波士頓物產 (BXP) 2003 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Boston Properties third quarter 2003 conference call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question and answer session. If anyone needs assistance at any time during the conference, please press the star followed by the zero. As a reminder, this conference is being recorded on Wednesday, October 22 of 2003. I would now like to turn the conference over to Ms. Diane Hettwer with FRB Weber Shandwick. Please go ahead, Ma'am.

Thank you. Good morning, and welcome to Boston Properties third quarter conference call. The press release and supplement disclosure package were distributed yesterday, as well as furnished on form 8(K) to provide access to the widest possible audience.

In the supplemental disclosure package, the company has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Regulation G requirements. If you did not receive a copy, these documents are available on the company's website at www.bostonproperties.com in the investor section.

Additionally, we are hosting a live webcast of today's call, which you can access in the same section. Following this live call, an audio webcast will be available for 12 months on the company's website in the investor section under the header, "Audio Archives". To be added to the company quarterly distribution list, please contact the investor relations department at (617) 236-3322.

At this time, management would like me 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 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 are detailed in yesterday's press release, and from time to time in the company's filing with the SEC.

The company does not undertake a duty to update any forward-looking statements. For management today, we have Mort Zuckerman, Chairman of the Board; Ed Linde, President and CEO; and Doug Linde; CFO. At this time, I would like to turn the call over to Doug Linde.

Thank you. Good morning, everyone. The prepared remarks this morning are going to come from myself and from Mort. Ed is also on the phone and is available during the Q&A section. Thanks for joining us as we talk about the third quarter results and our outlook for the remainder of 2003, and I guess more importantly, for 2004.

Given in the release last night, we did provide guidance for the fourth quarter and have raised the fourth quarter and full-year numbers for 2003. We expect to be between $4.04-$4.05 for the year, and that's up from $3.99 to $4.02. We are in the midst of doing our 2004 business plan on a bottom-up level as we speak.

Given the continued uncertainty regarding the demand for office space, offering tight guidance for 2004 seems premature. During the call, we will discuss the third quarter financial results, layout our basic assumptions for 2004, and talk about the most critical variables and provide you with a range of perspective results.

Mort will be with us this morning discussing the macroeconomic viewpoint and provide a perspective on the economy, business spending, and prospects for job growth. Before we begin the discussion of the third quarter financials, we thought we might give a perspective on the economic activity we are seeing from our vantage point as a supplier of office space.

In the office industry, many brokerage groups offering quarterly market reports on vacancy, absorption, and rental rates. The data this quarter shows marginal positive absorption in Washington, D.C., and Northern Virginia; San Francisco and Princeton, conflicting both positive and negative reports in the Boston CBD and suburbs, and negative absorption in New York City, as well as correspondingly small decreases or increases in the overall vacancy.

This data gives us some cause for optimism, but we still can't point to any direct evidence of return in the office market, based on business expansion. We believe that most tenants have realized that the bottom is close enough that the hopes of infinite opportunities running into the future are quickly disappearing. Many users -- and more importantly, their advisors, the brokers -- have concluded that the risk is now toward less availability at higher cost rather than more availability at lower cost. Our gross level of transactional activity, signed leases covering current and future vacancy, as well as our development property, edges up again, quarter to quarter.

During the first quarter, we signed a total of 813,000 square feet of leases. Last quarter, the number was 933,000 square feet, and this quarter the number is 1.153 million square feet. As we review recent activity, with continue to benefit from expanded law firm demand in New York City, Washington, D.C. and San Francisco. We are beginning to see some dividend in Northern Virginia from the expansion of the Defense and Homeland Security efforts in the form of both direct GSA requirements and related contractor solicitations.

Unfortunately, we are still seeing occasional business failures and corresponding termination income with subsequent vacancy. When we look back at the statistics two or three years from now, we do expect that we will have been at the bottom as of today. While we are optimistic that market conditions will not deteriorate further, we don't expect to see any meaningful improvement for the balance of '03, and certainly for the first half of 2004.

During the last quarter, private capital continued its incredibly aggressive pursuit of high-quality office buildings in our market. The most public transaction was the purchase of the General Motors building in midtown Manhattan for a reported $1.4 billion. Irrespective of the price or yield characteristics of the asset, there were more than two dozen groups offering what we would qualify at very aggressive pricing.

The capital sources included German investors, Middle Eastern investors, Mexican investors, U.S. pension funds, private high net worth investment groups, opportunity funds, New York's real estate families, private REITS and a few public REITS. With such strong interest in high quality real estate, it will continue to be very challenging for us to find opportunities to acquire assets.

Nonetheless, we have completed three transactions over the past 75 days. On August 6, we purchased our partner's interest in the One and Two Freedom Square in Reston, Virginia for $36 million and the assumption of debt. In a positive development subsequent to the acquisition, the major tenant of Two Freedom Square, Titan Systems agreed to be purchased by Lockheed Martin, upgrading the credit profile of the tenant from sub-investment grade [to BAA] to BBB.

Including the cost of the acquired interest, our unleveraged cash return on these assets for 2004 is expected to be 9.8%, and the unleveraged FFO return is expected to be 10.8%. The FFO number includes a reduction in yields of about 66 basis points from the above market lease adjustment required FASB 141. Projected unleveraged cash return for '04 will not stabilize since Titan Systems’ rent does not commence until May 1st, '04.

And on October 8, we purchased 1333 New Hampshire Avenue in Washington, D.C. for $114 million. This property has projected 2004 unleveraged cash yield of 8.2% and an unleveraged FFO yield of 10.6%.

The FFO yield here includes 176 basis points from below market lease adjustments required by FASB 141. In our supplemental disclosure, we broke out the gross non-cash FASB 141 adjustment, just as we provide a quarterly figure for the FASB 13 straight line rent. We've included a detailed calculation of the reconciliation of the unleveraged cash and unleveraged FFO returns in our press release.

While we actively review and continue to participate in all the fully-marketed sales brochures that we see, each of these acquisitions were completed on a sole source basis. There's one additional transaction discussed in our press release involving the formation of a joint venture on a parcel in D.C. that we wanted to comment on. 801 New Jersey Avenue is a potential urban campus that can accommodate up to 1.1 million square feet in the Capital Hill/Union Station sub-market.

Our target user is the large institutional and government agency seeking to consolidate a campus on Capital Hill. While we will be submitting the sites to the next round of governmental requirements in early '04 and are very encouraged about the prospects for development, we don't have any specific time frame for commencing construction here.

Last night, we reported third quarter FFO on a fully diluted basis of 98 cents per share. This is slightly above the height of our prior guidance of 96 cents per share, and slightly above First Call consensus. This quarter, of SFAS 150 became effective; simply put, this pronouncement requires us to share market value of the minority interest of consolidated partnerships deemed to have a finite life, and run the change of fair market value through our income statement.

The GAAP rationale for this action is that minority interests are presumed to be redeemable securities or debt, and if their value changes it creates a theoretical change in the consolidating party's liability, which should be taken through the income statement on a current basis. In our judgment, this is a nonsensical way to view real estate joint ventures that never have put requirements on the part of the consolidating partner. That being said, we own a 33% interest in a partnership which we consolidate because we have control, and the effective quarter from that one partnership is an SFAS 150 adjustment of $9.8 million to net income.

Final accounting standards -- the Financial Accounting Standards Board and the SEC are still reviewing the implementation of SFAS 150, and things may change in the future. For the third quarter, after excluding the effect of SFAS 150, our net income per share was 56 cents. Excluding the effects of gains on sales in the comparable period from '02, the net income was 55 cents per share for the third quarter of '02.

In subsequent quarters, the change in the value of the minority interest will run through FFO, as well as net income.

FIN 46 is another upcoming accounting pronouncement that has been deferred to the fourth quarter, but may affect our future results. This pronouncement determines whether a joint venture should or shouldn't be consolidated on the balance sheet. In our supplemental information, we give full disclosure of all of our joint venture activities. Depending upon how FIN 46 is resolved, we may have to consolidate one or more of these ventures beginning in the fourth quarter, and then, correspondingly, determine whether SFAS 150 should be applied to each venture.

Please stay tuned for these exciting accounting results. Our in-service portfolio occupancy was 92.2% as of September 2003, down slightly compared to 92.8% last quarter. As we previewed last quarter, our one industrial building in Boston was vacant as of August 1 and if we exclude that industrial asset, the quarter to quarter change would have been 92.7% versus 92.8%.

Reviewing our property-specific occupancy, aside from the change in the industrial asset, we saw occupancy at 170 [inaudible] Lane fall to 55%, due to a move out of a bankrupt tenant, which we discussed last quarter. We renewed but reduced the premises of a tenant at 91 Hartwell Avenue, which led to a reduction to 80%, and a government contractor move out of 32,000 square feet at Grainger Court in our VA 95 Park, reducing the occupancy in that building to 37%.

We have a signed lease at 7451 Boston Boulevard in VA, which commenced bringing that occupancy up to 100%. What we aren't showing in the statistics yet our signed leases which will bring our occupancy at 800 Boylston – that’s the Prudential Tower -- to 96%; 2 Discovery Square to 96%; 7435 Boston Boulevard to 100%; and 506 Carnegie Center to 100%. Finally, we just signed three leases at Waltham Weston Corporate Center, which brings the occupancy there to 65%. If we include these leases in our occupancy, the number would have really been 92.6% versus 92.2%.

Our statistics require that we only put in place those leases which have a rent commencement during the quarter. We expect our occupancy to decrease 50 to 60 basis points in the fourth quarter, from the loss of 140,000 square feet at Gateway in South San Francisco, 70,000 square feet at Carnegie Center in Princeton, and 40,000 at 100 East Pratt Street in Baltimore. Including all of the above lease terminations, our remaining [inaudible] outlook for '03 is 1.7% and for '04, 6.7%.

Our average remaining lease as of the end of the quarter still remains at 7.1 years. In the third quarter, we have lease terms commencing at approximately 860,000 square feet of second generation space, with a decrease in net rent of 13.6%. Two lease extensions in Washington total 520,000 square feet of that.

Obviously, they were the most significant transactions. If you excluded those transactions, the decrease in rents would have been 35%.

Regionally, things were as follows: In Boston, there was 159,000 square feet of leasing, there was a 59% decrease rent to rent. San Francisco, 73,000, a 23% decrease, and Washington D.C., 576,000 -- we were flat. Princeton, 32,000, 3% decrease; and then New York City, 20,000 square feet and we had an 88% increase.

To add some additional statistical color, of the 159,000 square feet leased in Boston we had 13 leases. Two of the 13 leases, one in Reservoir Place in Waltham and one at 101 Huntington Avenue, made up 60% of the square footage. 67% of the square footage involved renewable expansion. These figures don't include the Waltham Weston Corporate Center leases because those are first generation leases.

In D.C., the activity involved 12 leases, 99% of those cases from renewal. In San Francisco, renewals and expansions made up 30%, and 60% involved previously vacant space. The New York City, we had three new tenants expand into 20,000 square feet, and in Princeton, 46% of the leases were renewals. Excluding our hotel results, same store NOI, which is calculated as rental revenue less operative expenses and real estate taxes, was negative 1.4% on a GAAP basis and negative .5% on a cash basis.

This is consistent with our guidance of flat same store growth year to year. Our three Boston area hotels have yet to show any improvement. RevPAR was down 12%, and NOI was down 27%, in line with our projection -- they actually hit them right on the dot. Included in our third quarter results are termination fees totaling $1.7 million, one half percent of our quarterly revenue, and that stems from seven transactions. This is in line with our guidance of between $1 and $2 million per quarter.

85% of the revenue came from three sources. We collected a $900,000 security deposit from a 30,000 square foot center in Gateway in South San Francisco that gave back 15,000 square feet. We cashed a $240,000 security from a tenant in DC that defaulted on a 12,000 square feet lease, and we received $290,000 to cover transaction costs associated with our Raytheon guarantee at Carnegie Center, and that space is now 100% leased.

Our third quarter margin has been between 66.2% and 68.9% during the last few years. This quarter’s margin of 67.1% is in line with previous comparable periods. Two quarters ago, we implemented an internal rating base of our accrued [rent] assets to arrive at an appropriate reserve, calculated on a tenant by tenant basis, and we have four rating classifications, ranging from strong performance to in bankruptcy.

At the end of the second quarter, the reserve was $5.9 million on a balance of $173 million. This quarter it's $5.6 million on a balance of $186 million. Interestingly, approximately 1.5% of our total annualized revenue comes from tenants that are at our two lowest ratings. Our bad debt reserve against our accounts receivables balance decreased by $400,000 this quarter. A significant portion of that improvement came from our collection efforts, where we actually collected $500,000 of aged accounts.

Second generation office leasing costs ran at 42% of our average run rate at $6.43. Clearly, this was because we had those leases in Washington, D.C. that were done on an "as is" basis, no brokers’ commission, no tenant comp. That was 520,000 square feet of lease extensions. Excluding these lease extensions, the leasing costs would have been $17.73, about 16% above our average rate of $15.27 over the past four years. We continue to complete transactions on an "as is" basis with minimal tenant improvement concessions.

One of our most critical analytic tools when we're evaluating leases is net effective rent, which compares the profitability of alternative transactions, including all capital costs. We are not buying higher rents at the cost of providing extensive improvement allowances. Our dividend/FAD payout ratio for the third quarter is 74.5%, and includes a total leasing cost associated with all the leases beginning in the third quarter, as well as all recurring capital expenditures, including the hotels.

Recurring capital expenditures for the third quarter were at the low end of our normalized quarterly rate of between $0.10 and $0.15 per square foot. We do expect to have an above normal capital expenditure number next quarter, as we catch up on earlier spending shortfalls from the beginning of the year.

On August 12, we exercised our redemption right and converted the outstanding series one preferred units into 2.1 million common units. Next quarter, our FAD ratio will be calculated after taking into effect a full quarter of our reduced preferred dividend. Our estimates of average market rent in our market didn't change at all this quarter and they are as follows. We still believe the CBD Boston to be in the high 30's -- and again, this is on our portfolio, not the market in general.

Suburban Boston, mid to low 20's, CBD San Francisco, mid to high 30's, suburban San Francisco, which is for us only Gateway Center, low 20's, CBD Washington, low 40's, Northern Virginia, high 20's, Montgomery County, low 30's, midtown Manhattan, low 60's, and Princeton, New Jersey, low 30's.

Again, none of those have changed from last quarter. If we look at the portfolio on a regional basis, we still have a slight positive mark to market in New York City, flat in DC and Princeton, and negative in Boston and San Francisco. Since we have very little rollover in New York City in the next few years, we will continue to experience a rolldown in face rents across the portfolio in the short term.

We estimate that the embedded mark to market now stands at about a negative $2.55. That translates into negative $0.54 per share per year. Based on our third quarter results, each 1% change in occupancy is worth about $11 million, so at 92.2% occupancy, the incremental revenue potential from our vacant space, assumed it's leased at current market rent, is about $85,000,000 and $0.66 per share.

Our G&A expense for the quarter was $11.2 million. We still anticipate the full year being between $44 and $46. We provided FFO guidance of $3.99 for '03, and as stated, we are increasing our guidance for the fourth quarter to $1.00-$1.01; for the year it's $4.04-$4.05. That’s based on our new share count projections. Our net income for the '03 is expected to be between $3.62 and $3.64, the fourth quarter breakdown being 59-61 cents.

At this time, we are offering FFO guidance in the range of $3.93 to $4.11 for '04, and net income for '04 of $2.23 to $2.41. Here are the critical assumptions. Starting with the in-service portfolio, we expect up to about a 50 basis point decrease in occupancy during '04 from the fourth quarter of '03.

Our guidance doesn't assume any significant recovery in our occupancy during the year. There are major blocks of space we expect to see vacant for extended periods of time in over '04, including our Old Federal Reserve property in San Francisco, the Gateway properties in San Francisco, including 611, Newport Avenue and Harvard Street in Boston. On average, we expect to see a rolldown of between 8-12% from our expiring leases in '04.

We expect our margins for the year to be within the range of historical averages, based on the decreases in occupancy and the rolldown in rents on lease expirations in Boston and San Francisco. The guidance assumes an additional 200,000-450,000 square feet of office leasing at Times Square Tower for the calendar year 2004, understanding that the building will not come online until the second quarter of '04. We expect to have straight line rents of approximately $12 million for the fourth quarter of '03 and $40 million for 2004.

A portion of the straight line rent comes from Times Square Tower, where any lease will include customary free rent because tenants build out their own space in New York City. We're budgeting termination fees of about $2 million for 2004. Our third party income is expected to decline from over $60 million to about $12 million in '04.

We are maintaining our fourth quarter hotel contribution number of $6.6 million, and for '04 we are budgeting a $21.5 million contribution from the hotels. The projected full year hotel contribution is about 60% of the historical high reached in calendar year 2000. Our 2004 fully diluted share count assumption is to increase by 1.5 million shares over the course of the year, stemming from long-term equity compensation and estimated option exercises.

For modeling purposes, the G&A expense in '04 is assumed to go at 5.5%. This takes into account the increased cost for Sarbanes-Oxley Act, D&O insurance and compensation expense. Remember, our compensation expense includes the cost of any long-term incentive compensation, which is expensed over the full term of its vesting period.

For example, in '02 long term expense of compensation was awarded entirely in the form of restricted stock, and had a value of about $6.5 million dollars, vesting over the last three years of a five-year period.

One-fifth of that expense will be taken each year, so the '03 G&A expense included approximately $1.5 million associated with that cost. Our guidance assumes no additional acquisitions, dispositions or capital market activities in '04, and assumes no additional fixed rate debt offerings, secured or unsecured, during the year.

Our floating rate debt now consists almost entirely of our construction loans on Times Square Tower and New Dominion Two, $342 million, and borrowing on our own lines totaled $78 million as of October 9. Excluding our construction loans, our floating rate debt encompasses 1.5% of our total debt. That is the end of my prepared remarks, and I will now turn the phone over to Mort.

Good morning. I will just add a few general comments. We have been, frankly, relatively pessimistic about the macroeconomy for three years and we are in the midst, obviously, of something of a resurgence in the economy in the face of an unbelievable fiscal stimulus and monetary stimulus, the likes of which probably have not been equal since whatever the effects of World War II were on the economy.

And the question is, do we have a sustainable economic growth? It is certainly more optimistic today, I think, than we have felt over the last three years. There are real signs that the consumer growth, which has been powering all of this because of the huge influx of tax rebates and tax cuts that came about in the third quarter -- that this consumer growth is broadening into capital spending of some kind and you see where transportation companies are showing increased business, which is a reflection of business activity.

There are some weaknesses in it, of course. The consumer growth in particular was powered for a good time by consumer durables to a level that does not suggest sustainability and may just reflect the fact with the rebates and the other checks coming in from the Federal Government, that this sort of was a stimulus that may be a short term stimulus but we don't know.

A lot is going to depend on consumer confidence; and a lot of consumer confidence, in my judgment, is also going to depend on the employment side of things. The employment side of things is one of the areas of weakness in the economy.

Although again, I think we are beginning to see differences in the cities that we are in. Financial services, obviously, is a major player in New York, Boston and San Francisco. Here there's no doubt but that there has been a dramatic improvement in the profitability of the financial services industry and the activities of investment banking and the activities of banking and the activities of stock market players. So that's an encouraging sign. The one thing that I will bring to your attention -- and I have to say that I was astonished by this myself -- is something called Hedonic pricing, which frankly I have never even heard about. But to use the second quarter as an example.

The second quarter showed a growth -- ultimately was adjusted to 3.3% but these numbers were based when the economy was assumed to have grown by 3.1%. That represents approximately a $73.5 billion absolute increase in GDP. However, of that, about $38.4 billion was basically IT spending increases.

But of the $38.4 billion, $32.6 billion was Hedonic pricing. Now what is Hedonic pricing? Hedonic pricing is a method of calculating GDP which was intended to reflect the improvement in the quality of what you buy; and since IT in particular was being improved in qualitative terms dramatically year after year, they wanted to find some way to bring this into account in terms of GDP numbers. So they basically said, we are going to judge what the real IT spending is on the basis of assuming that you were paying for this improvement in quality based on 1996 prices with various adjustments.

As a result of that, $32.4 billion was basically a statistical construct, and if you take that $32.4 billion out -- because no money was paid and no money was received -- it's just a calculation based on an assumption as to what you would have paid had it been bought in 1996.

In fact, in cash terms, so to speak, the GDP only grew by 1.68%. And another $44 billion of that $77 billion was defense spending. So you could argue, if you took that out, that the private sector economy in fact contracted in the second quarter. It's those kinds of anomalies that make one sort of a little bit nervous about what is really happening in the economy.

But there is no doubt -- and we see this, for example, in the retail business, which we have a lot of contact with through other activities -- there is no doubt that the retail business, the major department stores, are meeting their plans. The major retail operations are doing a lot better on a store to store basis, especially Wal-Mart, which is a great bellwether for where the economy is going, in retail terms. So all I'm saying is that I think there is more reason to be optimistic now based on the huge fiscal stimulus and monetary policy than we have over the last three years. And as to its sustainability, I would say that the odds -- while I would have said six months ago that they were 40/60 are at least 60/40 in terms of this being a sustainable economic growth.

We are not basically assuming any of this begins to flow through in terms of anything that's happening at Boston Properties on the general theory that everybody has been promising an economic recovery some time in the next six months or a year for the last three years, and we still haven't seen it. I keep on saying that the people who write about the economy are a lot more bullish than the people who write checks.

Nevertheless, I think this is the first time where I think you can have some sense that there is a possibility that we will break through. If employment numbers do well over the next three or four months, then I think you can assume that this economy will sustain itself through next year.

And I think those are the critical issues that we have to look for. I think we are going to have a strong Christmas on the retail side. I think that business optimism is improving, but it is still lagging behind what you would be able to infer from reading economists' assessments of the economy.

I think we are in for a better year in 2004 than we've had in the last three years in terms of real economic growth and in terms of its impact on real estate. They say we haven't incorporated that into our own assumptions by and large, simply because we've just been around for too long to assume that this is going to happen. We are going to wait until it actually happens. It may not happen next year.

So that's sort of the general assumption. I do think that the Federal Reserve is going to keep interest rates low through a good part of next year, I think probably longer than most people imagine, unless we have such a strong level of economic activity and such an enhanced inflation rate that they feel they have to begin to release it.

One reason for that is that there is a much larger amount of variable rate debt in the economy, including mortgage debt; and if you begin to raise interest rates, you'll really crimp the consumer very, very quickly and I think they are going to be very reluctant to do that in 2004, which I think is coincidentally the year of the Olympics and incidentally the year of an election.

So that's sort of where we see things going and we are still extremely sort of satisfied that our basic real estate strategy has panned out because obviously our occupancy rates are much better than the industry at large, and that, we believe, is due to the markets that we are in and the quality of assets that we have, which by and large I think are at least as good if not better than any other comparable firm. And that shows up over and over and over again in terms of the ability to release space and to -- as Prudential shows -- and to do better than the market at large.

Now as Doug mentioned, there has been a phenomenal impact on real estate values. People are buying high-quality real estate in these markets that we are in at extremely aggressive prices and we have, frankly, been able to take advantage of the fact that we can close quickly and the people we deal with know that we will close and know that there won't be any difficulties and know that we will close quickly. I think it helps us make one of the best purchases we’ve made, which is the Citigroup building on 399 Park, and also the one in Washington, where we were able to go in with a commitment to close and back it up and do that very quickly, and we did it very quickly and it was in effect virtually a sole source.

And we had that opportunity on several other locations. The pricing has been a little too rich for us, but nevertheless we are still working along those lines; and we think that there remains a good prospect that we will be able to make purchases.

But it does show you what the value is -- not just on the income side, but on the valuation side of the kind of qualities that we have focused on for the last 40 years that we have been in business. And we think that will continue to be the case, and we will continue to have a portfolio of assets that will be the kind of assets that will be very, very attractive.

And the advantage of that is, as we have, for example, the opportunity to buy another asset such as 399 Park Avenue and we want to sell other assets, we are able to sell them, we are able to sell them at prices that I think exceeded almost everybody's estimates. We were able to sell them quickly. And so we have that as an ability to raise equity money in the event that we need it for a major purchase.

All of that I think still undergirds our basic strategy, and we intend to focus on that strategy, to continue that strategy. It's a disciplined strategy. We are not going into a lot of other markets, simply because of the fact that the conditions in which we feel we ought to concentrate in certain markets do not exist in too many other markets. So this is our sort of summary.

It is a somewhat more optimistic summary going forward, I think, than we've had for the last several years. But I think it is a fair reading of where the economy is, and it's in fact on the real state market. Why don't we open it up to additional comment. Doug?

I think we can open it up for questions, unless, Ed, you have something to say.

No.

Thank you, gentlemen. Ladies and gentlemen, at this time we will begin the question and answer session. If you have a question, please press the star followed by the one on your push button phone.

If you would like to decline from the polling process, please press the star followed by the two. You will hear a three-tone prompt acknowledging your selection. If you are using speaker equipment, you will need to lift the handset before pressing the numbers. One moment please for the first question. Our first question comes from Jonathan Litt with Smith Barney. Please go ahead with your question.

Good morning. I'm here with Gary Boston. Doug, I wanted to follow up on your comments on Times Square. You had said you expect 200,000 to 400,000 square feet of leasing in '04. Is that correct?

Yes.

Is there a basis in any activity that's going on today that gets you there, or is that just based upon, is that an assumption?

Ed, you want to take that?

I am happy to answer the question. It's not based on any specific transactions, John. We continue to see activity at Times Square Tower. We continue to follow our customary policy of just not commenting on specific transactions until we can say that they are definite transactions, and we are not in that position today. I will say that I think activity quarter to quarter has picked up, and it's a very good sign and we remain optimistic about our ability to lease that building, and it's ultimate value and quality.

Jon, I would just add that I think Robert Selsam is showing space in the building to prospective tenants more than once per week. Is that a fair statement, Robert? Robert, are you on, or Mort?

Yes, absolutely. We are in fact -- there's a dramatic increase in the traffic, and beyond traffic, and the translation of traffic into proposals and counterproposals. We will not go beyond that because it's just senseless speculation. But there's no question but that there has been a major increase in the activity in New York. As I indicated, too, there are several major sources of clients. One of them is that the financial services industry, for example, which had been putting some space on the market, was sort of shadow space or sublease space, is now taking that space back, and we see that.

And secondly, of course, law firms are still continuing to grow at an extraordinary rate and a lot of them are in buildings where they simply have no expansion space, so they are talking to us about moving into space which will be ready fairly quickly because they are really growing dramatically.

Doug, had you said it's going to come online in the second quarter. Can you just walk through how it's going to come through the income statement?

Sure.

The building is 23% leased, and those two leases will commence from a straight line FASB 13 perspective when we give the building over to O'Melveney & Myers, which will be the first tenant. And they are expected to relocate from Citigroup Center in some time in the April timeframe. They are actually building out their space right now, but with don't have a certificate of occupancy there. There still – there aren't any elevators working, the lobby is not done.

So once that base building work is completed, and O'Melveney & Myers is ready to pay rent, which should happen simultaneously sometime around April 1st to May 1st, the building will commence coming online and the 23% of the space that is leased will run through the income statement and we will cease capitalization on 23% of the cost. The rest of the building will continue to be capitalized for up to 12 months as we sign leases and hand over space to tenants. When they actually take possession of the space, we will start the straight line rent of those spaces on a percentage basis. We will take that additional amount of space and bring it online and flow it through the income statement without capitalizing it.

And so you are going to have 12 months from April until you have to start putting the whole thing through?

Yes, unless -- it's all [factum] circumstances in theory, John. If we didn't show a stitch of space and we weren't really developing the space from the perspective of actual activity, we might have to go shorter than that. But given the act of activity and the number of showings we are doing, we are very comfortable that we will have -- A, we hope we will have a significant amount of it leased before then. But we will clearly be under development for at least 12 months.

Okay, and I think Gary Boston had a question.

Doug, could you give us some detail on this transfer of the mortgage at Five Times Square and what that transaction was all about?

We had a mortgage on Five Times Square, and we transferred that mortgage to a third party and they paid us $1.3 million. We had also done some of that in the second quarter. I think it was about $3.4 million. We bifurcated the mortgage and assigned to it various people who were putting permanent financing on their properties. And so we gained about $5 million. We didn't deem that to be FFO because we deemed it to be a one time gain on the sale of an asset.

Doug, just another follow-up question.

John, I think we really have to give some other people a chance, please.

Very good.

Thank you. Our next question comes from Jay Leupp with RBC Capital Market. Please go ahead with your question.

Thanks. Good morning, here with David Copp. Could you give us a little bit more color at the property level with respect to your strategy toward both renewals of existing tenants as leases are expiring, as well as for vacant space that you are currently marketing and how you are competing in the marketplace, particularly in Boston and San Francisco?

Ray, do you want to take that one?

Yeah, I'll respond to that. First of all, we are in favorable of renewals, obviously.

We are taking the aggressive strategy to approach those tenants, not only in the '04 time frame, but in '05 and '06, doing what we call "Blend and Extend", trying to get them before they hit the marketplace. What we're finding is, existing tenants are facing capital crunches because the economy isn't general, and they are very happy in their buildings and intend to stay if a reasonable deal can be cut. And that's under way in all of our markets. In terms of marketing the aggressive space, aggressively marketing the space – the vacant space -- as Doug and Ed have said, we are not going to lease at all costs.

We are still trying to hold the line on reasonable net effective rent. We are trying to minimize the amount of CAPEX or transaction cost that we put into it, trying to be responsive to the marketplace in terms of rental rates, aggressively pursuing positive relationships with brokers. What we are seeing across the board -- which is very much in our favor -- is a flight to quality.

We are seeing tenants, most notably in Northern Virginia, moving up to Class A buildings from Class B buildings and paying what they perceive to be -- and in fact is -- a very competitive value rate for the rent. I think it is more now in Northern Virginia, where we have an industry-wide 20% vacancy and in the 3 million square feet, plus we have in Northern Virginia, we have less than a 1% vacancy. And all of that has been either acquired or developed in the last five years. So we feel very good about our position. We are aggressively pursuing all viable tenants in the marketplace, and as Ed and Mort have said, we are starting to see the bottom and starting to turn up.

Okay, and then just one follow up, Doug and Mort, as you were talking about the business planning that you all are doing and the economic assumptions that you are making. Supplementing Mort's comments about the economic recovery, can you give us some feel as to what you are planning, is assuming about what interest rates and the job growth picture will look like in the next two years?

Well, this is Mort. That's a very difficult question to answer, although it's a very good question. I mean -- I'm sorry -- my sense is that -- sorry –-

It’s just as good an answer as the one you were going to give out. [Laughter.]

Normally there is not a musical background on my cell phone -- if there is, it usually is a crescendo, not just a melody! In any event, we think that there will be a slow recovery in the job market, certainly in manufacturing. I don't know if -- I am sure many of you are familiar with the Federal Reserve study which showed that 80% of the job losses in the manufacturing sector are structural losses.

People will not be able to go back to these jobs. Only 20% of them will be able to go back to these jobs if the businesses recover. The other 80% are going to have to find new jobs. So that is a very serious change. It used to be about 25% or 30% lower in earlier recessions. It was about, I don’t know, 60-odd percent in the 1991 recession, 50-odd percent in earlier recessions.

So this is a serious issue. In terms of the office employment, I think that will begin to come back a little bit, but my own sense is that companies are going to be very cautious about adding people for several reasons, not the least of which is that the healthcare costs are going up dramatically, and this means that the non-wage costs for a lot of companies are going to be an impediment to new employment.

And people are just going to be looking to outsource in ways that they haven't done before. Having said that, I think we will see enough job growth next year. It won't be dramatic, but I think it won't be the kind of job losses that we have in effect have suffered for the last three years, and that will change things. And in terms of interest rates, as I said, I think the interest rate factor in terms of short term rates will be fairly modest. I don't think the Feds are going to raise rates dramatically.

I believe there may be a 50 basis point rise at the bottom and 100 basis point rise in the second half of next year, and I don't think it will be much more than that on the short term; and on the long-term end, a lot more will depend on inflation, but I don't see that there's going to be much pressure on inflation. Nevertheless, I expect that long-term rates will go up somewhat, not very much. Again, I would say at the most, 50 basis points over the next year. And I would never make a prediction beyond a year, but I don't see that there's going to be much of an impact on interest rates or employment next year. It will change, however, people's planning, because a lot of the leasing that we do is in advance, where you don't do that much leasing in which somebody comes in and says, okay, I will take the space, I will move in next week. People really begin to think ahead, and when they begin to think ahead in terms of adding people, that will make a major difference to the real estate market.

Thank you. Our next question comes from David Shulman with Lehman Brothers. Please go ahead with your question.

Good morning, everybody. Just two questions. First question, who is your partner in New Jersey Avenue?

Our partner in New Jersey Avenue is a local development company that has control of the site.

Okay, local development company.

And Doug, could you go into the restructuring of the Gateway mortgage from a fixed mortgage to a cash flow mortgage? It sounds like you had very serious negotiations with your lender on that one.

We never have serious negotiations with a lender. We basically accommodate to everything they ask, David.

Thank you very much.

To try and do this briefly, we have, our Gateway loan was $88 million, and everybody recognized that AT&T -- which was the major tenant which I've been highlighting -- was moving out of the majority of their spaces and will be moving out of their space in October. They recognized and we recognized that the current coupon on the mortgage would not be sufficient to pay on a current basis. We agreed to pay the loan down, and they agreed to reduce the interest rate to 3.5% in exchange for us using all available cash flow after that to pay principal.

They have a right after three years to extend the loan, assuming cash flow is at a certain level, which is the prospective cash. So right now it's a three-year loan and in three years, if things happen on the good side, they have the ability to extend the loan through original maturity.

If things don't happen on the good side they own the building?

No. If thing don't happen on the good side then we have a loan that comes due the end of three years and we decide what we are going to be in three years, and presumably we are going to pay the loan.

Okay. Thank you.

Thank you. Our next question comes from Dan Oppenheim with Banc of America Securities. Please go ahead with your question.

Thanks -- and then Lee Schalop has a question after me. Doug, I was wondering if you can talk about 2004. You talked about an expectation of a 50 basis point decline in occupancy.

I'm wondering if this is something where you are assuming that for the year -- but it could be more than that through the first half of the year and some rise in the second half -- and is that based on some rollover that is occurring early on, if you could add a little more color on it.

I would say that the 50 basis points is sort of a steady state through the year. Whether it's 30 basis points in the first quarter and 40 basis points in the second and positive 20 in the third -- we haven't, we are not prepared to give that kind of guidance at this point.

I will say that we have more leases rolling over toward the middle of the year than we do at the beginning of the year, the biggest being the Old Federal Reserve where Carrington is moving out -- someone correct me if I'm wrong -- I believe on July 31. That would hit in the third quarter of the year 2004.

Thanks. And now Lee has a question.

I actually have two questions. First for Doug or Ed, you mentioned FAS 150, and in the past you guys haven't been big fans at joint ventures. Can we read into that FAS 150 will make you less of fans going forward?

Nope, I think from my perspective, Lee, it's FASB and the SEC want to junk up our statements and make them unintelligible to the investor and the analyst, so be it. We are not going to change our business practice because of an accounting pronouncement.

Okay, and then for Mort, you mentioned that you don't see much inflation. I wonder how you reconcile that with your earlier comments about the unprecedented fiscal and monetary stimulus.

Well, you know, I think there are a lot of reasons why the two are not necessarily inconsistent. The fact is that we have a lot of slack in the manufacturing economy. We are still operating at roughly 74% of capacity. The fact is that you have a tremendous amount of foreign goods coming into the country that are much less -- they are susceptible to the decline of the dollar although I don't think that affects much of their pricing. There is very little pricing power across most of American industry.

I think people should be much more focused on making sure their costs are under control. The productivity is going up at remarkable rates, that makes it possible to allow for increased employment or at least increased wages without increasing prices. All of which suggest that I think employment -- I mean inflation pressures -- are going to remain muted. In fact, they continue to decline overall on a macro basis if you take out oil and food. So I just don't see that there are inflationary pressures building in the economy at this stage of the game. I do think in the longer term that our fiscal policies that have been followed are insane.

I cannot believe that we have given away, the degree to which we have, the Federal revenue base, especially to the people who don't need it, namely financial analysts and investment bankers. I mean, it's just, that's the one thing that I think really does present a problem in the longer term for the economic well-being of this country. But in the short term, by that I mean the next year or two or three, I don't see that it's going to be seen as that kind of a problem, either by the domestic economy or by the foreign investment community.

So I by and large do not see inflationary pressures, and I don't think there is going to be such a surge in the economy in terms of hiring and pricing possibilities that we'll have to worry about it; and therefore, I don't see that interest rates are going to reflect a big prelim for inflation being built into the longer term interest rates. We already had, as you know, an amazingly rapid jump in ten-year treasuries. Almost over a period of six weeks, we must have had something like 120 to 140 basis points. It went off a little bit, it came back a little bit. We'll see what happens, but I don't think you are going to see a big jump in ten-year treasury rates or longer rates. As I said, I think 50 basis points is the most.

Okay. Thanks very much.

Thank you. Next question comes from Carey Callaghan with Goldman Sachs. Please go ahead with your question.

Good morning. I had two quick questions if I could. First is on 1333 New Hampshire Avenue. Our understanding is you are buying that from a German fund, which seems likes quite a switch from what we normally expect to see as who is the buyer, who is the seller, and yet the cap rate seems fairly attractive, and so without being crass, I'm wondering, are there any physical or leasing challenges to that property?

Let me take that.

Oh yeah, Ray. You do it.

Well, go ahead if you want to.

No, no, go ahead.

This is a situation where we found a very opportunistic situation. We had a seller who was highly motivated to accommodate a transaction within a thirty-day window. We caught wind of it before it hit the market. We acquired what we perceived to be just a terrific building, validated by extraordinarily aggressive time line for due diligence. It validated that to be an outstanding building, great location, very efficient floor plate, and we picked it up as a price per pound that is well below replacement cost, and the location -- you can't find sites like this.

And with a very secure leasing structure.

It's leased by Akin, Gump, a top-20 law firm, lease term for another six years at substantially below market. So we just feel really great about that acquisition.

I think it's fair to say in response to your question that the reason why they had to move very quickly was they had made another commitment for a large acquisition and in order to do that, they had to liquidate this one so that they can proceed with the other one.

Is that a fair statement, Ray?

I think it's a very fair statement. I think it's interesting to note that we acquired this building for about $350 a square foot and sold 2300 N Street for $420.

Sounds like a great opportunity. Just quickly another topic, Waltham Weston Corporate Center, not to focus on a small asset and small lease, but you brought it from 43 to 56% occupancy.

If we did the math right, based on your lease expiration schedule, you leased about 40,000 square feet at about $14.50 per square foot, which if that's right, it's about half of what you indicated the market is. Can you comment on that suburban Boston asset, what are you seeing on the margin, is this indicative of where the market is going and what does it say about the health of those tenants in that corridor?

Two things, one is the leasing statistics, as I said, it's actually 65% leased, not 55% leased, because we have two leases where the rent doesn't actually commence until the fourth and first quarter of next year and therefore we couldn't bring it online. I can't get to your number there. I can tell you that the rents on the leases that were all done were basically done, as I suggested, in the mid to upper 20's and they were all turn key transactions and they were five and seven-year leases.

They are consistent with the market rents that we provided you with before. There was no -- I think there has been no change in that suburban Boston market in terms of rent levels over the last quarter.

I mean, the interesting thing, too -- those tenants moved out of Bay Colony, which I think if you were to look at the Boston marketplace and ask brokers what's the best asset in suburban Waltham, Bay Colony was the asset at least that would come to everyone's mind as sort of the highest quality and best located; and two of those tenants out of the three that we’ve leased [inaudible] moved out of Bay Colony into Western Waltham Corporate Center, which says something about at least their perception of Waltham Weston Corporate Center’s competitive advantages.

Okay, great. Just so -- maybe just comment broadly on the kind of momentum that you are seeing, looking forward here, in those technology-driven tenants that are typical in that corridor.

I think we still have -- the message is a mix. We are seeing some tenants actually expanding and moving into more space. One of -- I think at least one of the tenants in that building has expanded -- a high technology tenant.

On the other hand, there are tenants around 128, technology tenants, that are clearly giving back space and leaving space. So I think it really is, it's sort of a tenant by tenant basis. Overall, I would still say that the technology sector is probably contracting rather than expanding, but certainly at a much, much slower rate if that's the case. We are not seeing lots of sublease space coming back on the market and things like that.

And again, as we said about the Northern Virginia, our assets -- we are seeing a significant flight to quality, people looking to upgrade their presence in the corridor.

Great. Okay. Thanks, guys.

Thank you. Our next question comes from James Sullivan with Prudential Financial. Please go ahead with your question.

Thank you. Good morning. I wanted to start really by focusing on pricing, and I wanted to do ask you, Doug, if you could repeat those leasing spreads by market that you gave?

Sure. You mean where we saw the markets today?

No. Where you had the -- you actually gave the releasing spreads for the markets.

Yeah, on the market by market? In Boston it was a 59% decrease -- and these are lease to lease, so a space that is not dark for more than six months – on San Francisco it was a 23% decrease, Washington, D.C. was flat, so there was no increase or decrease, Princeton there was 3% decrease, and in New York City an 88% increase.

88% increase. Okay. You gave in terms of the assumptions underlying your guidance for 2004, you talked about occupancy but you didn't talk about pricing, and I wonder what your view is. Do you think pricing is going to continue to erode in the -- in your markets?

Our assumption on pricing is that it remains flat.

We have not seen any significant decrease in pricing levels over the last two or three quarters. I mean, if things have gone down, they've gone down on the margin less than 5 percent, and we are seeing a realization from at least more landlords that they don't need to give away the kind of concessions that had been bandied about. Instead of doing a $50 work letter, someone is saying, let's do turn key and the turn key ends up costing $41 a square foot, and it satisfies the tenant and it satisfies the landlord. So we think that overall there is more stability to pricing as opposed to less stability to pricing.

I’d just add one thing to that too. I think there has been an absorption of sublease space or sublease space that is no longer sublease space, either because the tenant went belly up or because the lease expired. And I think that also helps create some stability, the landlords rather than the tenants control more space. That may be not a good thing, but it's healthy in terms of market pressure.

So I guess if we can kind of conclude, the outlook on pricing and spreads would be that leasing spreads may continue to widen negatively, but that would be because of hiring rates on expiring leases.

Exactly.

And your mark to market probably should not change.

And hopefully it's going to start moving in the other direction.

Okay, and then the final question for me in terms of pricing, how that impacts your returns -- your now projected returns on Times Square? Any change from what you said in the prior call?

We haven't provided any returns on Times Square, other than to state that we thought rents on average in New York City are down 15-20% from what we had expected when we started doing our leasing there. The issue is going to be what's the cost. And we've had such a tremendous savings in our interest expense that we actually may bring the project in significantly less than we had anticipated, and the real issue is going to be, what's the velocity of leasing?

If we are able to lease 450,000 square feet of space in 2004, which is sort of the top end of our number -- I think the return is going to be significantly higher than if we are only able to lease 200,000 square feet. Until we have better clarity on the leasing profile, it's hard for us to throw out numbers on where we think the returns are going to come in.

Okay, fair enough. Thank you.

Thank you. Our next question comes from Lou Taylor with Deutsche Bank. Please go ahead with your question.

Yeah, hi, thanks, a couple questions.

One, with regards to just overall leasing activity, what percent of the discussions or leases contain or represent contractions and how much are those tenants contracting by, 15% or 20% or more?

Ray, can you comment on that?

Well, I would just say that it’s hard to make an across the board type of analysis. Clearly, were we are not seeing too much expansion now, I will say that. I would say the vast majority of the deals are pretty much status quo, and I would say probably less than 20% involve contraction, I would say.

I mean, the major contraction is the one that Doug spoke about in South San Francisco.

We've had some contraction, although I guess this isn't even in our statistics yet, is it? The deal in Boston, the renewal in Boston where we thought it was somewhat less space.

Yes, that’s in the statistics.

But most of them, as Ray said, are stable when they renew.

Lou, when I look at our vacant space in the conversations we are having, if I go market by market, in New York City, all of our tenants are looking to -- the conversation we are having with existing tenants are expansions.

There is not a tenant that is coming to us and saying, we would like to reduce our square footage. In fact, it’s truthfully law firms that are running out of space and they are looking for more space and they’re looking for expansions in their buildings, and we are having a hard time accommodating them. I think in Northern Virginia and in the District, it's the same thing. We have yet to see a decrease in a user in Northern Virginia or in the District over the last six months. San Francisco and in Boston, it is a little bit different.

There we have more technology companies who are quote unquote, rightsizing the premises, and there, there is more of a pressure for a decrease in square footage. And in Princeton, it's really status quo. Most of the tenants in Princeton have sublet space on the market and we have gone actually from indirect to direct leases with many of those tenants, and the tenants that are now looking to renew their leases are sort of staying where they are on a status quo basis.

Okay, second question just pertains to the hotels. I stayed at that Marriott Long Wharf this summer with a group and I thought our bar bill alone would have been enough to have upside for the quarter...

You don't represent the market, I hope you realize that?

That must be the case.

But we would like you to come back.

Yes, I plan to do so. The place was packed, but your results are still tough. Is it a matter, in hotels, of getting the rate up, or is it still a matter of getting the occupancy up?

It's all rate. These hotels are running in the mid 80's right now and it's all about rate. It's the competitive status and the price pressure of city-wide and of small business meetings which just are not occurring to the degree they need to, to give some traction to the hotel operators to push the rates up. I will say that in the last couple days, we are probably $100 higher at the Long Wharf Marriott than we've been since the beginning of the year in terms of what the rate is. I think it was closer to $290 as opposed to $190.

Unfortunately, the Sox lost to the Yankees, so we won't have the same thing this week.

It's just, I think there is clearly still not as much business travel coming into at least Boston. I can't comment on other markets, although I know when we go to San Francisco, what we are paying in San Francisco is a pretty unhealthy rate from the perspective of a hotel operator.

Thank you.

Thank you. Our next question comes from Mike Marron with Bear Stearns. Please go ahead with your question.

Thank you. The fifty basis point decline in office occupancy, what does that imply for same store NOI? Is that down 1% or 2%?

Yes, very slightly negative. You have to remember we are now -- we’re bringing buildings -- we have buildings that are fully occupied that are going to be on for the full year, so it all gets a little bit mushed together. But net/net there's a very slight same store reduction.

Finally on the leasing assumption at Times Square Tower, are you assuming any of that leasing activity actually takes occupancy in '04?

Absolutely. When I say 200,000 square feet to 450,000 square feet lease, I mean they take possession of their space in '04.

Remember that taking possession doesn't necessarily mean taking occupancy.

Possession and occupancy are different in New York City because the tenants builds up their space. Just to give you a sense, a typical law firm probably spends $190 a square foot on everything when they move from one building to another.

The landlord contributes somewhere between $45 and $55, and the tenant hires their own company to do that build out, given they are paying for the majority of the cost themselves, so they want to control that. So it generally takes them between six and eight months to build out 200,000 to 300,000 square foot of space.

The lease commences when they take possession of the space.

That implies there would be some leasing announced in the next quarter and the first quarter of '04?

I wouldn't make that implication. I would just say that we plan on delivering space of between 200,000 and 450,000 square feet some time in 2004 after the leasing of the other two tenants has commenced, which is somewhere between April and May.

The NOI assumption on hotels of only $21.5 million, is that being a little conservative in light of, there was definitely some improvement in RevPAR in the third quarter?

Well, we are going to be at $19 million this year, so we are taking it up about 16% or 17%. Obviously, given the historical high of $36 million, it's conservative; but given the -- as we were just speaking, the compression in average daily rates, I hope that I'm wrong, but I just don't feel comfortable pushing it much further than that.

Thank you.

Thank you. Our next question comes from Steve Sakwa with Merrill Lynch. Please go ahead with your question.

Hi, good morning, or good afternoon. I want to do follow up on David Shulman's question on the loan in San Francisco. It seems like a rather dramatic move from the standpoint of the lender. It would almost imply that maybe you are worried about complying with the loan. Does it say anything more about the market or does that say anything about your view of the San Francisco market?

I guess I'm not sure I understand what you mean by complying with the loan.

It seems to me that, okay, you have a property that's obviously not leased, not performing.

You could hand the keys back, you could default on the mortgage. It seems to me that they kind of cut you a 500 basis point slack on the rate on the loan. You haven't really paid a lot for that and I am just sort of trying to kind of read into it. I release the asset is not the performing well. But is there something in the lenders' minds?

This is how we thought about it and I assume the way they thought about it, which was we made a principal pay down of about $6 million, and we said, what's a fair three-year rate on a loan? Let's assume that we are going to refinance this thing for three years and we looked at the three-year treasury and we added spreads of three-year treasury and got to 3.5%.

That's really the fundamental we said, we had no intention of wanting to give the property back. I don't think they had any intention of wanting to take the property. We do in fact believe -- or we wouldn't have made a $6 million paydown -- that the property will come back at some point. While there's de minimus amount of activity in the market, we hope and believe that things will change and our San Francisco operations certainly believe that.

And so we sort of all agreed collectively that the appropriate thing would be to restructure the loan on a three-year basis, clearly make it so that the property was performing. We agreed that we would pay down principal and we will use any available cash flow to pay the principal down more to help the lender reduce the balance.

To answer your more general question, Steve, it doesn't represent a change in our feelings about San Francisco in general as a marketplace. South San Francisco is a market that is having great trouble now because of what's happened to the technology sector. But that doesn't sour us on that region.

Okay. Thanks.

Thank you. Our next question comes from Scott O'Shea with Deutsche Bank. Please go ahead with your question.

Yes, thank you. Quick question again on Gateway. How much of the building did AT&T take up?

Well, they currently lease 180,000 square feet and they’ve renewed a lease for 36,000 approximately, so they're giving up about 125,000 square feet.

Okay. So that's a little over, roughly 30% of the space, something like that?

The two buildings combined are just under 500,000 square feet.

Right, okay, great. Will you record a gain on the renegotiated mortgage in the fourth quarter?

No. Just a restructure and there will be no gain.

Okay.

And it was in the third quarter.

It was in the third quarter. Okay. Are there any other mortgages where you are similarly having discussions with a lender at this point?

No.

Okay. That's it. Thank you.

Next question comes from Jim Sullivan with Green Street Advisors. Please go ahead with your question.

Can we focus on the San Francisco financial district and what's happening with net effective rents there? You commented generally that rents haven't declined very much on average. Can you talk about San Francisco specifically?

Bob Pester on the call?

Yes, I am.

Do you want to comment, Bob?

Sure. Jim, as you know, having been here many times and looked at Embarcadero Center, it really depends on the particular space, the age of the space and the quality and improvements of the space. To briefly answer your question, the net effect of the rents are ranging from the mid single-digit range, let's say $5-$6 a foot, up to $15, $16 a foot.

Within Embarcadero, can you comment on net effective rents on the deals that you've either closed recently or are negotiating currently?

Our most recent deals are going to be in the $8-$12 range on net effective rent.

Again, that's obviously -- we are amortizing our transaction cost at 10-11% to pay up on the credit.

So, there's an interest expense associated with that and that's not a -- take the transaction cost, divide them by the lease length and reduce that from the rent, where there's a cost of capital associated with that calculation.

Okay. And then your '04 rollover that you show for San Francisco, presumably that's mostly Embarcadero?

Yes.

Thank you.

Thank you. Our next question comes from Greg [Karondee] with Wachovia Securities. Please go ahead with your question.

Actually, it's Chris Haley. Good afternoon. Looking at your land investment [joint] venture, where else might you be looking for land development beyond was already have two to three years out?

We continue to look at sites in all of our regions, and that that includes Boston, it includes New York, it certainly includes Washington.

We have a lot of development land already in Princeton and we have several development sites still in the San Francisco region. So we are not closing our eyes to anything. We don't -- we believe still that we will create value through development as the market improves down the road.

Do you believe -- where do you see in certain markets and in general terms land pricing in relation to asset pricing?

Somebody described to me something called "landowners’ disease", which means that every landowner thinks that their property is still worth what it was at the top of the market and they never get over it, primarily because they don't have to carry it. They don't carry that value, it's just in their head. So frankly, we have not seen land pricing come down.

The asset side, knowing that you create most of your value through the development process, but have been known to purchase a building here or there, where are you seeing if any potential loosening up in deal opportunity for acquisitions, whether it be Northern Virginia, which we've heard about some backlog of the building given the softness of the markets, some deals, some quality buildings can come to market? How about Boston or --?

We have not seen quality buildings, we have not seen any weakness in asset pricing in quality buildings.

In terms of forward expectations, would you expect to see more deals come to market?

I think there will be deals coming to market. The question is, at what kind of yield will those yields -- will those buildings be placed on the market, for what kind of yields? As Mort said earlier, our ability to make deals comes from our ability to try and not get involved in auctions. So I think that will remain true in the future, too.

Thanks.

Gentlemen, we have no additional questions at this time. Please continue.

I think if there are no additional questions we should wind it up.

We thank everybody for participating. We are encouraged, as Mort said, that things may be getting better, as opposed to staying the same; but we are not prepared yet to wave the flag and say the stampede to our buildings has been started.

Thanks, everybody.

Ladies and gentlemen, this concludes the Boston Properties third quarter 2003 conference call. If you would like to listen to a replay of today's conference, please dial 303-592-03000, or 1-800-405-2236, followed by access number 547315. We thank you for your participation in today's conference and you may disconnect at this time.