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BXP > SEC Filings for BXP > Form 10-Q on 8-Aug-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 the relatively weak economic recovery, relatively 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

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long-term space utilization and amenity needs in the local markets in which we operate, our relationships with 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.

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. This is particularly true in the San Francisco Central Business District ("CBD"), Silicon Valley, Cambridge, Massachusetts and suburban Boston submarkets where we are seeing increasing levels of leasing activity. 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 to cater to more collaborative work environments and fit people more efficiently into less space. In addition, markets such as Washington, DC and, to a lesser extent, midtown Manhattan that are more reliant on traditional tenants, such as government, financial services and law firms, are experiencing relatively lower levels of activity and growth. We are also seeing new construction in our markets accommodating both growing tenant sectors and tenants seeking more efficient space utilization. This may result in an increase in supply and create challenges for us to increase our occupancy and the rents we can realize. Despite these challenges, we remain optimistic about the long-term operating fundamentals in all of our markets.

Leasing activity in our portfolio remains strong. During the second quarter of 2014, we signed approximately 2.1 million square feet of leases covering vacant space, extensions and expansions, and pre-leasing for our development projects, including a 714,000 square foot lease with at our Salesforce Tower (formerly Transbay Tower) in San Francisco, California. This total exceeds the approximately 1.6 million square feet of leases signed during the first quarter of 2014 with the San Francisco and Boston regions being the largest contributors. The overall percentage of leased space for the 163 properties in service (excluding the three in-service residential properties and the hotel) as of June 30, 2014 was 93.0% compared to 92.4% at March 31, 2014.

In the New York region, during the second quarter we completed approximately 315,000 square feet of leasing in twenty lease transactions improving our occupancy from 93.3% to 93.5%. The strongest sector of demand in our CBD portfolio is from smaller high-end tenants, primarily in the financial services industry. For example, we completed four leases with these types of firms at 510 Madison Avenue at rents in excess of $120 per square foot. In addition, we leased approximately 131,000 square feet at our 250 West 55th Street development project which is currently 77% leased. We commenced revenue recognition on approximately 22% of the building in the second quarter of 2014 with revenue recognition on all currently signed leases expected by the end of 2015. We are actively engaged with various law firm tenants that currently lease more than 1.8 million square feet under leases that expire in 2016 and thereafter regarding possible renewals. If completed, these renewals will elongate our lease expirations, and in the aggregate increase the long-term income from this space, but may result in short-term income interruptions as these tenants reconstruct their space and, in certain instances, reduce their space needs.

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 office occupancy rate of 95.6%. We are actively engaging our law firm tenants with future lease expirations, including three firms currently occupying approximately 794,000 square feet in our CBD portfolio, 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 reducing our near-term revenue until this space is released, but should provide for more stable long-term revenues. In addition, with the renewal of a 261,000 square foot tenant in Reston, Virginia, our suburban Washington, DC assets are 96.7% leased at June 30, 2014, with moderate rollover/exposure through the end of 2014 of approximately 5.4%.

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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 211,000 square feet, or approximately 2.4%, of the Boston CBD portfolio vacancy leased to tenants that will commence in the future. Through the end of 2015, leases for approximately 900,000 square feet are scheduled to expire, including two large blocks totaling approximately 315,000 square feet in the John Hancock Tower. This space includes
(1) 170,000 square feet at the base of the building where we anticipate creating a new second lobby and rebranding this portion of the building "120 St. James Street" and (2) 145,000 square feet in the tower. While we believe all of this space is highly marketable and current market rents are greater than the expiring rents, we expect much of this space will be vacant during 2015 as new tenants lease and build out their space. As the overall Boston markets continue to improve, we also continue to advance our development opportunities. On May 20, 2014, we commenced construction of our 888 Boylston Street development project, our planned 365,000 square foot office building above approximately 60,000 square feet of new retail space at The Shops at the Prudential Center. With the signing of a lease for approximately 130,000 square feet at the base of the building the project is currently approximately 30% leased. The East Cambridge submarket is the strongest submarket in the region and our Cambridge portfolio is approximately 100% leased. During the quarter, we completed two early renewals for approximately 155,000 square feet at net rents that are approximately 53% above the current net rent and one expansion for approximately 71,000 square feet of space that does not become available until 2017. 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 120,000 square feet of leases during the quarter. In total, our suburban portfolio same property occupancy improved 640 basis points since June 30, 2013 to 87.4%. The strong tenant demand has absorbed significant large blocks of space and created the opportunity for new construction as tenants seeking in excess of 100,000 square feet have few options. As a result, on May 20, 2014 we commenced construction of our 10 CityPoint development project totaling approximately 245,000 net rentable square feet of Class A office space located in Waltham, Massachusetts. The project is currently approximately 62% leased.

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. During the second quarter of 2014, we leased approximately 948,000 square feet, including 714,000 square feet at our Salesforce Tower development project. Construction of 535 Mission Street is on schedule and we expect to be able to deliver space to tenants and commence revenue recognition for the initial tenant in the fourth quarter of 2014. The strong market fundamentals in the San Francisco CBD generated a 24% increase in our starting net rents on second generation leases that commenced during the second quarter compared to the prior leases.

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The table below details the leasing activity during the three and six months ended June 30, 2014:

                                                Three Months Ended              Six Months Ended
                                                  June 30, 2014                  June 30, 2014
                                                                  Square Feet
Vacant space available at the
beginning of the period                                   3,104,678                     2,683,647
Property dispositions/properties taken
out of service                                                   -                             -
Properties acquired vacant space                                 -                             -
Properties placed in-service                                669,816                       669,816
Leases expiring or terminated during
the period                                                  875,985                     2,237,822

Total space available for lease                           4,650,479                     5,591,285

1st generation leases                                       701,931                       724,179
2nd generation leases with new tenants                      549,052                     1,035,685
2nd generation lease renewals                               555,879                       987,804

Total space leased                                        1,806,862                     2,747,668

Vacant space available for lease at
the end of the period                                     2,843,617                     2,843,617

Second generation leasing
Leases commencing during the period,
in square feet                                            1,104,931                     2,023,489
Average Lease Term                                        56 Months                     63 Months
Average Free Rent Period                                    38 Days                       48 Days
Total Transaction Costs Per Square
Foot(2)                                        $              20.54            $            23.74
Increase / (decrease) in Gross
Rents(3)                                                       4.53 %                        3.13 %
Increase / (decrease) in Net Rents(4)                          6.37 %                        3.97 %

(1) Second generation leases are defined as leases for space that had previously been leased. Of the 1,104,931 and 2,023,489 square feet of second generation leases that commenced during the three and six months ended June 30, 2014, respectively, leases for 666,571 and 1,340,283 square feet were signed in prior periods for the three and six months ended June 30, 2014, respectively.

(2) Total transaction costs include tenant improvements and leasing commissions and exclude free rent concessions and other inducements in accordance with GAAP.

(3) Represents the increase/(decrease) in gross rent (base rent plus expense reimbursements) on the new vs. expired leases on the 900,466 and 1,645,825 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 for the three and six months ended June 30, 2014, respectively.

(4) Represents the increase/(decrease) in net rent (gross rent less operating expenses) on the new vs. expired leases on the 900,466 and 1,645,825 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 for the three and six months ended June 30, 2014, respectively.

From July 1, 2014 to December 31, 2014, leases representing approximately 3.5% 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 2019. We believe the development of well-positioned office buildings is justified in many of our submarkets where tenants

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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. As of June 30, 2014, our current development pipeline, which excludes properties which are fully placed in-service, totals approximately 4.8 million square feet with a total projected investment of approximately $3.5 billion of which approximately $1.6 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. To date in 2014, we have completed the sale of our Mountain View Technology Park properties and Mountain View Research Park Building Sixteen property located in Mountain View, California for an aggregate sale price of approximately $92.1 million and we have additional properties under contract for sale that we expect will generate additional gross sale proceeds of approximately $345 million. 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 August 4, 2014, of approximately $0.7 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 $1.6 billion of our development pipeline that remains to be funded through 2019, approximately $166 million (of which our share is approximately $45 million) of secured debt that matures through 2015 and approximately $300 million and $250 million of unsecured senior notes that mature on April 15, 2015 and June 1, 2015, respectively. 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 June 30, 2014 included the following:

On April 1, 2014, we commenced construction of our 99 Third Avenue development project totaling approximately 17,000 net rentable square feet of retail space located in Waltham, Massachusetts. The project is currently approximately 38% leased.

On April 3, 2014, we commenced construction of our 690 Folsom Street development project totaling approximately 26,000 net rentable square feet of office and retail space located in San Francisco, California.

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 commenced construction of the building.

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

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venture partner contributed the land for a 50% interest in the joint venture and we contributed cash of approximately $39.0 million for our 50% interest. We are accounting for the joint venture on an unconsolidated basis under the equity method of accounting. Under the joint venture agreement, the partner will be entitled to up to two additional payments from the venture based on increases in total square footage of the project above 520,000 square feet and achieving certain project returns at stabilization.

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 to the joint venture. We have a 50% interest in this joint venture. We are accounting for the joint venture on an unconsolidated basis under the equity method of accounting. 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. In addition, on June 23, 2014, the joint venture obtained construction financing collateralized by the development project totaling $26.0 million. The construction financing bears interest at a variable rate equal to LIBOR plus 1.50% per annum and matures on June 23, 2017, with two, one-year extension options, subject to certain conditions.

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