波士頓物產 (BXP) 2017 Q4 法說會逐字稿

Good morning, and welcome to Boston Properties' fourth quarter earnings call. This call is being recorded. (Operator Instructions)

At this time, I would like to turn the conference over to Miss Arista Joyner, Investor Relations Manager for Boston Properties. Please go ahead.

Good morning, and welcome to Boston Properties' fourth quarter earnings conference call.

The press release and supplemental package were distributed last night as well as furnished on Form 8-K. In 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 of these documents, they are available in the Investor Relations section of our website at www.bostonproperties.com. An audio webcast of this call will be available for 12 months in the Investor Relations section of our website.

At this time, we'd like to inform you that certain statements made during this conference call, which are not historical, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Boston Properties believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that it expects -- 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 any duty to update any forward-looking statement.

Having said that, I'd like to welcome Owen Thomas, Chief Executive Officer; Doug Linde, President; and Mike LaBelle, Chief Financial Officer.

Also during the question and answer portion of our call, our regional management team will be available to answer questions as well.

I would now like to turn the call over to Owen Thomas for his formal remarks.

Thank you, Arista. Good morning, everyone. We've been very active over the last few months, winning important new business and, in the process, delivered another strong quarter, which I would summarize as follows: delivered FFO per share $0.04 above Street consensus and $0.04 above our prior forecast, excluding the impact of the financing we did last quarter due to operational improvements; increased the midpoint of our full year 2018 guidance by $0.07 after an adjustment for a recent property sale; increased our quarterly dividend by $0.05 or 7%; leased 2.4 million square feet, which is significantly above our long-term quarterly average for the period; increased office portfolio occupancy by 50 basis points to 90.7%; completed an $850 million unsecured refinancing on very favorable terms; signed an anchor lease commitment and commenced development of 20 CityPoint; commenced development of The Hub on Causeway residential project; signed an anchor lease commitment for 66% of the office space in our 2100 Pennsylvania Avenue development; and in January, signed a lease with Leidos to develop their new headquarters at 1750 Presidents, the last remaining site in the core Reston Town Center. Clearly, we have been having a busy and productive period.

Let me first move to the macro environment. The prospects for global and U.S. growth are healthy and stable. The global economy outperformed consensus forecast last year, with growth projected to be just over 3% in 2018. Though U.S. economic growth slowed in the fourth quarter of '17 to 2.6%, growth is projected to remain at a comparable level for '18, and we believe recent federal tax reform will likely provide a boost and prolong our economic recovery. Job creation also remains steady and favorable with nearly 150,000 jobs created in December, and unemployment is at 4.1%, its lowest level since well before the global financial crisis.

On financial markets, fears of inflation and resultant higher interest rates permeate the press and consensus thinking. The facts are, the 10-year U.S. Treasury has risen only around 30 basis points this year, and inflation remains fairly steady and muted at 2.1%, though we believe the Fed is committed to further rate hikes in 2018, interest rates continue to be low globally, and we remain skeptical of a significant upward move in long-term rates in the U.S. in the near to medium term.

We think the impact to Boston Properties of the recent federal tax reform is clearly favorable, certainly for the foreseeable future. Many of the features of the U.S. tax code that are important to us and the real estate industry, such as REIT status, like-kind exchanges, deductibility of interests, depreciation of structures, they remain intact. Further, our customer base, generally taxpaying entities, will have increased earnings, which should spur investment and leasing activity. The office markets and submarkets where we operate remain in general equilibrium, however, new deliveries of office space outpaced net absorption in 2017. Doug will provide more specific leasing color, but the statistics for our 5 major markets are: net absorption for 2017 was 2.4 million square feet or about 0.4% of occupied space, while deliveries were 4.8 million feet or 0.7% of stock; vacancy increased modestly 40 basis points to 8.4%, while rents grew 3.3%; leasing activity remains healthy with broad-based activity in both the technology and traditional industry segments.

In the private real estate equity market, office transaction volume ended 2017 down 25% from 2016 levels, primarily due to less product available in the market. Though cap rates remain reasonably stable for leased assets in our core markets, many domestic and international investors have significant capital target in commercial real estate, and we foresee healthy transaction volumes and steady pricing in 2018. There once again were numerous significant asset transactions in our markets this past quarter. A few are:

In Washington, D.C., 1440 New York Avenue sold for nearly $1,200 a square foot, and mid-4s cap rate to an European institution. This is a 200,000-foot building that's fully leased. Also in Washington, a smaller 114,000 square-foot building, 900G Street, sold for $1,300 a foot, a low-4s cap rate to a European high-net-worth buyer. This deal represents a new record price per square foot for the Washington, D.C. market.

In downtown Santa Monica, 520 Broadway, which is again, a little over 100,000 feet sold, and it's 50% leased to WeWork and 84% leased overall, sold for $1,036 a square foot and a 3.9% cap rate, though the stabilized cap rate upon lease-up will be over 5%.

In El Segundo, Campus 2100 sold for $574 per square foot and a high-4s cap rate to a domestic pension advisor.

And lastly, in New York, the sale of a minority interest in 1515 Broadway is under agreement at a valuation of over $1,000 a foot and a low-4s cap rate. This is a 1.8 million square-foot building, it's fully leased and it's being recapped with a European institution.

Now I'll move to our capital activities. Last year, we sold $31 million in noncore assets and just completed the sale of 500 E Street in Washington, D.C. for $128 million or around a 6% cap rate when incorporating capital required for an existing tenant obligation assumed by the purchaser. In 2018, we will continue to prune noncore assets and, as a result, upgrade our portfolio and expect to sell approximately $200 million to $300 million of properties, including the 500 E Street sale.

We do not anticipate a particularly active year in acquisitions. Though we are always in the market reviewing deals, we would prefer to develop to 6% to 7% yields than purchase assets at a yield which is generally 200 basis points lower. Assets that require repositioning could meet our criteria, and we continue to have ambition to carefully grow our footprint in L.A.

Development will remain our key strategy to create value for shareholders, and our development activity remains very active with many new preleased projects either committed or under pursuit. As mentioned, this quarter, we added 20 CityPoint to the active pipeline. It's a 211,000 square-foot mirror building to 10 CityPoint in Waltham, which we completed in 2016. The property is 52% preleased, and the anchor tenant is projected to occupy it in the third quarter of 2019.

We added the next phase of our mixed-use Hub on Causeway development in Boston, which is a 440-unit high-rise residential building. We owned this in a joint venture with the Delaware North companies, and our share of the project cost is $154 million. The project will deliver its first units in late 2019.

With these additions, our current development pipeline stands at 12 office and residential development and redevelopments, comprising 6.2 million square feet and $3.4 billion of development. Most of the pipeline is well underway, and we have $1.5 billion remaining to fund. The commercial component of this portfolio is 81% preleased, up from 75% last quarter, and aggregate projected cash yields are approximately 7% in total.

Further, we have committed to, but have not yet commenced in our active pipeline, 2100 Pennsylvania Avenue in Washington, D.C. and 1750 Presidents for Leidos in Reston, together representing 744,000 square feet and $520 million in investment. These projects are collectively 76% preleased. And lastly, we have 4 different tenant negotiations underway in Cambridge, Boston, Washington, D.C. and Reston to anchor 4 significant and largely preleased new office developments, representing 2.5 million square feet of additional starts in 2018 and '19.

The pace of our new development activity has clearly accelerated over the past few quarters. This is solely due to our success in winning mandates with important customers, not due to our willingness to accept lower yields and higher levels of risk. All of the projects we have recently launched and hope to start in the next few quarters are substantially preleased.

New developments, such as the Salesforce Tower, will come into service over the next few quarters and dramatically increase our operating cash flow. As a result, we will be able to fund our new development pipeline using debt without materially increasing our leverage profile. If, however, we elect to seek equity to fund a portion of the pipeline, it will be raised through the sale and/or joint venture of select assets or developments, not through issuing equity at our current share price.

So to conclude, we're increasingly confident about achieving our clearly communicated plan to materially increase our NOI starting in 2019 through development deliveries and leasing up our existing assets. And growth beyond 2020 is now becoming more clear and likely given all the new developments we've added and expect to add to our pipeline.

I'll turn it over to Doug.

Thanks, Owen. Good morning, everybody. Happy New Year. I want to pick up on Owen's economic commentary as it relates to office demand in our markets. As evidenced by their actions, our primary customers, which are larger real estate users, the publics, the privates, the start-ups and the established, are exhibiting renewed confidence by making the decision to either upgrade and consolidate their space and, in some cases, expand. As Owen suggested, as we began '18, we are as busy as we have ever been with new development investments on a preleased office portfolio. We also have 3 residential projects, Owen described the most recent, and 2 of those are opening this year. In fact, one of them is open as we speak and we're taking leases in Reston. 20 CityPoint was leased to an engineering firm; 1750 in Reston Town Center is leased to Leidos, a Science, Engineering and Technology government contractor, also called the defense contractor. They're currently in 170,000 square feet in 2 of our other buildings in Reston Town Center, and as part of a consolidation, they're taking 100%, 275,000 square feet, of this new building. While we continue to see the bulk of new incremental office demand from technology and life science businesses, there is also robust demand for new space, though not necessarily growth, from traditional industries. If, for example, you look at the leasing activity in Manhattan in 2017, the finance, insurance and real estate sectors led the way. I think there were some articles recently about 2 banks that looked like they were expanding and/or consolidating in Midtown, and there are a number of recent law firm announcements that will be coming to take new space in Midtown Manhattan.

One of the topics that we are being queried about recently are our expectations for market growth, rental growth in our markets. So the first thing you have to consider is that we've seen significant market rental growth over the last few years from the lease-up and delivery of all of the new construction in our market. New construction rents are higher, in most cases, than current rents. This is true in New York City, in Boston, in San Francisco and Washington, D.C. Now the impact on existing inventory, which makes up the bulk of the availability in all the markets is not quite as simple to delineate. But in general, we would say that overall, taking rents for existing space in '18 are probably going to be pretty flat versus '17. Now this excludes some of the exceptional submarkets, like Cambridge or the leasing at newer buildings South of Market in San Francisco. These will also come with rising tenant improvement contributions. Now you've heard me say this before and it bears repeating, higher concessions are the product of 2 factors: one is increased supply, and the second is dramatically higher construction costs when building out tenant improvements. We increased our TI contribution as we completed the last round of deals at Salesforce Tower, along with significantly increasing our rental rates and our annual escalations. On the other hand, we've also had to increase our contributions in New York City as supply has become more of a factor.

Now as you know, the increase in market rent is a much less important determination of our revenue growth than the mark-to-market of our expiring leases and changes in occupancy. This quarter, the mark-to-market on our leases that have an economic impact was pretty flat overall but wide -- varied widely by market. In Boston, we were up about 6%, though 98% of the portfolio that hit the numbers this quarter was in our suburban assets. In New York City, we were actually down just under 4%, but this was because of the big ticket re-lets that we have done at 399 Park Avenue, and they're pretty close to the forecasting that we've talked about over the last few years. The base of that building is going to be pretty flat, the high-rise in the building is going to be up. In D.C., we were down 6% due to a 22,000 square foot lease in our last suburban Montgomery County asset, where rents have rolled down significantly, and in San Francisco, we were up 62% on a small portfolio of about 50,000 square feet, which was concentrated in our Mountain View single-story product.

I'm going to start my regional comments with Salesforce Tower in San Francisco, and I suspect this is the last call we'll have much to say about leasing activity there.

During the quarter, we leased an additional 205,000 square feet, including leases with a law firm, a private equity firm, an investment manager and a co-working company. As of today, we are 97% leased, and the first tenants have moved into the building. Every lease we have signed or are negotiating is scheduled to commence by the third quarter of '19.

The only new construction with remaining availability in the city of San Francisco today is Park Tower's 750,000 square-foot building, which will likely be available in late '18. The next building to be delivered first in Mission is probably 2022 or beyond. Large blocks of contiguous available space are going to come in the form of sublets from tenants that are moving to the new construction or business failures. This quarter, our 56,000 square-foot tenant at 50 Hawthorne exits the market, and they entered into an as-is sublet for the entire space with a 9-year term remaining, at a mid-$80s starting rent. They were paying $64 gross. We share in the sublet profits.

As we move into '18, our Bay Area activity is going to be centered around the 80,000 square-foot block we're getting back from the one tenant, the only tenant that is relocating from Embarcadero Center to Salesforce Tower, and 4 available floors at EC 4, though they're not contiguous, along with a whole host of early renewals that were -- are underway.

In the fourth quarter, we completed about 100,000 square feet of office leasing at Embarcadero Center. As of Monday, we had 3 offers on the block that we're getting back of 80,000 square feet in EC 1, 3 offers on an 80,000 square-foot block. There will also be some rollover in Mountain View, where we continue to be delighted by the strength of that market.

The bulk of our portfolio increase in our 2018 estimates outlined in the press release is a direct result of the strong leasing occupancy gains from the Boston region. In Boston, we completed another 66,000 square feet of leasing at 200 Clarendon during the quarter, bringing our total leasing to 350,000 square feet in '17. And we currently have another 25,000 square feet that were done this quarter, and we're negotiating a deal for a last currently vacant floor, 30,000 square feet. We completed our lease negotiations at The Hub on Causeway for 147,000 square feet of the 180,000 square feet of podium office space. That building, as Owen said, is going to be opening in the third quarter of '19, and we have reached agreements with retail users for 36,000 square feet, which will get us to 95% of the retail space committed and 89% of that total project. Demand for space in Boston from growing technology tenants is as strong as we have ever seen it, hence our discussions with another tenant possibly for the tower at The Hub on Causeway.

A year ago, I described the possible opportunity to recapture the Microsoft lease at 455 Main Street in Cambridge. This has, in fact, happened. We took it back on the 31st of December. We have signed a lease, we've re-let 90,000 square feet of 105,000 square foot block. The roll up on the 90,000 square feet is 122% on a net basis. That will hit our statistics next quarter.

In our Waltham/Lexington suburban portfolio, we completed 395,000 square feet this quarter, including another 71,000 at our 191 Spring Street redevelopment, that's now 88% leased and saw its first occupancy earlier this month. Last quarter, we foreshadowed starting a new building, Owen said, we hit the goal at 20 CityPoint. And we have active interest for the remainder of that building.

As we said at our investor conference, the most significant opportunity for high-contribution occupancy improvements is in our New York City portfolio. At 399 Park, we are in active discussions with a tenant that could take the entire low-rise block, 250,000 square feet, and we have an active pipeline of tenants of between 65,000 square feet to 150,000 square feet for the low-rise space if that deal doesn't happen, and a number of tenants for high-rise floors. In fact, we have an excess of 700,000 square feet of proposals outstanding at that building.

At 159 East 53rd Street, discussions are even further along with a tenant that will take the entire 195,000 square-foot block. Here too, activity is significantly higher than it was at the end of the third quarter, and we have multiple proposals outstanding. These deals are in line with our original rental assumptions, mid- to high-$80s, starting rents in the low-rise, but our tenant improvement contribution will be higher than what our expectations were 2 years ago. At the top of 399, we have a full floor lease under negotiation where enter -- rents are at $120 a square foot area. Given the condition of the space and the buildout requirements, future executed leases for these buildings will not run through our 2018 numbers but they will be part of 2019.

We completed a lot of leasing during the fourth quarter in 2,000 -- in New York City, 622,000 square feet, and it was centered around long-term renewals. I previously mentioned, in the previous quarter, the early lease extension that we were working on with Ann Taylor at Times Square Tower for their 2020 expiration. While we've also completed a 70,000 square-foot law firm renewal at Times Square Tower, a 90,000 square-foot law firm expansion at 601 Lexington Avenue, and at 767 5th General Motors Building, one of our anchor tenants has exercised an expansion right and will be adding the 77,000 square foot of swing space that we recaptured last year, you remember that termination income that we discussed, as part of its premises when it renews and extends in '22, and we have another anchor tenant that expanded by 39,000 square feet. Big quarter in New York on the renewal and extension perspective.

Finally, our view of the high-end in New York, which is defined as over $100 a square foot, in 2017 is as follows: there were a lot of deals done over $100 a square foot, the most since 2008 based on total square footage. 7 of the top 10 were new construction, which tells you tenants will pay a premium for new product and, on the other hand, there is more competition for existing high-end space. As we look into '18, the new buildings on the west side, with space priced over $100, are significantly leased and the next set is not going to come online until 2021 and beyond. We expect that deals completed during '18 and are over $100 a square foot are going to drift back to the existing product or the new product on the east side, which has a much higher price point.

Finally, D.C. Last quarter, I broke out our DC activities into 3 themes. The pattern holds true for the fourth quarter: first, matching sites and tenants together to launch new development. Last quarter, it was Marriott and TSA, this quarter, it's 2100 Penn and 1750 in Reston. The second theme is the strength of Reston Town Center as a magnet for private-sector contractors and technology tenants. This quarter, we completed 7 transactions for 205,000 square feet of office leasing and are working on more than 300,000 square feet of additional deals at our existing Town Center properties, predominantly future lease expirations. And finally, the CBD Class A market remains highly competitive with more availability coming online. The good news is that we don't have a lot of this space, the challenge is that there are lots and lots of options for smaller tenants.

I'll stop there and let Mike continue on.

Thank you, Doug. Good morning.

I'm going to start by describing our activity in the bond markets last quarter. We actively monitor the markets and we saw a window late in the quarter where the bond market was feeling very strong combined with a relatively stable rate environment. This was an opportunity for us to take some financing risk off the table, lock in future interest savings and refinance our 2018 debt maturities. So in December, we elected to redeem $850 million of unsecured bonds that carried a 3.85% all-in interest rate and that were scheduled to mature in November of 2018. We funded the redemption with a new 7-year deal, also $850 million, with an all-in yield of 3.35%. We recorded a charge on the early redemption of $13.9 million or $0.08 per share that was not included in our prior earnings guidance. We also locked in approximately 50 basis points of interest savings or about $0.03 per share to 2018. Given the recent sell-off in treasuries, it looks like a good decision today, but we'll have to wait until late 2018 to know for sure.

Turning to our earnings, our fourth quarter funds from operations came in at $1.49 per share. Excluding the impact of our debt redemption, our FFO exceeded our guidance from last quarter by about $7 million or $0.04 per share.

The majority of the increase came from higher-than-projected NOI from the portfolio that beat our budget by about $5 million. Largest contributors were expansions by existing tenants in New York City and in Boston that occurred earlier than anticipated, and about half of the improvement was due to operating expenses coming in lower than our budget.

Lastly, we recorded approximately $2 million of higher-than-projected fee income across the portfolio.

Overall, 2017 was a solid year for us. We increased our dividend 7%, we grew our FFO per share by over 3%, and we grew our share of the same-property NOI by 2.6%, despite dealing with a significant amount of lease rollover in New York City. We also delivered developments that added approximately $17 million of incremental NOI, and we're positioned to add substantially more going forward. And we completed $6 billion of debt transactions, extending out our maturities and reducing our overall borrowing cost by over 50 basis points.

Looking at 2018, the major changes to our earnings projections come from asset sales, interest expense and portfolio leasing assumptions.

As Owen mentioned, we sold 500 E Street in Washington, D.C. during the first week of January. 500 E Street was built in the 1980s and it was one of the first buildings we developed in Washington. We had recently extended the anchor GSA lease with a long-term flat extension so the property had minimal NOI growth going forward. The sale was not included in our prior projections and reduces our projected 2018 FFO by approximately $0.05 per share.

In the portfolio, as Doug described, we have strong activity on some of our vacant space, particularly in Boston, New York City and San Francisco.

In Boston, we've now leased Bay Colony to over 90%, we project 200 Clarendon Street to reach 98% leased this year, and we just signed a 90,000 square-foot lease, as Doug mentioned, to backfill the space vacated by Microsoft in Cambridge at a big roll up in rent.

In New York City, we project 250 West 55th Street to reach near 100% occupancy this year, backfilling all of the space we got back from Al Jazeera's termination. As Doug mentioned, we have good leasing activity at 399 Park Avenue but we don't expect any meaningful impact to our 2018 earnings due to the timing of occupancy.

And in San Francisco, we're seeing a steady stream of activity and expect to continue to gain occupancy as we fill the small vacancies, complete renewals and work on backfilling of the Bain space that comes back to us in early 2018.

Overall, we are keeping our guidance for 2018 same-property NOI growth steady. It's a little ironic that the improvement in our fourth quarter 2017 run rate mutes the impact of the improvement in our 2018 leasing assumptions. We still assume growth in our same -- in our share of our same-property NOI for 2018 over 2017 to be within a range of 0.5% to 2.5% but from a higher starting point. However, we are increasing our guidance for straight-line rent by $5 million at the midpoint to a range of $55 million to $75 million, and we project our occupancy will improve throughout 2018, approaching 92% by year-end.

Our guidance for the incremental contribution to 2018 NOI from our developments is unchanged at $40 million to $50 million. We plan to deliver 2 residential projects in the first half of 2018, 1 in Cambridge and 1 in Reston, but their NOI contribution for the year is projected to be nominal during the lease-up period and is expected to pick up in 2019. The 2 largest contributors to 2018 NOI are 888 Boylston Street, which is now 93% leased, and Salesforce Tower, which just commenced occupancy at the end of 2017. Salesforce Tower, now 97% leased, is projected to generate less than 20% of its full run rate in 2018. We project it to generate its full contribution upon stabilization in the third quarter of 2019.

Our net interest expense assumptions have changed as a result of our refinancing activity and the increase in development with the addition of 20 CityPoint, The Hub on Causeway residential and 1750 Presidents Street to the pipeline. We project net interest expense for 2018 to be between $365 million and $380 million, which is about $7 million less than our prior expectation.

After accounting for the reduction in earnings from asset sales, we are increasing our guidance at the midpoint by $0.07 per share for FFO. The changes from our prior guidance include the loss of $0.05 per share from asset sales, improvement in the NOI contribution from the portfolio of $0.03 per share and lower interest expense of $0.04 per share. Our new guidance range for 2018 FFO is $6.23 to $6.36 per share.

As both Doug and Owen described, the most significant growth driver for us going forward is from delivering our existing developments and adding new developments to the pipeline. This quarter, we succeeded in both of these areas by increasing the pipeline to 81% preleased for commercial space, adding 2 new projects to the pipeline, and advancing several of our other opportunities through the predevelopment phase. These activities build on the already strong growth we project over the next few years.

That completes our formal remarks. Operator, if you could open up the line for questions, that would be great.

(Operator Instructions) And your first question comes from Manny Korchman with Citi.

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

Well, I think, Michael, that the -- if you go through the development activity that we're doing, it's a combination of factors that our customers are seeking new space. I mean, obviously, some of it is relocation, some of it is consolidation from multiple locations, and some of it is actual growth. So it's not all zero-sum, so let's take that at the outset. And then second, as it relates to our existing portfolio, we clearly spend a lot of time assessing each of our buildings and keeping a close watch on those buildings that we think are the most competitive and the least competitive. And as we went through in our investor conference last year, we selected quite a few of our existing assets and we've embarked upon pretty significant refreshment projects, not sure I'll go through all those on this call right now, but whether it'd be at 53rd and the Lex, what we've done out in the suburbs of Boston, there've been a number of assets that we think are long-term, viable and interesting to customers. I mean, Doug talked about the work we're doing at 53rd and Lex and the leasing activity that we're seeing at 399 and 159, is very, very active. So yes, we are making those investments on assets that we think are long-term competitive. We're seeing good results from that. And then lastly, we have been selectively taking assets that we don't think are going to be as competitive for the long-term and we have been pruning them. Yes, this has been a smaller activity over the last few years, but I think we've fairly consistently sold between $100 million and $300 million of assets over the last 2 or 3 years.

So Michael, and if you look at the 4 markets that we're in, in a significant way and that we will hopefully, we'll be in the significant way in Los Angeles at some point in the near future, the Boston market has primarily been driven by tenants coming into the market from outside the market, so there's been very little "sort of musical chairs" that is going on, which has driven the majority of the new construction. A lot of it's been from the suburbs. I mean, San Francisco, as you're aware, the vast majority of the new construction has been taken out by growing technology tenants. And so again, there's been very little inventory that's been left over. In Washington, D.C., we -- there's a problem, Owen and I have referred to it as the "muffin top issue" which is there are a lot of people who are building new buildings and they're leasing the tops of these buildings for law firms and they're struggling and struggle with the rest of their space and then -- that is a lot -- much more of a musical chairs market, and you're well aware, from your conversations with other public REITs, about the issues associated with the supply in Manhattan. And the issues that those tenants -- those buildings that are not recapitalizing themselves are going to have to be real issue and there's going to be a significant demarcation in availability of space in those buildings versus new construction and buildings that have made the leap of faith and put new capital in. 1271 is the best example of a really tired building that said they bit the bullet and they're going to -- they put $300 million in new capital in, literally redoing the facade and all the HVAC systems in addition to lobby, and they're going to be -- they're being very successful leasing space. So I think you're seeing what's actually going on in real time in these various markets.

I think Manny had a question, too.

Just -- Doug, if you can help clarify, on Leidos, just to understand correctly, how much space are they coming out of in your existing assets? And when is that going to happen?

So they're coming out of 170,000 square feet, they're in 2 separate buildings, they're -- so one of the problems in -- just in their own predicament in Reston is that they were not all consolidated in 1 building and then they also did a major acquisition. And so they are going into 275,000 square feet, and it will happen in probably the second quarter of 2020.

Your next question comes from Jed Reagan with Green Street Advisors.

You talked about the renewed confidence from tenants and obviously, you reported a lot of activity this past quarter. I mean, what you described there is -- it is being a really noticeable shift in tenant activity just in this last quarter from tax reform changes and other maybe sort of optimism from other areas. And then based on what you're seeing on the ground, do you believe that net absorption or rent growth could accelerate in your markets in the next year or 2?

I think, Jed, my -- maybe I'll take the first part and Doug can take the second part. I think it's a combination of factors. I don't think a switch got flipped when tax reform came out, and all of a sudden, the leasing activity went up, but I do think it's a positive boost. Companies that pay taxes being more profitable and, therefore, more willing to invest. I think that is clearly a plus. I think the one thing that also is shifting is the breadth of the leasing activity. We've talked for -- quarter after quarter, about the importance of technology and life sciences, and that clearly still is growing and is important, but we're also now seeing growth and net absorption activity from financials, even law firms are moving in, and some cases, taking more space. So I think the breadth of the demand has also been very helpful.

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

And so you don't see the growth in concessions that you referred to, you don't see that abating anytime soon either?

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

And then separately, one other question. A few of your peers have been buying back stock recently, and just curious to get your latest thoughts on that strategy for BXP versus development or maybe other uses of capital?

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

And your next question comes from John Guinee with Stifel.

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

John, we like it. We started in the business, as you know, by developing on a mixed-use site where we would acquire the site or -- and/or entitle the site and it would have a multifamily component, and I think in the far past history of Boston Property, those sites were generally sold. But we started developing them ourselves, we were successful. We've made money on it, not just on paper. We sold The Avenue in Washington, D.C. for a very significant profit for Boston Properties shareholders. So I think we demonstrated the ability to do it. And as we run across -- and we come across sites, most of the time, there are going to be, in some way, associated with our office development, but not always. And if it is a site that we believe in, and we think we can generate the kinds of yields that we've been talking about, we're going to continue to grow it.

Okay. And then a quick question for you, Doug. Boston, I think, you talked about immigration, which is helping grow demand, if I got that right. What industries are coming to Boston and from where are they coming?

So it -- for the most part, it's both the -- what I'd just refer to as life science companies and they're coming from out-of-state as well as the suburbs and then there are some technology companies and they are coming predominantly from the suburban locations, and those are locations in the greater 128 area, so Lexington and Waltham and Needham and places like that. But interestingly, there are other growing tenants in those same submarkets that are grabbing the space that's coming available. So there's incremental net organic demand and new business activity in the suburbs of Boston a.k.a. the deal where you were starting, that is absorbing the space as these other tenants are moving into the city.

Your next question comes from Craig Mailman from KeyBanc.

Owen, maybe just going back to your commentary about the ability to fund new development. With debt, at this point, not really impact leverage? I'm curious at this point in the cycle, maybe what's the high end of your tolerance range on debt-to-EBITDA versus looking to accelerate asset sales or harvest value to joint ventures?

I'll answer that, Craig, just so I can answer something. So right now, our net debt-to-EBITDA is in the mid-6s. And our tolerance over our desired target range is somewhere plus or minus 7. Based upon the delivery of developments that we have going on and the -- and when the NOI comes on, it's going to reduce our net debt-to-EBITDA to 6x or even maybe below 6x. So as we kind of looked out at this development pipeline that we have planned, plus adding some more that might happen, we feel very comfortable that we can stay below 7x the entire time. There may be blips, like for example, in the first quarter of '18, we're likely to blip above 7x because we're not going to have any income from Salesforce Tower, and all the money is going to be out. But then it's going to come right back down through '18. So we don't -- we think that we have the ability to use that to fund the foreseeable pipeline that we have without needing to raise any equity.

Okay, that's helpful. And then, Doug, your commentary on kind of where higher-priced deals in New York could go. Just curious, do you think there could be enough activity coming back to the east side to kind of change the narrative about the center of Manhattan shifting west?

I'm going to be honest with you, I think it's already happening. There were 2 institutions on the financial side, 2 banks that are -- that took additional space and what I referred to as traditional mid-town not the far west side. And there are 3 or 4 major other transactions that we expect will happen in the first quarter and people will say, "Jeez, I guess the East side hasn't quite lost its luster" I mean, quite frankly, the fact of the matter is there is no available space in the Hudson Yard any longer. It's all new construction. The next building is not coming online until 2022-plus. There's available space downtown in the buildings that are currently under construction or recently completed. And I think people are feeling really good still about Midtown Manhattan, and there's, a significant amount of traditional tenancy that still values the Grand Central station and the East side amenities. And so we're pretty confident. And again the amount of activity that we've seen in the last 3 quarter or so at 399, now that we're showing a finished product predominantly. In 159, where the skin is on and people can walk around and they can feel what we're doing, and they're seeing what likely common areas are going to look like, we're getting a great reaction and people are encouraged, and a lot of this is growth.

Your next question comes from Rob Simone with Evercore ISI.

Owen, in your opening remarks, and then Doug later on, both made reference to, obviously, smartly expanding your presence in L.A., and Doug, you've used the term near future. I'm just wondering if you guys can elaborate on that? Is there anything specific that you're working on? And then I have a quick follow-up if there's time.

We're always working on new business in L.A. John Lang is on the phone as well and we're thrilled to have John in the company and it's really helped us to have some boots on the ground and eyes and ears on the ground. So we have ambition, but as I've said many times, we're going to do it in a profitable manner. We're not going to grow for the sake of growth. We have -- we think a nice profit in the Colorado Center acquisition, and we are going to similarly seek to make profitable investments in L.A. We're looking at some development things, we're looking at some existing acquisitions, not an easy time to do this, I talked about a deal that sold in El Segundo for 4s -- mid- to high-4s cap rate, in nearly $600 a square foot. So it's not an easy time to buy existing products, but we're very helpful thru development perhaps repositioning, that we'll continue to grow in L.A.

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

The fourth quarter -- third or fourth quarter of '19 for when the cash is going to hit the majority of it. And then on a full run-rate basis, obviously for 2020, right, so -- because you're going to get partial year. And we feel really good about our prospects. I don't like to sort of give a probability number out there, but we are in lease discussions, active lease discussions, which means that we have letters of intent that are being pushed back and forth multiple times. We have lots of interest in the building. There are literally more than 2 or 3 tours a week on the low rise of that space, and we could have lightning in a bottle and have a handshake with somebody, in 2 days or it could take up to 2 months. I just can't -- I can't give a good approximation on that.

Okay, Doug. No, that's helpful.

Yes, this is John. The building's looking really good now. The façade work is about 80% done, the storefront's done, we're going to finish up the entrance in the next month or 2. The city's out, we've demolished some of the floors, so there's a reason why it's all happening now.

And your next question comes from Jamie Feldman from Bank of America.

I'm just hoping to get your latest thoughts on the consolidation and just space per employee, where you think we are in that part of the cycle as you're seeing re-leasing pick up in your markets?

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

Okay, if I could just ask a follow-up on the comments you just made in terms of -- It's just hard to find people. When we read about where that -- where that's the biggest challenge, it does seem to be in your markets. Can you just talk about your thoughts on long-term job growth in some of the -- in kind of your coastal markets and how you think that might impact?

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

Your next question comes from Nick Yulico from UBS.

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

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

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

If you -- I don't -- I can't tell you on a square-footage basis because we never sort of think about it that way. We think about it on a revenue basis. I mean -- and you can ask them the question every quarter, and I'm happy to -- and I'll have the numbers, and I'm happy to give them to you, but we're going to -- we're moving into of saying, okay, we've given you an '18 number, we've given you a '19 number, we told you when all of these stuff is going to come online, and you'll know when we do a lease at 399, because we'll tell you, I promise. And that will be the biggest contribution to getting us really close to the ultimate objective.

Okay, all right. Fair enough. And just one other question, Mike, going back to the guidance you mentioned, $5 million of higher straight-line rent. I want to be clear, is that just free rent related to leases already signed? And then, what is the potential for seeing additional straight-line rent benefit in '18 if you get more leasing done based on your vacancies, is there any space that can be delivered into a tenant this year and commence free rent?

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I think that's how we will get to the high end of the guidance range. There certainly is projections that we have of things that hopefully will happen where we will sign leases for either expiring space or vacant space, and we'll get stuff started and we'll have a pre-rent period. Certainly, the increase in the guidance is associated with leasing activity that we have or believe we're definitively going to get, that has free rent period. So the vast majority of all the straight line is free rent.

And I guess I want to make one other point about free rent. So there are different kinds of free rent. There's free rent, which is a concession to a tenant where once they start their actual occupancy in the space that we have, they have a period of time when they're not paying, and that's Washington, D.C. free rent. Free rent in New York City and free rent in the Boston market are: we sign a lease, we deliver the space, the tenant is building out the space over a period of time, and during that period of time, we are recognizing revenue because of the condition of the space. So there's a subtlety there that's important to understand.

That's helpful. I guess, is on 399 Park, does that mean -- does that fit any of the -- is there any space that would fit that potential to get, if you've got more lease signings done, it would have more free rent this year?

Yes, so -- I think I've talked about that before, and it's a good point just to bring up, which is that the fact that we won't have that at 399 because of the condition of the space. So John described that we're sort of getting a really great look, and that reason we're getting a great look from the tenants is because we're demolishing the space, and when you demolish a space, where -- it's really not "ready" for its intended use. I'm talking in accounting jargon here. You can't straight line it. You basically have to wait until the space is actually delivered, which means, interestingly, we're at the whim to the extent a tenant is delayed and they're building out the space in order when we could recognize that revenue, even though we may actually have rent commencement, which again, is a situation that we have on our new construction in San Francisco, where we're actually receiving cash rents from Salesforce.com and a lot of that space and we're not recognized in revenue because the space isn't build out yet.

And your next question comes from Alexander Goldfarb from Sandler O'Neill.

Just 2 quick questions, first for Mike LaBelle. On the dispositions that you guys talked about, which includes the one that already closed in D.C., the $200 million to $300 million. Does that mean there's roughly sort of another $0.05 of loss on an annualized basis that's not in guidance? Or is there some sort of adjustment already reflected in guidance for what Owen outlined?

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

Alex, we do get cash money for those sales, you know.

I know that, I know that. The second question -- as we heard this morning, cash flow is good. Just second question is, Owen, you mentioned that at year-end you expect to get to 92. It sounds like if you get all the city space backfilled, that's another 100 basis points that gets you to 93. Do you think...

We have time for one final question, and that question comes from Blaine (technical difficulty)

What's going on?

I'm sorry, Alex. I'm sorry, operator, we still have the question going on.

Alex, you want to start over on the question?

Yes, can you hear me?

Yes, we got you.

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

I think that we should be able to get to 94% to 95% on a run-rate basis, and most of that is the availability we have in Manhattan. So that you add the 200,000 square feet we have at 159 and you add 500,000-plus square feet we have at 399, which should be leased on a long-term basis. But overall expiration schedule that we're looking at for 2000 -- and I showed you this when we did our investor conference, if you look at those slides, you can see it. For 2019 through 2020, it's pretty light. So we should be -- we should get there by the end of next year.

Your next question comes from Vincent Chao from Deutsche Bank.

Just going back to the development conversation, obviously, a lot of success on leasing there, adding a few more projects, but I'm just curious and we're hearing a lot about labor shortages as well as rising construction costs, I haven't heard you guys really change your development yield expectations recently, so I'm just curious, I guess, the implication is that rent growth is keeping up with construction costs. But curious if you could comment on what kind of construction cost increases you've seen over the past year? And then also, what you're seeing from just the availability of labor on the construction side?

So I think I made a comment earlier on one of the reasons the tenant improvements are going up is because it just costing a lot more to build out space, which is I think a statement that we see -- we see significant inflation in the construction industry. What we -- when we do our base buildings, when we are making a bid on a project, sometimes we actually bid it on a formula basis, so the tenants paying a percentage of a factor on what the actual costs are, so it sort of moves. But in most cases, when we bid a building and we provide a rent to somebody, what we have done is we build in cost escalations into our construction component in our development budget. And over the last, call it, 3 or 4 years, we have been building in anywhere between 3% and 6%, depending upon the marketplace on an annual basis for that component of the project cost.

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

Yes. So that's -- honestly, that's the reason for the escalation, for the most part, is labor shortages. And so you have tenants -- you have contractors who are working with subcontractors who are bidding to lose effectively or saying, "Well, we'll do the job, but-- and I think one of the advantages that Boston Properties has is that we are a perpetual user of labor in our markets with our contractors and with our subcontractors, and we have an impeccable reputation with regards to making payments on time, treating our subcontractors well, dealing with change orders appropriately, and because of that, I don't want to say we get preferential pricing but we certainly get preferential access to the subs who want to do work and know that if they do work with us in a good market, they're also going to be able to do work with us in a bad market. So we have not kind of procurement problem or any of our jobs.

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

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

No, no. Development spend, specifically.

2018, something around $800 million.

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

Yes. Predicting rates is obviously perilous. But I think material will be something significantly over 3%.

Significantly over 3%? Okay.

That's what I would say will be material. Okay. Thank you for your time and attention and interest in Boston Properties. That concludes the call.

Thanks, everyone.

Thank you.

This does conclude today's conference call. You may now disconnect.