referred to as "TAMI"), mobility, life sciences and medical devices, and these segments of the economy are expanding and leasing additional office space. However, there continue to be headwinds against more rapid improvements in the overall office business. The strongest force is densification, which occurs as businesses seek less traditional layouts that cater to more collaborative work environments and fit people more efficiently into less space. We are also seeing moderate levels of new construction in our markets accommodating both growing tenant sectors and tenants seeking more efficient space utilization, and the resulting increase in supply presents challenges for increasing our occupancy and the rents we can realize.

Leasing activity in our portfolio during the first quarter of 2014 was strong and exceeded our five-year quarterly average as we signed approximately 1.6 million square feet of leases covering vacant space, extensions and expansions, and pre-leasing for our development projects. However, we had approximately 1.4 million square feet of lease expirations and approximately 0.9 million square feet of leases with new and existing tenants that commenced in the quarter which resulted in a decline in occupancy in our portfolio during the quarter from 93.4% at December 31, 2013 to 92.4% at March 31, 2014.

In the New York region, overall leasing activity during the quarter remained strong and we completed approximately 537,000 square feet of leasing in twenty-four lease transactions, including three leases in Princeton totaling approximately 239,000 square feet. Activity in our portfolio has improved with same property occupancy increasing by 230 basis points to 92.2% as of March 31, 2014, with little near-term lease expirations. The demand in our CBD portfolio is driven by smaller tenants, primarily in the financial services industry. We also experienced activity from larger tenants and during the quarter we signed lease extensions with two tenants at 767 Fifth Avenue (the General Motors Building) for an aggregate of approximately 150,000 square feet. Subsequent to March 31, 2014, we executed a lease with a tenant for approximately 85,000 square feet at 250 West 55th Street. Our 250 West 55th Street development project has been partially placed in-service and the property is currently 73% leased and we expect to commence revenue recognition on a portion of the signed leases beginning in the second quarter of 2014 with revenue recognition on all currently signed leases by 2015. At 510 Madison Avenue, we completed seven leases during the quarter and are in lease negotiations with four more tenants, which, if signed, will bring the property to 95% leased.

In our Washington, DC region, the overall leasing activity continues to be slow and public sector and defense contractor demand has been adversely impacted by continued federal budgetary uncertainty, sequestration and the reductions in discretionary spending programs. Our near-term exposure in the Washington, DC CBD is limited due to our strong occupancy rate of 94.7%. In addition, with the renewal of a 261,000 square foot tenant in Reston, Virginia, our suburban Washington, DC assets are 95.4% leased at March 31, 2014, with moderate rollover/exposure through 2014 of approximately 5.9%. We are actively engaging our law firm tenants with future lease expirations to provide new space configuration in exchange for extended lease terms at market rents. This may result in us reducing the amount of space the tenant leases and thus near-term revenue, but would provide for more stable long-term revenues.

In the Boston region, the expansion of the life sciences and technology industry is positively impacting each of the submarkets in which we operate. Our assets in the Boston CBD are 95.5% leased, with approximately

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205,000 square feet, or approximately 3.0%, of the Boston CBD portfolio vacancy leased to tenants that will commence in the future. We have been actively leasing space to cover our 2014-2015 lease expirations at the John Hancock Tower and the Prudential Center and have signed approximately 780,000 square feet of new leases, early renewals and relocations. However, the positive rental impact from these leases will not be realized until 2015 because (1) a portion of these leases are with existing sublease tenants and therefore higher rents will not commence until the new direct lease takes effect and (2) other tenants do not take occupancy until 2015. We have approximately 651,000 square feet of lease expirations in 2014 and 2015 in these two buildings where we expect the tenant to vacate and we have not yet signed replacement tenants. The East Cambridge submarket is the strongest submarket in the region and our Cambridge portfolio is approximately 100% leased. During the quarter, we negotiated two early renewals with tenants in Cambridge at net rents that are approximately 50% above the current net rent. In the suburbs of Boston along the Route 128 corridor, we are also benefiting from the strong tenant demand in the technology and life sciences industries with the completion of approximately 291,000 square feet of leases during the quarter. In total, our suburban portfolio same property occupancy improved 740 basis points since March 31, 2013 from 78.4% to 85.8%.

The San Francisco CBD and Silicon Valley submarkets continue to benefit from business expansion and job growth, particularly in the technology sector, which has resulted in positive absorption, lower vacancy and increasing rental rates. Despite this positive trend, since December 31, 2013, occupancy in our assets in the San Francisco CBD and Silicon Valley submarkets has declined from 89.9% to 86.1% primarily due to a 165,000 lease expiration at 3120 Zanker Road in North San Jose, California. During the first quarter of 2014, we leased approximately 309,000 square feet, including an approximately 79,000 square foot lease at our 535 Mission Street development project. Construction of 535 Mission Street is on schedule and we expect to be able to deliver space to tenants in the fourth quarter of 2014. In addition, on April 10, 2014, we announced the signing of a 714,000 square foot lease with at our 1.4 million square foot Salesforce Tower (formerly Transbay Tower). With the execution of the lease, we have committed to complete the building in early 2017 at a projected total cost of approximately $1.1 billion.

The table below details the leasing activity during the three months ended March 31, 2014:

                                                             Three Months Ended
                                                               March 31, 2014
                                                                Square Feet
Vacant space available at the beginning of the period                  2,683,647
Property dispositions/properties taken out of service                         -
Properties acquired vacant space                                              -
Properties placed in-service                                                  -
Leases expiring or terminated during the period                        1,361,837

Total space available for lease                                        4,045,484

1st generation leases                                                     22,248
2nd generation leases with new tenants                                   486,633
2nd generation lease renewals                                            431,925

Total space leased                                                       940,806

Vacant space available for lease at the end of the period              3,104,678

Second generation leasing information:(1)
Leases commencing during the period, in square feet                      918,558
Average Lease Term                                                     71 Months
Average Free Rent Period                                                 62 Days
Total Transaction Costs Per Square Foot(2)                  $              27.59
Increase / (decrease) in Gross Rents(3)                                     1.50 %
Increase / (decrease) in Net Rents(4)                                       1.29 %

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(1) Second generation leases are defined as leases for space that had previously been under lease by us. Of the 918,558 square feet of second generation leases that commenced during the three months ended March 31, 2014, leases for 673,712 square feet were signed in prior periods.

(2) Total transaction costs include tenant improvements and leasing commissions and exclude free rent concessions.

(3) Represents the increase/(decrease) in gross rent (base rent plus expense reimbursements) on the new vs. expired leases on the 745,359 square feet of second generation leases (1) that had been occupied within the prior 12 months and (2) for which the new lease term is greater than six months.

(4) Represents the increase/(decrease) in net rent (gross rent less operating expenses) on the new vs. expired leases on the 745,359 square feet of second generation leases (1) that had been occupied within the prior 12 months and
(2) for which the new lease term is greater than six months.

From April 1, 2014 to December 31, 2014, leases representing approximately 4.0% of the space at our properties will expire. As these leases expire, assuming no change in current market rental rates, we expect that the gross rental rates we are likely to achieve on new leases will on average be greater than the rates that are currently being paid.

Although we continue to evaluate opportunities to acquire assets, the abundance of capital and demand for assets has resulted in increasing prices. As a result, in the current environment we are able to develop properties at a cost per square foot that is generally less than the cost at which we can acquire older existing properties, thereby generating relatively better returns with lower annual maintenance expenses and capital costs. Accordingly, we believe the successful lease-up and completion of our development pipeline will enhance our long-term return on equity and earnings growth as these developments are placed in-service through 2018. We believe the development of well-positioned office buildings is justified in many of our submarkets where tenants have shown demand for high-quality construction, modern design, efficient floor plates and sustainable features. In addition, select first-class residential developments that are part of a mixed-use environment, which combine office, retail and residential uses, have proven successful in our markets. During the first quarter, we fully placed in-service The Avant, our 359 unit residential project in Reston, Virginia. Each of our development projects underway is pre-certified USGB LEED Silver or higher. As of March 31, 2014, our current development pipeline, which excludes properties which are fully placed in-service, totals approximately 4.0 million square feet with a total projected investment of approximately $3.2 billion of which approximately $1.4 billion remains to be funded. Additionally, we are working on several new developments in each of our markets that could commence in 2014 or later.

Given investor demand for assets like ours we continue to review our portfolio to identify properties that may have limited opportunities for cash flow growth, no longer fit within our portfolio strategy or can attract premium pricing in the current market environment as potential sales candidates. During 2013, we sold approximately $1.25 billion (our share) of assets and we are in various stages of the sale process for additional properties that we expect will exceed an aggregate of $1.0 billion in 2014. In general, we structure asset sales for possible inclusion in like-kind exchanges within the meaning of Section 1031 of the Internal Revenue Code. The ability to complete a like-kind exchange depends on many factors, including, among others, identifying and acquiring suitable replacement property(ies) within limited time periods and the ownership structure of the properties being sold and acquired, and therefore we are not always able to sell an asset as part of a like-kind exchange. When successful, like-kind exchanges enable us to defer the taxable gain on the asset sold and thus limit our REIT distribution requirement and preserve capital. If we are unable to identify and acquire suitable replacement property(ies) in a like-kind exchange, then we expect to distribute at least the amount of proceeds necessary to avoid paying a corporate level tax on the gain realized from the sale.

We continue to maintain substantial liquidity, including available cash, as of May 5, 2014, of approximately $0.9 billion and approximately $990 million available under our Operating Partnership's $1.0 billion Unsecured Line of Credit. Our more significant future funding requirements include approximately $1.4 billion of our

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development pipeline that remains to be funded through 2018 and approximately $77 million of secured debt (of which our share is approximately $70 million) that matures by the end of 2014. We have access to multiple sources of capital, including current cash balances, public debt and equity markets, secured and unsecured debt markets and potential asset sales to fund our future capital requirements.

Transactions during the three months ended March 31, 2014 included the following:

On January 27, 2014, our Compensation Committee approved the 2014 Multi-Year Long-Term Incentive Program (the "2014 MYLTIP") as a performance-based component of our overall compensation program. Under the Financial Accounting Standards Board's Accounting Standards Codification ("ASC") 718 "Compensation-Stock Compensation," the 2014 MYLTIP awards have an aggregate value of approximately $12.7 million, which amount will generally be amortized into earnings over the four-year plan period under the graded vesting method. As detailed in our proxy statement for our 2014 annual meeting of stockholders, this reflects the Compensation Committee's decision to shift a significant portion of our incentive compensation from time-based to performance-based awards to build stronger pay-for-performance alignment with our stockholders.

On January 31, 2014, the measurement period for our 2011 OPP Awards expired and our total return to shareholders ("TRS") was not sufficient for employees to earn and therefore become eligible to vest in any of the 2011 OPP Awards. As a result, we accelerated the then remaining unrecognized compensation expense totaling approximately $1.2 million. Accordingly, all 2011 OPP Awards were automatically forfeited.

On February 10, 2014, we completed and fully placed in-service The Avant at Reston Town Center development project comprised of 359 apartment units and retail space aggregating approximately 355,000 square feet located in Reston, Virginia. The retail space totaling approximately 26,000 net rentable square feet is 100% leased and the residential units are currently 32% leased.

On February 18, 2014, our Operating Partnership repaid at maturity the $747.5 million aggregate principal amount of its 3.625% exchangeable senior notes due 2014 plus accrued and unpaid interest thereon.

Transactions completed subsequent to March 31, 2014:

On April 10, 2014, a consolidated joint venture in which we have a 95% interest signed a lease with for 714,000 square feet at the new Salesforce Tower (formerly Transbay Tower), the 1.4 million square foot, 61-story Class A office development project currently under construction at 415 Mission Street in the South Financial District of San Francisco, California. In conjunction with the lease signing, we have committed to construct the building and expect to complete the building in early 2017 for a projected total cost of approximately $1.1 billion, which includes capitalized interest in accordance with generally accepted in the United States of America, or GAAP.

On April 10, 2014, we entered into a joint venture with an unrelated third party to acquire a parcel of land located at 501 K Street in Washington,
DC. We anticipate the land parcel will accommodate an approximate 520,000 square foot Class A office property to be developed in the future. The joint venture partner contributed the land for its 50% interest in the joint venture and we contributed cash of approximately $39.0 million for our 50% interest.

On April 30, 2014, our partner in our Annapolis Junction joint venture contributed a parcel of land and improvements and we contributed cash of approximately $5.4 million. We have a 50% interest in this joint venture. The joint venture has commenced construction of Annapolis Junction Building Eight, which when completed will consist of a Class A office property with approximately 125,000 net rentable square feet located in Annapolis, Maryland.

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Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, or GAAP, requires management to use judgment in the application of accounting policies, including making estimates and assumptions. We base our estimates on historical experience and on various other assumptions believed to be reasonable under the circumstances. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied resulting in a different presentation of our financial statements. From time to time, we evaluate our estimates and assumptions. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information. Below is a discussion of accounting policies that we consider critical in that they may require complex judgment in their . . .

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