波士頓物產 (BXP) 2003 Q1 法說會逐字稿

Please stand by for the realtime transcript of this conference call. the Boston Properties, Inc. conference call will begin shortly.

Good morning. My name is Princess and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Boston Properties, Inc. conference call.

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Good morning and welcome to Boston Properties, Inc. first quarter conference conference call, the press release and supplemental package of information were distributed yesterday. Even if you did not receive a copy, the documents are available on the company's website at www.bostonproperties.com. in the investor section. Additionally, we are hosting a live web cast of today's call which you can access in the same section. Following the live call, a web cast will be available in the Investor section under the header "audio archive." If you would like to be added onto the distribution list, contact the Investor Relations department at BXP at (617)236-3322.

Before I read the Safe Harbor statement, Douglas Linde will not be at the JP Morgan Debt Conference in New York City. Management would like me to inform you that certain statements made during the conference call which are not historical may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Boston properties believes expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be attained. Factors and risks that could cause actual results to differ materially from expectations are detailed in yesterday's press release and from time to time in the company's filings with the SEC.

Joining us today from management we have Edward Linde, President and Chief Executive Officer and Douglas Linde, Chief Financial Officer. Without further ado, I'd like to turn the call over to Doug for opening remarks.

Thanks, Claire.

In an attempt to slow my speaking role down so that people can take copious notes I've decided to give it cold which everyone will hopefully notice in my intonation of words and I apologize in advance for that, that's why I'm not going to be going to the JP Morgan conference this afternoon.

Good morning and thanks for attending the first quarter call. Before I discuss the quarter operating results, it seems like it's an appropriate time to review in total and with the benefit of actual rather than estimated numbers, the transactions involved in our billion dollars can recycling program which accompanied the acquisition of 399 Mark Avenue. Our entry into the unsecured debt market and resultant transformation of our balance sheet. We took advantage of the continued appetite of the buyer for precisely our type of assets by being a very active seller of properties in late 2002 and 2003. The marketplace placed a significant and consistent premium on these kind of assets.

Heretofore, we provided assumptions on timing proceeds and interest rate changes and we can review the actual results now. On March 18, we closed the sale of 2300 North Street in Washington, D.C. bringing the number of assets sold in 2002 to 12 and the first quarter of '03 for a total purchase price of $983 million. The sale individually detailed on page 50 in our supplemental package produced a book gain of $417 million, that's a book profit of almost 75% on book costs. They were sold at a collective blended forward-looking CAP right excluding any management fee expense because we don't pay ourselves the management fee of 7.2%.

On a third-party basis, including a management fee, (indiscernible) it would have been about 7%. This compares to the expected cash NOI yield of approximately 8.1% for 399 Park Avenue even after account for the impact of the 18% New York City real estate tax increase in December of calendar year 2002 and a GAAP NOI yield of 9%. We financed the (indiscernable) with a unsecured bridge loan and retired property specific debt. By financing 399 Park on an unsecured basis we expedited our entry into the corporate bond mark. 399 dramatically increased our unencumbered asset pool providing the opportunity to increase the size of our inaugural unsecured debt transactions.

Beginning in December of '02 we completed three separate bond transactions. We issued $925 million of 10-year notes, the cost of 6.29%, and in March of this year, we issued $300 million of 12-year notes at a cost of 5.64%. This equates to a blended interest expense of 6.13%. We used the gross equity of $581 million raised from the property sales and the 1.225 billion of unsecured debt to repay our bridge loan and certain other secured debt facilities. We made an important but highly prudent strategic decision to lock in long-term fixed rate financing in as hospitable a debt market as we have seen in decades, recognizing that this would impact short-term results. By fixing our debt on a long-term basis at approximately 300 basis point spread over today's existing short-term rates we have increase our short-term incremental interest expense by about $37 million on an annual basis.

Stated another way, we decreased our earnings by about 30 cents per share on an annual basis. If you review our debt maturity schedule on pages 14 and 15 of the supplemental, you'll note we have no scheduled maturities in '03 and only three in '04, the only significant one being a construction loan for Times Square Tower.

We had a one-year extension option and maintained the same size, $605 million. We refinanced last week a loan, the proceeds came from our line and from a loan with offset rights from proceeds from our bond transaction. This was done to accommodate future financings on -- 5 Times Square.

We made one additional acquisition in the quarter. On April 1, we purchased from our partner the remaining 50% interest in Discovery Square, our 450,000 square foot building in western Virginia. The building is now 95% leased and based on our development/acquisition costs for the 50% interest, has a forward-looking 12 month NOI yield of 10.5% and a GAAP yield of 11.4%. We have applied the new FASB ruling of 141 to this acquisition and will be recording a market run asset between five and $6 million. [INAUDIBLE] into a recurring noncash expense abduction from FFO of about $600,000 annually over the life of the existing leases. And that is taken into account in the yields that I just gave you, the 10 1/2% cash and the -- doesn't include the GAAP yield 11.4 does.

As we move through the summary of our results for the first quarter and provide our outlook for the remainder of '03, please remember that we're beginning with the second quarter. The full impact of all the transactions is built into earnings performance. For those of you interested in the specific timing of the transactions, the dates are included in the earnings prostheses. Before we get into the details of the first quarter results and describe specific property leasing stats and prospects, I want to raise a general caution. This is my time to be bearish. We have not seen any signs of recovery in any of the markets we follow. There continues to be a significant overplanning of space and no evidence of job growth. We believe the rate of decline in rent rates and supply have slowed, we're hopeful we're near the bottom, we continue to see credit consolidation, and retrenchment and sporadic business failures.

There is leasing activity in our market and our associates are making significant progress in our portfolio but it's not net positive absorption. We continue to expect significant downtime on vacated space. The current economic environment withstanding, we are extremely pleased with our corporate performance. Which is a testament to our strategy of developing and acquiring a portfolio of the highest quality assets on a long average term basis with tenants with strong balance sheets. We released our supplemental disclosure package on form 8K to provide the widest possible audience with a compilation of our detailed information in addition to our mandatory filings. We've always reconciled funds from operations to GAAP net income and beginning this quarter we reconciled non-GAAP financial measures to the [INAUDIBLE] directly comparable GAAP measure complying with the new requirements. You'll notice a significant number of additions to the 8K filing in our supplemental package because of that.

In addition, we will be archiving our conference calls for 12 months on our website. Last night we reported first quarter funds from operation on a fully diluted basis of $1.03 per share 10.8% yes, sir over first quarter 2002, about 3 cents ahead of first estimates. Net income was $1.91 an increase of 208% over net income from the first quarter, of 60 cents per share. These results include the effects of gains on sales from asset sales reported in our press release. Excluding gains, net income would have been 60%. Our in-service portfolio occupancy was 93% as of March 31, 2003, compared to 93.9% last quarter. This decline is due in large part to changes in portfolio composition. The portfolio now excludes 8,753rd Avenue, 95.2% leased, the CANDL building and 2300 North Street 98.9% leased. Combined, they made up 5% of the portfolio in square footage last quarter. Included on the in-service portfolio for the first time in western Waltham Corporate Center, only 43% leased.

The first quarter 2003 same property occupancy is 93.5% compared to 93.8% for the fourth quarter of 2002. In our mind, that's the appropriate comparison to be looking at when you're looking at sequential occupancy or vacancy in the portfolio. We experienced not significant unexpected lease terminationed or bankruptcy issues in the portfolio during the first quarter.

I'd like to offer the following commentary on the property occupancy statistics on pages 19 to 22 in the supplement willing. We've reelectricitied an expandsion on an actual growing tenant of 19,000 square feet from 204 Second Avenue to 56,000 square feet in Boston. This tenant replaces the full building tenant that failed during the quarter and is responsible for a portion of termination income I'll discuss in a minute. In DC, we signed leases bringing occupancy in Discovery up to 95%. At 7435 and 7451 Boston Boulevard we have agreements to occupy all remaining leases. At building 506 in Carnegie Center, we have -- economically, that building is 100% leased. 2 Freedom Square is 100% leased up from 65% leased last quarter. After taking into account a leased executed with Titan Systems for all the remaining direct space as well as all available sublet space in that building, and at 901 New York Avenue we are negotiating a lease that will bring committed space to 77%.

I also want to highlight our major short-term uncovered leases exposure in 2003. We anticipate a significant reduction in the occupancy of 601 Gateway in October stemming from the lease expiration of AT&T Cellular which occupies 180,000 square feet. (indiscernible) we have a 53,000 square foot lease expiring in November. At Carnegie Center, we have a full vacating building totalling 47,000 square feet in October. In Boston, an industrial building totalling 169,000 square feet will be vacant on August 1 and in Baltimore, an expiration in November. Including all the expirations, our remaining office lease rollover for '03 is 3.4% and 7.4% for 2004.

In the first quarter, we released approximately 506,000 square feet of second generation space with an increase in net rents of 16.2%. This result includes the renewal of Lord and Taylor for 129,000 square feet where previously in the gross rent they paid did not cover the operating expenses. If you exclude them, there was a decrease of 19%.

It's important to emphasize that these results continue to remain consistent with our internal expectations and guidance we've been providing. Original results are as follows: In Boston, if you exclude Lord and Taylor, we did 168,000 square feet, 36% decrease net-to-net. San Francisco, 100,000 square feet, 17% decrease. Washington, D.C., 43,000 square feet, 13% decrease. Princeton, 52,000 square feet, flat. And in New York City, 18,000 square feet, a 45% increase. To add a little bit of statistical color, in Boston, we signed 20 leases, the largest, other than Lord and Taylor, was 56,000 square feet. 69% of the square footage involved renulls or extensions. In DC, 6 leases, 100% of the space was new tenants. In San Francisco, we signed 22 leases and renewalls and expansions made up 57%. The largest lease was 22,000 square feet. In New York City, we did three very small transactions. In Princeton we covered a portion of the space where we were receiving a payment from (indiscernible) and we now have only 16,000 square feet that is still being covered by that guarantee. Excluding the hotel results, same store growth was .9% on a GAAP basis and negative .7% on a cash basis consistent with guidance of flat same store growth year-to-year.

Our three Boston area hotels had a dreadful first quarter. NOI was down 32%. (indiscernible) on a daily basis and the hotels continue to be down 10 to 15% from our expectations of being flat to 2002 results for the current period. We are revising our original full year hotel contribution down to $20 million from our previous guidance of $23 million. The quarterly breakdown should be 10 1/2% for the first quarter, 30% for the second quarter, 27% for the third quarter, -- sorry, 30 for the second, 27% for the third quarter and 32 1/2% for the third, remembering the fourth quarter has an extra period as a point of reference the hotels contributed $36 million in calendar year 2000.

To get out in front of the question of why we don't show them, if we had shown them as a recovery, they would have been strong candidates for resteal. Selling them in this market does not make sense.

Included in the first quarter results are term making fees totalling $1.7 million, one half of 1% of quarterly revenue stemming from five transactions. This was in line with our budget and with previous guidance of between one and $2 million per quarter as we said before, we expect on a going-forward basis a run rate of between one and $2 million per quarter termination fees. Specifically, we had the (indiscernible) technology center in Boston which discontinued its operations that was responsible for $700,000. We have released that entire building as of May 1, 2003. We reached an agreement with a retail tenant at the Prudential Center that closed down a division to pay $400,000 and we have (indiscernible) and they opened yesterday. We terminated a floor center in Washington and released that space. A tenant had a contractual right to terminate 9,000 square feet in a center and we recognized that payment. Finally, we received $225,000 from our (indiscernable) at Carnegie Center.

Looking back, our first quarter margin exclusive of hotels has been between 68.1 and 68.8, this quarter no exception. As we move forward in '03, we expect a reduction in comparable period margins due to increases in base year operating expenses and taxes, as well as increased vacancies of 100 basis points by the end of the year. G&A expense was $11.4 million in the first quarter. Our G&A expense for the full year is anticipated to be between 44 and 46 million. This includes an especially dramatic increase in our DNO premise, as well as cost associated with a nine rather than a 7 member board of directors, increase the directors fees and other legal and administrative costs associated with corporate governance. Year to date, we have capitalized wages of $1.2 million netted from the above G&A estimates. Last quarter, we implemented an internal rating base analysis of our acrude assets. An appropriate reserve was calculated on a tenant-by-tenant basis with four ratings classifications rating from strong to bankruptcy.

At the end of the fourth quarter, reserves is to do at $5.1 million against an accrued balance of 170 million. This quarter we've increased reserve to $5.1 million against a balance of 148. The currency in the accrued rent balance has to do with the sale of properties like 857 Third Avenue and 2300 North Street.

As I review our exposure, we continue to see cause for concern though the pace clearly seems to have slowed. We are working through westerly combined leases and reduced exposure in suburban Boston. We released 39,000 square feet of their space and reduced WorldCom space to 15,000 square feet for a net loss in occupancy of about 16,000 square feet starting in the second quarter.

Unfortunately, business failures continue. This quarter, our bad debt reserve against our first quarter revenues increased by $650,000. During the first quarter, we had unanticipated revenue of about $2.2 million, this includes rent from WorldCom on the leases we had expected to be rejected early in the quarter which have been terminated or amended, about $600,000. Operating expense reimbursement $400,000. Income associated with releasing a utility company from contractual equipment removal, they didn't do the work and gave us a payment of $840,000. As well as percentage rent from parking leases in the Washington, D.C. region for 2002. We have since restructured the leases to require a higher minimum rate. Excuse me, a higher minimum rent and, therefore, should not be in the run rate on a gang forward basis.

We recognize approximately 1 1/2 million dollars of benefit from one time expense reductions including trips for calendar year 2002 property operating expenses on vacant space, prior year tax abatements and reduced nonreimbursable property-related G&A for the first quarter. Our second generation office leasing costs were extremely low in the first quarter at $8.27 per square foot. As we continue to complete acquisitions on an as-is basis with minimal tenant improvement concessions. While we have seen dramatic declines in base rent we have tried to minimize up-front capital costs wherever possible. We're not buying rents at the cost of providing extensive improvements. We would suggest using an average of our last three years, 1391 as a run rate when you project forward our forward-looking funds available for distribution. And not the $8.27 that we had for this quarter.

The average remaining lease term for the portfolio has of March 31 is still very high at 7.1 years, 50% of the portfolio expired before April of 2010 auto body 50% afterwards. Our average market reps: Very few changes from last quarter. The CBD of Boston, low 40s, unchanged. Suburban Boston, low to mid it wasn't changed. CBD San Francisco, mid to high 30s, you changed. [INAUDIBLE], which is Gateway Center, low 20s, you changed. CBD Washington, low 40s, unchanged. Northern Virginia, high 20s, unchanged and Montgomery County, Merrill Lynch, you changed. Midtown Manhattan low 60s, and Princeton, New Jersey, low 30s, you changed.

If we look at the policy, we have a slight (indiscernible). Since we still have very little rollover in New York City in the next year, we will continue to experience a roll down across the portfolio the shorter term. Infirst rate average gross rents with escalation increased from last quarter arrest the additional reimburse. For 2002 was added to the contract rent. With this change, our embedded mark-to-market now stands at negative 38 cents per share or negative $1.78 per square foot. on the portfolio.

Remember, the potential impact on earnings will be the difference between the straight line GAAP on last year of the expiring less significantly less than last year's lease rate and (indiscernible) typically higher than the rent (indiscernible). The numbers I provided were cash to cash. Based on first quarter results, each change in occupancy is worth about 11 1/2 hires, at 93% occupancy, the incremental revenue is $81 million or 64 cents per share. The (indiscernible) for the first quarter of 67% including the total leasing costs associated with all leases beginning in the first quarter and recurring capital expenditures for all properties including the hotels. The recurring capital was very light, and we expect a right of 10 and 15 cents per square foot, a quarterly rate.

We provided guidance of 393 to 407 per share during our last call, at this time we are narrowing the range 398 to 404. The quarterly breakdown is as follows: Second quarter, $1.01 to $1.02, third quarter, 97 to 99, and fourth quarter, 97 to $1. The net income for 2003 is expected to be $3.74 to $3.80. The quarterly brown as follows: Second quarter, 64 to 66 cents, third quarter 68 cents, fourth quarter, 61 to 63. Our critical assumptions or as follows: Given our internal view of no net positive absorption, we have extended our rollover assumptions assumed a modest decrease in the portfolio and no increases in any rental rates. Much of our 2003 rollover does not include (indiscernible) until fourth quarter, we see minimal effect on in-service portfolio. The fourth quarter had been more significant decline due to occupancy but that is partially absorbed by the extra hotel period which falls in the quarter.

We look for flat slightly negative, same portfolio growth year to year as we benefit from a full year and we anticipate few negative or positive surprises in '03 other than the always possible but unexpected major tenant failure. We expect to have straight line rents of approximately $38 million for the year including the first quarter. We continue to expect having recurring termination fees of about one to $2 million per quarter. Our third-party fee income is expected to run around $16 million for the year.

We've built into our estimates the ongoing impact of real estate tax increases in New York City, this will impact vacant space, leases impose in fiscal 2002 tax escalations including those discussed at last quarter 399 Park Avenue and new leases. San Francisco aside, the fiscal uncertainties in New York City should strengthen the advantage in leasing in Times Square Tower, a very low payment in lieu of taxes of less than $4.50 with contractual increases averaging only 5.3% per year on that low base for the first 20 years of property operations. That compares to average taxes on a premier New York City office building of somewhere in excess of $12 a square foot. We expect to dramatically lower contribution from the hotels, and we're budgeting hotel net operating income of $20,000,000.2003 versus 23 million. We are still expecting G&A to range again 44 and 46 million.

At the January board meeting the committee approved the significanting of restricted stock for officer level employees and certain other individuals and granted no stock options. In 2003, the award had a value of $6.5 million and vest over the last three years of a five-year period. One fifth of expense will be taken each year. 2003 includes $1.5 million associated with this expense. We've assumed no additional property sales or acquisitions in our projectionss.

The full impact of our financing activities is in the new projections. 1.22 billion of floating rate debt has been replaced with 1.225 billion of fixed rate debt with an average interest cost of 6.13%, 300 basis points greater than the floating rate mix. The revenue minus expense contribution from the properties sold during the first quarter was approximately $4.9 million and that included 1.1 million of FAS B 13 adjustment the low end anticipates the early lease extension of leases with post-2003 expiration dates which we're currently working on which would have a negative short-term impact in return for covering long-term exposure.

That's all I have and I'll turn the call over to Ed. Good morning Doug and congratulations for making it through that with your cold. Thanks everybody for being with us. Let me just go over a few items and then we can turn to the Q&A.

I think you probably gathered from Doug's comments, the markets and our reports on a region-by-region basis which I will not go into the statistics on, since they're widely available from many different sources, however, our regional managers all remain very sober about what the markets are telling us. We're not seeing net additions to demand and while brokers may now be reporting that things seem to have bottomed out, that is certainly not translated into any treasure on rental rates or pressure on tenants to make early decisions or to feel that they don't have plenty of opportunities out there. We are doing more than our proportional share of deals and we're very happy about that. Just to look at our vacancy rates I think would indicate that. And I think we are still continuing to see what we've spoken about before, that this is a time for tenants to move up and to move to quality space. I mean, some of the deals that Doug reported to you in suburban Boston, I think, are very good examples of that where we have covered exposure in competition with other buildings simply because tenants moved, took the advantage to move to quality.

I thought I might just take a moment to talk about how we analyze deals as we do them in the marketplace. Because there's been speculation and Doug alluded to it, that our people buying deals by giving all sorts of concessions and not looking at things on the right economic basis. So let me tell you how we look at things. All of our deals are analyzed essentially on a net effective rent basis. By that I mean that we take into account the full rental stream that we will get from that tenant over the course and term of the lease. And we build into that any-free rent so that, in fact if a tenant has free rent for a certain period of time, that reduces the average rent. If there are rents step that is increases the average rent on a net effective rent basis but we don't do it on a straight line average we do it on a discounted average.

So in other words increases later on in the lease term do not count as much as higher rents early in the lease term. We also of course then subtract out operating costs and real estate taxes which are built into the lease, and which are expenses of ours, and then on top of that, we amortize all transaction costs over the term of the lease at that same discount rate. And, therefore, we are really taking into account every dollar that we spend, every leasing commission dollar that we spend, if we have to provide some other concessions to a tenant, we take that economic impact into account to come up with, at the end of the day, a bottom-line net effective rent per square foot. And that's the basis on which we do our deals.

Now we do something else as well. We take a look at what that net effective rent is for square foot and what the term of the lease would be with a decided preference of course where in this market the net effective rents are low to do short-term deals and that's a sacrifice the long-term value of the assets. We also look very carefully at whether it makes sense to do the deal at all. Because even though we will only use conservative assumptions in making this analysis, we look at what the trade-off is between holding a space vacant for a year or two or maybe even three and assuming a low rent at the end of that three-year period but perhaps a more normalized rent than what we think today's market is giving us. And if it makes sense to keep a space vacant, we will keep a space vacant. We believe in occupancy but we don't believe in occupancy at any cost. And, in fact, I think we've lost a few deals on that basis. But to really not have faith in the, for instance, sick value of the real estate which we own, we think would also be making a serious mistake.

Let me comment on the Discovery Square acquisition that Doug reported to you in western Virginia. This was where we took advantage of an ability that we had because of our partner's desire to sell their interest, our partner in that transaction is an opportunity fund with a relatively short-term hold period built into their operating strategy. And we have the opportunity to acquire their 50% interest. That was not a put, it was an opportunity to acquire it at a market price or, in fact, to sell our 50% interest along with them, if we felt that the investment was -- would require too high a purchase price by us us. As the returns that Doug reported to you indicated, we did not feel that was the case.

In fact, we think it was a very attractive acquisition with a stable tenant roster with good rates, long-term leases and once again, we have faith in the real estate so as the leases roll over, we think there's upside potential as well. It was an asset that also, of course, fits our strategic objectives since we consider that market to be an important place for Boston Properties to remain very much involved.

Let me comment on terrorism insurance. Our insurance program was put to bed on March 1. That's when our property insurance rolled over. And many have asked what the impact of TRIA has been. That's the shareholder hand for the act passed buy congress last fall, I guess it was. The bottom line is that we did use TRIA, so we did, rather than getting a stand-alone terrorism insurance policy we included terrorism coverage as part of our overall all-risk policy. And by doing so, we were able to significantly increase the terrorism insurance that we had carried last year. Last year, we had a $250 million policy stand-alone policy which was only go for one occurrence. So that, in fact if an act of terrorism occurred, that would have been the basically all the coverage we had. Our policy this year provides a $640 million per occurrence coverage, and allows for multiple occurrences.

Now, in order to obtain that insurance, our costs did go up. Last year we had a $2.7 million premium that we paid for terrorism insurance that was on the stand-alone basis. This year the insurance premium for the terrorism part of our all-risk coverage is $3.6 million or a 33% increase. But as you can see, the amount of the coverage went up very much more significantly than the premium did. However, overall insurance continues to be an expense which has gotten more and more burdensome with each passing year, at least in the recent past and our overall insurance will go up to a premium of about $16.7 million in the year beginning March 1, which compares to 13.8 million last year, a 21% increase. And that 13.8 did include the stand-alone terrorism insurance. So even without the TRIA coverage, the -- our insurance premium would have gone up by 18% with the TRIA coverage, the terrorism coverage, it went up by 21%. I think the bottom line is the coverage is there, we still believe that the expense is too high.

Obviously we're the buyers, not the sellers, probably the sellers don't agree with that, but, in fact, I think the one thing we have seen is that the domestic carriers have responded much more reasonably we believe in terms was pricing of the terrorism portion of the coverage than some of the overseas insurers have. We're hopeful the situation will get better with the passage of time.

I wanted to go back to one of the things Doug said because I think it's important to point out that if you look at our development type line, that with the exception of four properties which I will talk about in a moment, all of the properties that have been underdevelopment are now in service, even those which have significant vacancies. So 611 Gateway the property we built out in south San Francisco but which we have been unable to lease and which we really don't expect to lease in the near future, has a 0% occupancy, but that is in the in-service portfolio, so no longer really carried as a development property. The same thing with the Waltham Western Corporate Center, which has a activity% -- 50% occupancy with a small building in our broad run park with a 50% vacancy. And so when lieu at that 93% occupancy percentage that Doug mentioned you have to bear that in mind.

Now what's still being carried as developments are the following: Two Freedom Square, the Shaw's Supermarket and I believe the Shaw's Supermarket will come on line in the near term. 601 New York Avenue, a building under construction and not ready for occupancy until well it would be 2004, it's 77% committed.

And that brings us to Times Square Tower, which I know alot you are interested in our progress there. In keeping with our practice of not announcing leases until they're signed or until they are at worst almost about to be signed, with all of the causes negotiated, I really have nothing new to report. We have signed and announced the [inaudible] deal for 200,000 square feet but have not signed any additional leases and are operating in a very tough competitive market. However, I think it is important to point out that in that market, in that midtown New York market, there are tenants out looking for space. And that's something that you can't say about a lot of markets. Tenants of size, 100,000 square feet, 200,000 square feet and more out looking for space is not something that characterizes most markets. In fact, a market report put out by one of the brokerage firms yesterday reported that three tenants of 100,000 square feet or more in size had committed to space in March in various locations.

So I guess the bottom line is that we still believe that there is market support for an asset like Time Square Tower and while it will take longer to get there, we remain very optimistic about the prospects of that happening and happening really quite well. We are pursuing multiple tenants, we will have the opportunity and have been asked to make proposals to several. I hope that next quarter I will be able to announce one or more of those. But if not, I'm still not going to lose any faith in the long-term success of that very important well-located building and which as Doug pointed out, the tax advantage that it has. I should point out also by the way that we've just signed a deal for what is called a spectacular sign at 5 Times Square, a term of art, but it is a multi-year deal and at a very attractive, from our point of view, rate.

Finally, just before I finish, I guess since we've been somewhat down about market prospects, I do think that it's important to point out that we are very happy with our performance. You know, if you look at Boston Properties FFO growth, since actually we became a public company, we've had a compound annual growth rate of about 16% a year. Now, you know, we're going to be flat this year, flat to down this year, versus last. So maybe if I were saying this next year, that would be something like 13%. It still is, we believe, a very impressive record. And I think that considering the condition of the markets and the last year to two years, I think we're doing what we should be doing. Now, I'm too superstitious to not be always looking over my shoulder at the bad things that might happen, I think all of us at Boston Properties act with a certain amount of paranoia which I think is quite healthy, but I think we're quite well-positioned and we're feeling happy about that.

Mort is not with us today because he's dealing with an illness in his family so I will open up to questions right now.

At this time, I would like to remind everyone, in order to ask a question, please press star then the Number 1 on your telephone keypad. And your first question comes from John Litt, Salomon Smith Barney.

Good morning, I want to ask a couple of questions on your presentation, Doug, you said, I think the FAS 141 the charge related to the discovery acquisition was 600,000 a quarter. Does that mean rents were above market there?

Yes, a year, John, not a quarter. Yeah what, you do is you basically -- the analysis we did was we looked at what the current rents were, we looked at what the absolute lease contract rates were, we did a net present value calculation of the difference between those two, we're going to record that as an asset on our books. And we're going to expense that on a straight line basis over the average remaining term of those leases. It works out to somewhere in the neighborhood of $600,000.

That would be in your FFO?

Yes.

What's the term of the lease, how long?

The leases are different certainly. 7-year lease, a 12-year and I think on average it's 10 years.

It will be with us for a while?

I understand that other people are taking a different perspective on whether or not they want to take that as a deduction on FFO but our view is unless (indiscernible) changes their mind, it's what we're supposed to be doing.

I missed your number on San Francisco, you subsidiary you did 160,000 square feet of leasing what was the change in rent?

It was a negative 17%.

You dated a number of spaces that will vacate sometime during the year, a number particularly in the fourth quarter. What's your sense on the releasing of that space?

You know, we've -- we look at each space on a market-to-market basis. On average, the down time I would say that we have on large spaces you know, is in excess of nine months.

And so you're in front of those spaces, nine months in front of where they're expiring so is there a reason -- My assumption is they don't get released in 2003.

Nine months from the activate leasing, Ray's on the phone he can comment, we're in front of leases expiring in 2006 right now. And all the leases, the reason I brought up the ones I did, it's clear the current tenant isn't going to be staying. So that is pure down time. We have to go out there and lease that space, you know, to the market as opposed to having an incumbent that we can have a chance renegotiating with.

John, while we're seeing some tenants vacant, we're seeing a number of tenants who are also facing financial challenges who want to take advantage of the current market and renew and advance and stay in place and radios that are capital expenditure by moving.

By the way, when we do analyze deals, along the lines of what I was talking about before, if we reduce somebody's rent on the so-called blend and spend -- lend and extend model that reduction we build into our numbers as a cost of doing the deal.

Right. You did 500,000 square feet of leasing in the quarter, that does not include (indiscernible); is that correct?

That is not. It's only second generation.

And you had 300,000 square feet expiring in the quarter. How much of the difference, 200,000 square feet difference is-related to, you know, later terminations, expirations, and how much is leasing up of vacant space?

Mike Walsh is here, maybe he can answer that, he knows the statistics.

The way everything we [INAUDIBLE] 0 current basis, we suffer the economic impact of the deal. So of the approximate hundred thousand with expiring the 500 net positive, to net positive absorption of about 200,000 square feet for that vacant space.

So the 200 was vacant, it's not further (indiscernible)?

Yes.

Okay.

It either was or became vacant during the quarter.

Got it. Your average term for your new leases was 122 months. What's the average contractual increase in rents over that time?

That's not one I could even wager a guess at. It depends on -- unfortunately it's lease-by-lease, market-by-market, truthfully, I don't think we've ever compiled that.

Are you finding that you're getting.

In order to be fair, I don't think we should turn this into a dialog.

Okay. Just let me finish up on that question. Are you getting contractual rent increases on new leases?

Yes.

And so this is an example, in Washington, D.C., there are contractual increases of two to 3%.

Got it. Of the gross rent. Thank you, guys.

Thanks.

Your next question comes from Gregory Whyte, Morgan Stanley.

Good morning, a couple of follow-up questions. You alluded to the fact that this was a seasonally low quarter for the CAP X and TI's and stuff. Can you give color as to why?

We report our CAP X, Greg, on a cash basis so when the money gets spent we report it. I can tell you that we had budgeted more than that and for whatever reason, our operations people didn't spend the money they were supposed to spend. But we have not seen them come to us and say we're eliminating those projects. So we assume that they're going to make it up.

Okay. And then I guess for two reasons I wanted to just get you to give a little more color on the sensitivity to second half earnings. One you sort of alluded to the fact that there will be a little bit of a makeup in the fourth quarter because of anticipated higher revenues from the hotels. And then secondly, I note obviously that there's a fair amount of space rolling in San Francisco occurring in the latter part of the year. Can you talk to both of those issues? If you are able to, can you put a framework on how sensitive that would be on a (indiscernible) basis?

Well, let me try and characterize my statements as follows: We -- all of the spaces that are rolling over that are significant in the fourth quarter, we've assumed are vacant. And so the only positive -- only effect would be a positive on the upside.

Okay.

The hotels, as I said, we're taking down our numbers and the fourth period -- the fourth quarter is one period, has one period, practice, a 13 period year for the hotels, so about 3 1/2, 4% increase on a percentage basis for the hotels. The downside on my numbers is really more to do with some of the leases that we are currently working on where we are -- and these are real deals -- where we are currently negotiating lease extensions with them and where we will be restate lining the rents and some tenants will be getting a reduction on a cash basis in their calendar year 2003 rent and, therefore, our earnings would be on the low side on the $3.98 if we didn't do any of those. If we didn't do those deals, we would be much closer to the $4.04 I gave you.

I also note in first quarter it seems disproportionately higher operating expenses. Was it weather and utilities that drove that?

I don't think so. We provide the quarterly numbers, and remember the hotels are in there, as of last quarter so the hotel revenue and hotel expenses are in there, but we net those out in our supplemental. The margin is generally run between 68.1 and 68.8%. And we're at 68.3% for the first quarter of calendar year 2003. So it's really not much different than what it has been.

Okay. Maybe this is a tough question for you to answer, but in terms of the Times Square development, when you think about the type of rents that you're discussing or to the throwing out of perspective tenants, what do you think the difference is likely to be in terms of your pro forma return versus, you know, what you'd expected 12 months ago?

It is a hard one to answer. I think that there's certainly been movement downward in market rents and so but I don't -- you know, at this point I really don't want to put a number on it. I think I've said before the O'Melvany deal was not made at a number significantly different than the Anderson deal. I think the same thing is more likely to prevail in the lower parts of the building than in the upper parts of the building. Just to help you, on our in-service portfolio, we've taken the rent down somewhere between six and eight bucks. You know, on average. Over the last, call it three-quarters.

Right.

I'm told by the way that just for anybody who wants to ask a particular question, that Mort is now on the call if anybody wants to direct a question to him. Let me add one thing to that just in case that has been forgotten in the longer term of this whole process with Times Square. The rents in Times Square by definition are, shall we say, relatively competitive to the marketplace because the structure of those estates involves a fixed real estate tax base with annual increases that are fixed for 20 years. It is considerably lower, particularly after the last tax increase that was passed through the city of New York, than competing space. So that I mean, we're talking $10 or more in terms of a differential between the taxes on a new building and in Times Square. We have that as an advantage in relation to the overall market in Times Square.

Okay. Just one final question: You know, obviously earlier in the year you were sort of addressing sort of the balance sheet and stuff and so that would have explained your lack of activity on a buy back basis. I'm curious to know what your thoughts are right now.

We always have -- bear that in mind, but we also look at our relative stock price and use of capital, et cetera, Greg. And I -- right now, we don't have anything more to add to that, to the comments we made about buybacks before.

Okay, thanks a lot, guys of.

Your next question comes from David Kostin Goldman Sachs.

One short-term question and one long-term. Doug, I appreciate your speaking more slowly this quarter. I believe you made reference to Lord & Taylor's lease and the average second generation rents was about 16% overall. But if you excluded that, it seemed like a sharp decrease. Can you talk about the economics for that?

Actually, I prefer not to. I mean, we generally don't talk about a specific tenant and what they're paying for rent. We sort of have an agreement with Lord & Taylor we won't publicize what they're paying. They're paying a significant rent to us and, you know, it's certainly within the market but you have to remember it's 129,000 square foot store and the economics of the deal, I just don't think would be appropriate to discuss.

Would you anticipate that the lease economics on the other market is more consistent with what you expect the balance of the year? Lease roll-downs?

Absolutely.

My other question is for Mort and Ed. You both have been in this business since 1962, that's 40 years. In the 60s and 70s you developed in the suburbs and that was the right thing to do. I seem to recall in 1986 you did enormous convertible mortgage with a Japanese lender a variable coupon and basically (indiscernible) money conversion option. You stopped developing in '89 at the top of the market and didn't start until '96. Most real estate went public in 93, 94, you held off, and you just unsecured 25% of your balance sheet at what Doug identified as the lowest mortgage rates in something like 40 years. So the question from your perspective of experience is: How do you reconcile the reasonably unattractive net present value, lease economics with the fact that asset values for office buildings seem to soar dramatically? How do you think about that from the perspective of (indiscernible) capital?

This is Mort. If I may, I'll take a crack at that. I must say to you, I actually don't think that that's very difficult to answer because you have two factors, it seems to me, that are very important to the estimate of the value of real estate.

And let us be clear here, we're not talking about real estate in every market. The real estate that really has established the kinds of values and escalated values are still in the major markets. And not in the minor markets. But the major factor, if I may say, so is A: alternative investments have not worked out too well, that is to say financial assets for a lot of different investors, and B: interest rates are significantly lower. If you lower the interest rates, the obvious consequence of that or corollary of that is the cap rate changes. And, you know,-Carla Vanity used to say to people, ask me about my drinking but never ask me about my thirst. Whatever the rents are you have to value them, and when you can borrow at much lower rates it changes the valuation.

Since people do believe that the real estate business is cyclical, if they have, depending on the leasing structure in a building, if you look out any period of time, since this is the fifth cycle I've been in crew, you know, one in the 60s, 70s, 80s, 90s and now, you have to assume there's going to be a downpiece in every decade and an up piece in every decades. People think wherever rents are now, if you look out long enough, they're going to go up from where they are now and I think that is a valid instinct, judgment. Although of course everybody has to make a judgment as to when. But when you're evaluating even the current rent, you're doing it at a different interest rate level. It makes a very big difference in terms of the valuation of real estate. That's really what -- I will also say to you that in -- there are certain markets where the assumption that the longer term rental structure will move back up, it seems to me, as an entirely valid assumption.

If that's the case and treasuries are 4% and you can basically buy at an 8% return, your outstanding, yet you got 47 debt to the total assets, and your covenant let's you go up to 60%, why wouldn't you borrow more money in this environment and buy more real estate?

You can't answer that question, Mort. There will people from the fixed income side of the call, too. I'm being facetious.

to borrow money, if the rental structure.

Let me point out to you, we have been very active in looking for additional investments. We just bought some buildings, I don't know if that's been mentioned. Yeah, we talked about that. We bought, I might add, in the last quarter, last year, the end of September, 399 Park Avenue for a billion and $60 million which had an initial yield of over 8% with 80 percent of that -- with 80% of the space leased for 50 years and built-in expirations into the leases. It seems to me that we are, in fact, following implicitly what is the logic of your question, and frankly we are looking for real estate. But we have always held to a certain philosophy of the kind of real estate that we want to buy because -- which is of course the best quality of real estate, even if we have to pay up for it because we find that those buildings do better in good markets and much better in markets such as the ones we're in today. We don't find them every day, believe me, we've been out looking for them. If you happen to know of anybody, please ask them to call us. We're looking, and only looking in certain markets. And frankly, there are people who are They're leveraging to 80%.

The last question, the average price from pension funds as a way of recycling part of your capital, is there an increase in that over the last three to six months?

I'll answer that question. We have had a significant number of inquiries from either advisers or direct pension funds who would love to do deals with us. They want to cherry pick our existing assets and our comment has been we'd love to do something with you if there was something with which we could use the capital to acquire. And we just haven't been able to find ourselves in a situation where we'd had an opportunity to put the money to work.

I think that will happen, I really do.

Thank you very much.

By the way, if Goldman Sachs wants to sell any of their real estate with a long-term lease on it, we're willing to talk, David.

Your next question comes from Lee Schalop from Banc of America Securities.

Hello everyone, for guys that have such a tough view of the office market business seems to be pretty good. I have a specific question on Times Square Tower and how the accounting is going to work. Could you take us through, let's take a sort of unattractive scenario where there is no additional leasing from today. At what point would that show up on your income statement and how should we think about that in the future?

My counterparts from PWC are on the call so they'll get a kick out of how I respond. The way you look at this is based upon fax and circumstances. The rules that we have guided ourselves by have been that we will stop capitalizing on interest and expenses on a development no later than twelve months after initial occupancy of the building. And initial occupancy is defined as when we have delivered a space in a building that the tenant can actually use.

And in the case of a development in New York City, where we actually are delivering a shell and core, a case where the total envelope of the building isn't actually on and the lobbies aren't done and elevators haven't been completed, effectively the first tenant in when they actually start occupying that space is really when you would start that period. So assuming there are no other transactions that are done, Lee, and there's nobody in before, on or about April 1 of calendar year 2004 our 12 month period would run. To the extent we're actively negotiating with other tenants to lease the space and we are working on transactions, they may or may not happen but we are in active dialog and we are quote, unquote, continuing to develop the building, we will continue to capitalize the interest associated with the development but no longer than 12 month. So we weren't talking to anybody at all, and it was just dead in the water, I think the facts and circumstances would be different and we would probably have to take a hard look at why we would be capitalizing that asset. You know, AKA look at 611 Gateway. The shell and core was completed, we had no prospects and stopped capitalizing.

And just to be sure I followed that, so assuming that you have continuing negotiations with tenants that are interested in leasing and assuming O'Melvany moves in in April of 2004 we'd look at cessation of capitalation in April of 2005.

Correct and the income from O'Melvany and the proportion would be brought into service as of the date of the lease. It would only be on the vacant portion, not the portion occupied.

Got it. Thanks very much.

Your next question comes from Lou Taylor of Deutsche Banc.

Thanks. Doug, just staying on the accounting for a second, in terms of the FAS 141 of Discovery Square, why didn't you have to do it at 399 Park?

We looked at the current market rent at the time we acquired 399 Park and they were at market on average for the building tenant by tenant. And really, it's facts and circumstances, as of the date of acquisition that you look at that. The leases were actually done as of the acquisition date, there wasn't much in the way of a mark-to-market up or down.

Secondly, maybe I missed it, in terms of TI's and commissions in the first quarter, I've seen pretty low, around eight bucks, what were the driving factors there?

The driving factors were we did a significant number of renewals and most of them were done on an as-is basis. As I said, on a run rate basis, I think it's too low, given what's going on in the marketplace. We look back over the last three years, the average was about $13.91, that's probably a more appropriate rate to look at when you're doing an FAD calculation.

Second question is with regards to City Corp. Center and backfilling the O'Melveny lease there, any prospects or expected timing?

We have 140,000 square feet of pace to lease there. We are in discussions with one tenant for one floor an incoming tenant in the building and we're hopeful that that may happen. But that's tenant not exactly rushing to get a lease signed tomorrow. We've put proposals out to other tenant on the other floors and we, you know, at this point are being in sort of a similar when we have a deal, we'll announce it kind of a constraint because we're uncomfortable with the way New York City's working these days and the fickleness of tenants even if they say yeah, we're ready to do a deal, you don't have one until it's done.

Okay. Last question then for Ed, at Times Square Tower what kind of feedback are you getting from brokers or tenants that have chosen to go to other locations as to why they've gone there over, say, your property?

Well, you know, there aren't that many examples. I think one tenant went to another location strictly on price, and another went, I think it was as back and forth, and back and forth and chose another location for reasons which I'm not sure I can explain, but we certainly were a very, very, very viable alternative right up to the last-minute. And I think there was a -- it was a law firm, I think there was a vote of the partnership and the partnership split fairly evenly but we came out on the short end of the vote.

Okay. Thank you.

At this time, there are no further questions.

Thank you all for being with us today and we look forward to continuing to be able to report good progress in the quarters ahead. Bye-bye.

This concludes today's Boston Properties conference call. You may now disconnect.