波士頓物產 (BXP) 2005 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Boston Properties second-quarter 2005 earnings conference call. (OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded Wednesday, July 27, 2005. I would now like to turn the conference over to Ms. Kathleen DiChiara, Investor Relations Manager for Boston Properties. Please go ahead, ma'am.

Good morning, everyone, and welcome to Boston Properties' second-quarter conference call. The press release and supplemental package were distributed last night, as well as furnished on Form 8-K. In the supplemental package the Company has reconciled all non-GAAP financial measures to the most directly comparable GAAP measures in accordance with Reg G requirements. If you did not receive a copy, these documents are available in the investor relations section of the Company's website at www.bostonproperties.com.

Following this live call an audio webcast will be available for 12 months on the website in the investor relations section under the heading Events and Webcasts. To be added to our quarterly distribution list, please contact the investor relations department at 617-236-3322.

At this time we would like to inform you that certain statements made during this conference call which are not historical may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Boston Properties believes the expectations reflected in any forward-looking statement 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 last night's press release and from time to time in the Company's filings with the SEC. The Company does not undertake a duty to update any forward-looking statement.

With us today I would like to introduce Mort Zuckerman, Chairman of the Board; Ed Linde, President and Chief Executive Officer; Doug Linde, Chief Financial Officer. And during the question-and-answer portion of the call today our regional management team will also be available.

Now I would like to turn the call over to Doug Linde for his formal remarks.

Good morning, everyone, and thanks for joining us for the call this morning. As everyone I hope saw in the press release last night, all of the asset sales that we have been in discussing over the last few quarters have all officially closed. And we announced a special dividend approved by our Board of Directors of $2.50. The record and the payment dates of that can be found in the press release.

We're going to spend some time reviewing the reasons for that decision later on the call. Ed and Mort are going to take the lead on that, but I'm going to spend some time discussing the results of our operating portfolio and provide some color and some perspective on the trends and the operating specifics that we see in our supplemental package.

We reported second-quarter funds from operations of $1.06 per share after adjusting for the prepayment penalties associated with all those sales that we completed during the quarter. That's about $0.04 above our prior guidance calculated in that same way. And I think I explained last quarter that we were going to report this way, and that we believe that reporting funds from operation after the supplemental adjustment is more useful because it more appropriately reflects the results of our operations exclusive of the impact of those sales transactions. To us it would be logical to deduct the sales related prepayment expenses from funds from operations while at the same time excluding the gains from those very sales. We think it is very congruent to do it the way we reported it.

I do want to reiterate, however, that we only adjusted funds from operations for the prepayment penalties incurred as a result of the sales. So this quarter we did in fact have additional non-sales related debt prepayment expenses of about $1.9 million, and they are included as an expense in our funds from operations as adjusted results.

The positive variance this quarter was attributable to what I would characterize as sort of five buckets, the first related to Riverfront and East Pratt Street where we actually had a negative impact on the quarter, largely due to the fact that our guidance assumed that the sales would occur at end of May and they occurred a few weeks earlier. That actually cost us about $850,000, and I just want to give you just a couple of numbers on those two sales so as you're thinking about adjusting your models on a going forward basis you have the impact of Riverfront and East Pratt Street.

The 2005 GAAP NOI from those assets to date would have been $11.4 million for the period of time we held them, and the corresponding interest expense was $4.7 million. The net annual loss contribution from the elimination of both that GAAP income and the reduction of interest expense for the whole year would have been $17.4 million. I think with that you can adjust for what the sales contribution is.

Second, we had positive items of about $3.3 million. And those are onetime items as we would characterize them. Some of it was third party fees. That was about $525,000. We had previously budgeted about $1 million of termination income. As you recall, I think last quarter we talked about Genentech taking the remaining space at 651 Gateway. But we also received an additional $2.8 million of what I would refer to as unbudgeted and unplanned and unexpected termination income. 2.4 million of that was from a bankruptcy involving a 24,000 square foot tenant in 280 Park Avenue in New York City.

The good news is that we re-leased all of that space with basically plus or minus of downtime. The bad news is that the average rent that we got, while it was pretty high at $82.80, was still $13.50 less than the previous lease, which was actually signed in 2000, which gives you a perspective on sort of where market rents are today versus for they were on some spaces with escalations obviously included from the leases that were signed in the go go days. And that really results in the roll-down in second generation rents in New York City which are shown in the supplemental package.

The third category is what I would call portfolio revenue gains and that is either from percentage rent increases, higher garage revenue, earlier than anticipated lease commencement. That was about $1.5 million. Those were really very small individually, the largest being about $130,000, making up that 1.5 million.

The fourth item was reduction in operating expenses of about $1.6 million. That really came from lower non-budgeted -- lower budgeted, non-escalatable expenses which don't get reimbursed, and then timing of repair and maintenance expenses where we thought we might spend some money in the second quarter and we probably pushed it out to the third quarter. So that's really a timing issue as opposed to a recurring item.

And then finally, interest income and interest expense had a positive variance of about $950,000 against what our budget was and really a lot of that had to do with again the timing of sales of Riverfront and Pratt street.

In the second quarter we continued to lease space at a pretty strong pace. We leased just over 900,000 square feet of space. That was 91. These are new leases and/or amendments or renewals. And that was a little bit less than we were in the first quarter where we were at 1.25 million square feet and had 93 transactions.

The quarterly activity was led by Boston with 300,000 square feet, and that's the first time in quite some time that Boston actually had more transactional activity than our other markets. DC had 227,000 square feet. San Francisco had 183,000 square feet. 136,000 square feet in Princeton. There was one large transaction of just over 100,000 square feet that really took up the bulk of that which we talked about before. And there was 56,000 square feet in New York City, and that included the 24,000 square feet of renewals that I just spoke about.

From a macro perspective the office markets are still improving, albeit probably at a slower pace than what we experienced at least between the fourth quarter of '04 and the first quarter of '05. Across the portfolio our average market rents continue to move up in all the markets that we operate in, maybe with the exception of the Boston CBD, Cambridge and Montgomery County and Princeton markets, where they're not going down; they are just not increasing. Although if you look at some of the statistics from those markets, you might actually see modest increases, although we're just not seeing it in active deals that are going on.

Our portfolio total weighted average rent today sits at $42.52, and that is versus a market rent of about $42.16. So that would be a negative roll-down of about $0.36 per square foot. Last quarter that spread was $0.80 on the negative versus -- and I think I told you this last quarter -- about $3.95 a year ago. So we continue to narrow that gap and are probably pretty close to the point where we're going to be talking about positive marked to markets within the whole portfolio.

I wish I could declare, however, that those roll-downs are a thing of the past on a short-term basis because excluding retail space expiring rents on specific spaces rolling over the next 18 or so months as we look at it is about $38.90 so that that bucket of space, if you will, versus the 43 I just talked about. And unfortunately, the estimated market rents on some of that space is still going to be rolled own probably about 9% as we continue to experience the expiration of leases were signed in 1999 to the early 2001, which is when things were very overheated.

Our largest exposure over this timeframe is again in Boston. The average expiring rent on that bucket of space is about $30.95. We think the roll-down in Boston is probably going to be a little bit more dramatic, about 20%. A lot of that is in the suburbs.

We're going to leave specific market condition comments to the question-and-answer session where Ray and the other regional managers who have been in the trenches are prepared to answer questions to the extent that you have them.

The most noteworthy of the quarterly leasing achievements that was really the continued success we're having at Capital Gallery which is the redevelopment project in the southwest part of DC. And the Smithsonian Institute has leased an additional 32,000 square feet of space, and we're in active discussions on virtually all of the remainder of that 300,000 square foot addition.

So that new Capital Gallery space, while it stands at 56% committed, we expect to start delivering in the second quarter of '06. And based on our current leasing expectations, we think this project is going to achieve a cash on cash return in excess of 12% when it's fully stabilized. And we expect the full stabilization to occur probably in the last quarter of '06 or the first quarter of '07.

In San Francisco, we, as I said, completed our termination discussions with all of the tenants in 651 Gateway, other than one 7000 square footer who just can't seem to get out of their own way just yet allowing Genentech to lease virtually that entire building so that by year end Genentech is going to have over 540,000 square feet of space at Gateway Center.

At Embarcadero we have continued to successfully negotiate renewals on our 2006 expirations, and this quarter we completed an 80,000 square foot renewal on a block of the lower floor of the EC 2. As we have talked about in the past, it's those lower floor spaces which start to compete with the commodity space, which is where the struggle continues to be in the San Francisco area.

Our total in-service portfolio occupancy was 93.2 as of June 30, and that compares to 92.4% in the first quarter after adjusting to reflect the elimination of the assets sold during the quarter.

Times Square finally hit over 90%. We're at 90.1%. And we continue to work on the 32,000 square feet of available retail space we have at the base of the building. And it is probably a little bit slower than we would like, but there is activity. Our average remaining lease length is still about 7.5 years.

The second generation leasing staffs which are broken out in our supplemental show some roll-ups and roll-downs that I think might have been a little bit surprising this quarter. I talked about the New York City roll-down. Net-net throughout the portfolio we showed a relatively de minimus roll-down of about 4% in rents on a gross basis and 3% on a net basis.

In San Francisco we saw positive upswing, which I think a lot of people probably were surprised at. This really was the result of a lease that I think we've been mentioning for a couple of quarters, which was KMPG lease at the EC 3 which expired December 31 of last year, and we had leased that space to another big four accounting firm. And we had said at that time that the new rent was going to be higher than the old rent. Well in fact that is the case and it's showing up on our statistics now. And that really is the result of the positive increase in San Francisco. So as you think about what's happening statistically it's very hard to make generalizations based upon the numbers on a quarterly basis without understanding where those numbers are coming from.

The second generation leasing costs were also higher than normal at just over $30 per square foot. During the quarter we put over 300,000 square feet into service in San Francisco where the average transaction costs, particularly this one significant lease on this 160,000 square feet of space, were over $50 a square foot, bringing up the average. But if you blend the transactions for the last two quarters, the number is about $25 a square foot at $24.85. And that really is in line with what our expectations are. We think that our transaction cost are going to run somewhere in the mid-20s during this year and probably into next year.

Non-recurring capital expenditures were pretty much in line with what we expected. And where we're running at about $0.75 per square foot on an annual basis.

Our hotels continue to show good top line improvement. RevPAR was up 4.8%. And excluding the hotel results, our same-store NOI on the GAAP and on a cash basis was essentially flat.

As I mention the hotels, I do want to say that as of this week we are officially marketing our Residents Inn hotel in Cambridge for sale. Confidentiality agreements are being signed and there's a package of materials that is being printed and will be going out to the marketplace over the next few days. We are also preparing offering materials on additional office assets located in different markets in the country. And in total we have additional property that we could be selling before the end of the year of over $300 million.

We remain disciplined and disinclined to purchase assets in the current pricing environment. But these same conditions clearly make it highly desirable to continue to think about selling select assets, and that's what we're doing. If these sales occur they will likely close in the late portion of the fourth quarter of '05 or the first quarter of '06. If we identify some acquisition opportunities that satisfy our return and underwriting standards, we will aggressively pursue them, but we're not counting on it.

During the quarter we completed a number of financing transactions, including an extension of our corporate revolver, a refinancing of our Times Square Tower loan and a modification of our Gateway loan allowing prepayment at the end of 2005. Last week we prepaid our $225 million loan at 599 Lexington Avenue with our revolver on an interim financing basis. While from a pricing perspective it clearly an appropriate time to be issuing debt be it secured or unsecured, we just struggle to find uses for additional borrowing.

As we look towards '05 and '06 we will continue to focus our energy and our capital on our current and our future development pipeline. The current development pipeline sits at about $350 million, and that includes our share of 505 9th Street, which is going to get going in September. That's in Washington DC.

And from a timing perspective we expect 7 Cambridge Center to be placed in service in January of next year (indiscernible) Reston in July of next year and Capital Gallery to start to come into service in July of next year as well. So as you're thinking about bringing those properties online, those are pretty good dates to start the income and reduce the capitalized interest.

We're pursuing additional development opportunities with our current land positions, including a 200,000 square foot, 22 story residential tower in Cambridge at our Cambridge Center project. And the next phase of our mixed-use product in Reston Town Center which is going to include over 300,000 square feet of office space, 300,000 square feet of residential units and over 50,000 square feet of retail space is moving forward to getting underway. We are also looking at some build-to-suit projects in both the Boston suburbs surprisingly and the Greater DC market.

Going out and thinking about our guidance for 2005, with the declaration of our special dividend there is clearly some more clarity to our immediate use of cash, and therefore our 2005 earnings. And our guidance is based on the following assumptions --assuming that we're going to earn somewhere between 3 and 3.25% on our cash balances while we have them; we're going to make that $2.50 per-share special dividend payment on October 31, which is normal payment date for our quarterly dividend which will also likely be paid at that same time; and we will obviously have a core (indiscernible) reduction in our interest income starting in the fourth quarter. We are going to repay our Embarcadero Center West loan and our Gateway loans in California in the fourth quarter. That's about $175 million.

We're maintaining our prior outlook on occupancy. We don't see much happening in the third quarter. We're going to lose some occupancy. Our largest rollover is at the Prudential Tower in Boston, and we're going to lose about 65 basis points in the fourth quarter, but we're going to actually gain about 65 basis points from the lease commencement of Genentech at 651. I think that our occupancy is going to be very close to where it is through the end of 2005.

We will continue to experience the rent roll down in '05 on our expiring leases. Probably abut 18% and 9% if you think about it over the next 18 months. But this is going be offset by higher contributions from our newly delivered buildings. With the burn off of free rent at Times Square Tower our normalized quarterly straight line rent is going to somewhere between 10 and $12 million for the remainder of the year per quarter.

Our 2005 interest expense run rate is going to pretty much follow the second-quarter results if you adjust for the Riverfront and Pratt Street. And for the second quarter that was about $1.5 million of interest expense related to those properties.

We think our margins are going to be consistent with where they've been historically, maybe be slightly lower based upon occupancy roll-downs.

And we are increasing our budgeted third party income to about $14.5 million. I think we had it at about 13, 13.5 last quarter. That number looks like it's going to be right now at about $12 million for '06.

We are going to see some amount of termination income going forward, probably minimal, about $1 million.

We're budgeting our hotel NOI contributions for the remainder of the year to be somewhere between 14.2 and 15.7. Obviously if the Residence Inn is sold prior to the end of the year, that number is going to change accordingly.

Our second-quarter G&A at 14.2 was right online with what we expected. And we still think over the year we're going to come in at between 55 and $56 million, which is as we have talked about before. While we make sell additional assets up to that 300 million plus or minus I talked about, for the purposes of our projection we're assuming these sales are going to effectively affect our results in '06, not in '05. And to the extent changes will obviously include the projected impact of results in our next regularly scheduled guidance to the market.

We're projecting a growth rate of somewhere between 0.5 and 2% on the second-quarter 2005 NOI after you adjust them for the sales and no property acquisitions for the remainder of the year to sort of get our baseline run rate.

We're using about 140 million shares as our share count for '05.

So with that, we think our range is going to be somewhere between $4.15 and $4.22. That's versus our prior guidance of $4.15 to $4.25. And obviously with the special dividend at the end of the third quarter and simply the reduction of interest you can sort of understand how we got there. And we think the third quarter we're going to somewhere between 102 and 104. With that I'm going to turn my call over to Ed.

Thanks Doug. Good morning everybody. My intention this morning is to provide you with insight on the Board's deliberations which led to our decision to declare -- the Board's decision to declare -- a special dividend.

Let me begin by talking about the acquisition market. I think it is clear by our own performance that given our underwriting standards and our returns requirements we are seeing a paucity of attractive acquisition opportunities.

In those cases where there are auctions, and that is I would say probably characterizes 100% of the high-quality assets that come to sale in our markets, sub-6% returns are the norm. Sub-5%, or at least close to 5%, returns are also even possible. And most of the underwriting that is done for those kinds of assets assumes very aggressive assumptions about rental rate increases, perhaps 15% per year in the short-term and 5% per year sustained thereafter.

And while I don't mean to imply that the values that people are paying for those assets are inappropriate in absolute terms, the real question is do they meet Boston Properties' objectives and do they meet Boston Properties' picture of where it is going in the future.

You have to remember that certain buyers can use leverage at very high levels which are inappropriate, we believe, with a REIT balance sheet. Some investors are projecting a short hold period, which of course is something that REITs can't do. And in addition to that, we have certain -- we have criteria that as far as delivering return on equity to our investors that make buying a sub-6% yield with 50% marginally positive leverage not terribly attractive when it comes to growth in earnings and return on investment.

So you have to remember that our strategy is not to grow for growth's sake. And we believe the ideal size for Boston Properties is not some absolute number, but it's a size that produces the right return, the right total shareholder return which we can provide to you who own this Company.

That applies, by the way, not only to acquisitions, but to dispositions, which is why Doug mentioned earlier that we're continuing to look at our portfolio to see which assets might be disposed of on an attractive basis given this investment market as it exists today for real estate. So that was the number one discussion that we had at the Board.

Secondly, we looked at our balance sheet because the one thing that we didn't want to do is to put ourselves in a position where we might not be able to pursue whatever attractive opportunities came along. If you look at our balance sheet, at the moment we have $525 million in cash on that balance sheet.

After the special dividend, of the roughly 350 million that would leave about 175 million of additional cash. And as Doug mentioned a moment ago, we intend to pay off some loans that will absorb that money. So there is plenty of cash on the balance sheet to do what we plan to do as far as paying off debt and still leave room for the $350 million dividend.

In addition, if you look at our balance sheet in terms of debt, we're operating now at a leverage ratio, if you take the stock price as a proxy for net asset value, which as you know we ask you to think about the cap rates that people are paying for assets of the kind we own. And I think it probably casts into doubt whether the stock price is the appropriate proxy. But taking that conservative view, our leverage is really roughly in the area of 35%.

Now we've said before, and we believe this it still to be the case, that we are quite comfortable operating at leverage ratios as high as 50%. And so there's ample room on our balance sheet to increase debt in order to take advantage of opportunities that might come along in the future. We have an unused line balance of about $380 million. We have used the rest of that line, $225 million, to pay off the loan at 599 Lexington Avenue.

But of course that also reveals something else that's quite important, which is that on many of our assets, the property specific debt is well below what one might be able to refinance those assets for on a permanent basis. We currently have $225 million of debt on 599 Lexington Avenue, which is roughly 1 million square foot building. That works out to $225 per square foot of debt. I think everybody on this call recognizes that that asset is worth many multiples of $225 per square foot. And it would be easy to double the amount of debt on that asset when and if it was appropriate to do so.

Similarly, we also feel comfortable that we could go into the unsecured debt market if we so desired and put very attractive debt onto our balance sheet without in anyway straining our capacity or any of the ratios which either the rating agencies or our line borrowers look at in assessing the strength of Boston Properties from a financial point of view. As Doug mentioned, this would be a wonderful time given pricing to add more debt. But of course the issue is what do you do with the proceeds. That is why we haven't at this point chosen to add debt for example by permanently financing 599 Lexington Avenue at some much higher number than $225 million. But we have the ability and the capacity to do so.

In addition, Doug mentioned that we were contemplating roughly $300 million of additional asset sales. And in fact, if you look through our assets, you can probably identify -- and we're constantly doing this on an analysis obviously -- additional access that could be sold to raise even more money.

So in fact the bottom line is that this dividend presents no encumbrance on our ability to take advantages of opportunities that come up in the future, whether those be additional acquisitions, additional developments, or other ways in which we could really meet what our main objective is. That of course is producing a superlative, a better than you would expect total return for our shareholders. That's the way we've operated the business since we went public in 1997. It's the way we intend to continue to operate the business going forward.

So that I hope gives you some clarity as to how the Board came to the decision it came to. And with that let me ask Mort if he has any additional comments he would like to make on that subject, or any other subject for that matter.

One other consideration that was important in our decision to go forward with the special dividend is the fact that the shareholders of the Company would have had a unique taxable income to take into account from the sales. And therefore, they would have had additional taxes to pay simply because the taxable transactions at the Company level would have been translated to them at an individual level. And so this was an appropriate thing, we felt, to do in order to provide them with the coverage of that particular exposure.

But to go to the larger issues, we're still in every way that we can focusing primarily on development at this stage for quite an obvious reason. That is that our overall on leverage returns on these developments given that is our core capabilities are in double digits. And this is where we think we can continue to grow and continue to grow at an effective economic rate that provides the kind of return on capital that we feel we're striving for, for the Company and the shareholders of the Company.

And in that regard, frankly, we are proceeding in a number of different areas, particularly in the Greater Washington area, very successfully. Although I will tell you that it is not easy to find major development sites in any number of the markets we're in, but particularly in New York where we have been trying to acquire such sites and are still working on a number of them. But it is an extraordinarily aggressive market.

There has been, in my judgment, a fundamental reassessment of the value of real estate assets, something which I think is going to continue by and large for quite a while. And that is based in part on the financing, but in part on the fact as well that -- when I say financing I mean the amount of money that is available to go into this area of assets accumulation and the financing that is available to people who combine that with a lot of equity going into these areas.

But there is another important factor, and that is I think in most of the markets that we're in we're clearly in an up-trend in terms of rental rates. It is certainly true in New York. It is certainly true in the suburbs of Boston. It's certainly true in the Washington area and in the suburbs of Washington and definitively true in San Francisco.

I think people are incorporating that fundamental into their estimates of the valuations that they're applying to the acquisition of real estate assets. And we're applying it too in terms of the kind of developments that we're involved with. As Doug was suggesting before when we talking about Capital Gallery, which is a project that we undertook and we frankly undertook it in someway on a spec basis, and we're anticipating that by the time the building is completed that we will be virtually 100% leased and we will have a kind of rate of return on the total investment that will be on the order of 12%.

And we look for better than double -- not better than double, but higher than 10% overall returns in almost all of our development -- not in almost, it all of our developments. So that is really we're focusing our activities in the shorter term, and frankly the medium term, and in the longer term. This is where we still have a real core competency and where we do expect that we will continue to find opportunities to be active.

I think we're in a situation now where there is relatively little new supply coming on the market, much increased improved environment for the commitment to space requirements. It is a changing market, but it is an improving market. And we're going to participate in the markets that we're in. We're still looking to see where we can expand our presence in other markets, although as you know what our criteria are, there are relatively few markets that we're interested in. But we remain very comfortable in terms of where we are.

One of the things of course, that while we look at some of the escalation in values, which we think, as I tried to suggest before is a relatively long-term projection, we are happy to have close to 45 million feet of absolutely prime space in every market that we're in that is participated in that. And I think that when you compare the quality of assets that we have accumulated and built over the years, we do feel it is still the single best inventory of absolutely prime real estate assets. And frankly, we think were we to put many of them on the markets we would be able to sell them at 5% cap rates or under that given what the nature of the interest is.

So we're very happy to be able to participate in that appreciation. It doesn't mean that it's making it easier for us to make additional acquisitions at this time. We're just going to have to be very selective and if necessary very disciplined. As we have said over and over again, this is a long-term game, not a short-term game. And still in the long-term we're very bullish about the kinds of assets we have and the kind of assets we can develop.

I think that's all I have to say and we will now move onto the next phase.

Next phase will be question and answer.

(OPERATOR INSTRUCTIONS) Greg Whyte, Morgan Stanley.

Ed and Mort, I think you articulated pretty clearly why you chose to give the special divi (ph) back in terms of asset pricing. Can you comment on why you may not have thought of a stock buyback, or should we interpret similar thoughts on stock valuation?

I'll take a crack at that. No, I don't think it reflects stock valuation. It really does reflect how we thought we ought to benefit the shareholders to deal with the tax obligation that they were assuming as a result of the sales we have made which was roughly somewhat over $1 a share. And we really felt that this was a better way to benefit everybody. It was a serious conversation that we had about going one way or another, and this was the way we came out for the reasons that Ed and I have mentioned.

But frankly, in terms of how you value the stock, we never make these judgments other than to suggest to you for a long time that the relationship of the net asset value of our assets to the stock price we feel is an extremely conservative valuation of the stock price. This takes nothing into account for the going -- the value that we provide as a going concern, our ability to continue to add at least very good development projects in various markets at various times and the improvement that we see across the board really in various ways in the real estate markets that we're in. It's not a comment on the stock price. Quite the opposite.

Just for the amounts that we're involved and for the specific conditions that we thought our shareholders were in we decided that this was the preferred way to go.

Just a couple of other things. Doug, in terms of the potential asset sales, does that include maybe some of the other hotels?

It doesn't include the other hotels right now.

Can you give some comments on the sort of Gillette and P&G exposure, any discussions there?

Let me comment on that since I've been talking directly to our Gillette contacts about that.

We thought that we would have clarity by now. They told us that we would have priority by now as to what their ultimate plans were. But I have to confess it doesn't come as any great surprise that they postponed making decisions as to who is going to stay in Boston and who is going to move to Cincinnati, what the use of their space in the Pruitt (ph) Tower is.

Remember, they have at lease until August of '09 -- December of '08. Sorry, I got my tenants mixed up. '09? December of '09. And we're not pressed. We would like have clarity simply because we think that it would allow us to have a jump on leasing and they might even participate in helping make their space even more attractive so that they can get off some of their obligations earlier if they were not going to continue to use the space. But so far we haven't gotten any.

Just one quick last question. Any update on the value add fund?

Just that the same environment that has made it so difficult for us to acquire core assets at appropriate rates of return from our point of view applies to the investors in the value fund along with us who have hurdle rates for making investments which are somewhat inconsistent with today's heated environment, even for what you call "value added plays".

Thanks a lot guys.

Jay Leupp, RBC Capital Markets.

Here with Brett Johnson. Just a couple of follow-up questions. First of all, Doug, on your comments on tenant demand going forward, can you give us just a little color and your thoughts about whether or not you think the existing tenants in your portfolio are likely to expand over the next 18 months, also maybe your thoughts on the key industries and their prospects for job growth in New York and Washington DC?

Ray, do you want to take this one?

Yes, let me jump in there. What we're seeing with our existing tenants, there's some modest growth, but really very appropriate for our asset base. We're seeing a constant upgrade in the space that tenants are seeking. So in buildings like Metropolitan Square, Embarcadero Center, Citigroup Center, we're seeing tenants who are looking to come to those high-profile assets and pay the higher rents over the more commodity space. So the differential between high end view space and commodity space has never been greater, and candidly that works very much in our favor.

In terms of the key industries, I think the legal services are the group we're seeing the most again for our asset base. They are the group that is prepared to pay the higher rents for those better quality spaces. And obviously here in Washington DC the defense side is still very strong, the intelligence community. We're seeing some strong tech growth. Obviously biotech is very important to us in South San Francisco with Genentech and also in suburban Boston and Princeton. So again, not too much new on the tenant demand side, but again the better quality space is being leased at the higher rents.

I would also say that financial services firms in New York seem to be prospering. But people on this call probably know more about that than we do.

Certainly Morgan Stanley is adding a lot of people recently. That's going to help the market.

Just one other follow-up. With respect to the analysis that went into declaring the special dividend, how hard did you look at adding a sixth market? And how did that come into play in your decision to declare the special dividend? And then also, no one use the term blend and extend on this call. Is that era over now?

Moving into a new market or an additional market really had very little impact on the decision to declare a special dividend, because, as I say, if we found an attractive opportunity to move into an additional market, we believe we have the resources after the special dividend to do that. So it's not as though the special dividend would hamper that or was driven by the fact that we didn't feel we could move into another market. Now having said that, we looked long and hard at lots of different markets, and have not found any that really have the criteria that our existing markets have, which makes them as desirable as those existing markets.

As to your second question, which is a blend and extend, as Doug said, we are doing, for example, lots of deals to cover '06 roll-over in San Francisco. Some of those are blend to extend. And tenants are still looking for that. But where they're looking to blend and extend leases that expire in '07, or '08, or '09, they haven't found a very friendly audience at Boston Properties now or in the past because in fact it's very tough to make those economics work especially if you have confidence in the markets in which you operate.

Thank you.

Lou Taylor, Deutsche Bank.

Doug, can you talk a little bit about the ongoing earnings impact of the special dividend without giving '06 guidance? On our numbers it looks like with the cash being distributed rather than reinvested in assets that will cost roughly about $0.15 a share to your ongoing annual run rate to earnings. Is that a fair number?

I think it's all a question of what your expectation would have been for that $350 million of incremental investment. If we were getting 3.5% on it, that's one number. If you thought we were going to invest it in acquisitions at 6% clearly on an incremental basis it's better. So our perspective was that buying assets for the sake of growing earnings and doing it by buying core assets at 6% going in or stabilize returns was not the right thing to do with our capital.

Sure, I mean I --

So I am just saying the answer is clearly there's an economic impact on our earnings for next year. It's hard to gauge what it would have been based upon what our expectation is in terms of how we would have used the money.

That's fine. I understand that. But as we look at our earnings for next year and beyond we should make some assumptions and take some reduction from those earnings as a result of the special (multiple speakers)

It's nowhere close to 15% (multiple speakers)

(multiple speakers) $0.15.

I mean $0.15 -- because if you just -- I mean, that assumes we're going to earn I think a little bit of a higher return than we would expected to do that. And it doesn't -- because really what it would substitutes for at some point or another is not an equity return, but basically a debt return. Because whatever we don't have in the way because of the $350 million we can easily borrow it, and that's not going to cost us that kind of money.

$350 million at 6% is $21 million, which is $0.15 a share. That's where I was getting the number.

Right.

Second question, and maybe I missed it, was the East Side Science Park. Any news or update there?

(multiple speakers) I'm sorry Mort. You go ahead.

and there have been no decisions on that at this point.

Thank you.

Ross Nussbaum, Banc of America Securities.

Here with John Kim. Most of my questions have been answered. I had two questions. One is can you give us an update on the status of retail at Times Square Tower?

For that one I think Doug had said that we are -- we have I think about 32,000 square feet left. We're in discussions with potential tenants, but have no deals announced at this point.

The color I would put on that is that we think that that space is highly valuable space. And we have been and will continue to be patient to find the right tenant who recognizes what we think it might get in terms of rents. We could clearly rent the space tomorrow if we wanted to just take "market rent". But we're confident that we're going to find somebody who's going to -- that understands what the unique value is of particularly the 7th Avenue corner and get a very handsome return on that.

The other question is on the balance sheet. I want to make sure I understood this. With respect to 601, 651 Gateway, what was the rationale for putting the short-term loan there? Is it that you're going to refinance the building after Genentech is fully in there or you plan on selling?

The rationale was we were able to work out with our lender an ability to pay that loan off. The interest rate was going to be jumping up to over 6% starting next year. And they were looking to do some things, we were looking to do some things, so we came to a mutual agreement that it would be best for us to pay the loan off at the end of this year.

Whether or not we sell those buildings or refinance those buildings is a question we haven't come to a conclusion on. But it just puts us in a perspective and in a position where we can do a lot more than we could otherwise have done with the existing debt and encumbrance on the asset.

To pay it off there will be no prepayment penalty which would have been a fairly substantial amount at the higher interest rates that would have resumed as of the end of this year. So it really made sense for us do what we did, and we took -- we also had the benefit, as you may know, of a lower interest rate, 3.5%, until the end of this year. So it really worked out very well for both them and for us. And I think we're very happy with the way that negotiation worked out.

Thank you.

Anthony Paolone, JPMorgan Securities.

A number of your office REIT peers seem to have gone down other paths in trying to find growth through either mezzanine financing and even other property types and joint venture use. Do you have those types of discussions internally? And if so, can you give us some color on how those go?

We have had those types of discussions internally, and in fact have had those types of discussions externally, because we have explored some JV relationships. And without going into any great detail because of where we are in the status, but we are continuing to have discussions about that where we can bring certain expertise to the table and combine it with others.

In fact, the project that we're doing down in Washington, which we're doing with New England Development and with Archstone, a multiuse project on the site of the old Hecht's Department Store. We're doing the office and we're combining with people that are doing both the retail and residential. So yes, that is something we very definitely are aggressively pursuing in a lot of different places.

As far as mezzanine debt, we did have a discussion at the Board level about that, and made the decision that we shouldn't step into the shoes of a lender, that that was not where our particular expertise lay. Now there may be some special situations where taking a mezzanine piece gives us an opportunity to do something beyond that in the future, and that's certainly not off the table.

I think, Ed, you might also mention the possibility of what we might be doing in Cambridge.

We do -- as Doug mentioned, we have a site in Cambridge for a residential building. And we are now examining our options there, whether we do that as the development is a JV, as our own development, or sell the development rights. And we're going through that analysis as we speak.

One other question. In talking about just the competitive environment for deals, can you maybe quantify just how big the spread is, or what your perceived spread is between your underwritten IRRs and where you see deals going at? How big of a delta is that?

I don't think it's that big a delta, I have to tell you. But it is -- there has been a delta to date. I think we are still sort of looking at some of these sales, and they're just beyond our pay grade that we feel. It's not a huge delta, but there definitely has been a delta. Certainly, if I have to give you a number it would certainly be on the order of 1%, 100 basis points so far. But that has been enough for us to come in behind other buyers who are prepared to reflect these values at a lower cap rates than we thought we could.

I'm not suggesting it is 100 basis points on every transaction, because frankly on some of them and even less. So far we have not been most aggressive player in the number of different situations. I can give you an example. For example, in a big portfolio that just came up in Washington DC which was marketed by Goldman Sachs, they were at least I would say at least 100 basis points lower than we were in terms of the cap rate. And we're very comfortable not to make a transaction. And there were several others in that category. There were a couple where we were much closer and we just didn't come out on top. But I think we will find our place in that regard.

Also, aside from just the pricing model, what they're prepared to assume in terms of rent growth and underwriting assumptions and risks and waving due diligence, we're just not prepared to take those kind of risks on the type of assets we're looking at in today's market.

Please bear in mind what I said earlier, and this doesn't apply to all assets that we've looked at, but our use of leverage is different than leverage an enterprise individual might use or an opportunity fund might use. Similarly, our hold period is different as a REIT than others may look at the asset. And finally, our current return criteria are different than others might accept who are not delivering earnings per share to their shareholders on an annual basis.

Just one final question on the special dividend. Is there any re-pricing of stock options as a result?

The answer is yes. Our stock options are going to be re-priced to neutralize the effect of the special dividend.

Does that just mean they go down 250?

Actually there's an accounting formula that has been blessed by the FASB that you use. And there's a portion of price and a portion of volume that is affected. But it neutralizes it so the effect of the value of the option pre and post the dividend is identical. And there's no accounting adjustment.

Thanks.

Jon Litt, Smith Barney.

I'm here with John Stewart as well. I wanted to explore a little more the acquisitions environment. You guys are suggesting that the returns you can get on these assets are not at the level that have it make sense for you. I guess part of an IRR would be your reversionary cap rate. I'm trying to figure out if you think that this cap rate environment is not sustainable, and therefore you're not finding acquisition opportunities. Or is it that if this cap rate is the new cap rate environment going forward, the IRRs that you're looking at are unacceptable?

That's a good question. Let me just say I have felt that for a long time, and that's why we were partly as aggressive as we were, that real estate with an undervalued asset. And I think there has been a really a reappraisal across a whole range of financial investors of real estate in good part on the issue that you mentioned, which is the residual value that people I think are taking into account in a different way than they did before. And we do think that is a legitimate way to look at real estate.

There are situations now where we are frankly going to be relying primarily more on the residual value than we have in the past. And we're in the process of dialogue on a couple of situations that really do reflect that. So I do think that has become a different factor than it has before.

And I will give you just sort of -- in the broadest sense of this issue I think part of the reason why there's been a wholesale change in the view of real estate is the fact that in terms of alternative investments according to Lipper all of the mutual funds in the United States, if you measure them 5 years from March of 2000 to March of 2005, the total return was 1%. And for the 50 largest I think the total return was a negative of 42%. In fairness they had a lot of technology into them (ph).

Obviously that has not been true of real estate. Real estate has really, despite frankly a flat, even a declining rental market and commercial real estate for parts of this five-year period, overall real estate values have continued to go up and in my judgment legitimately, partly as well, I might add, because you had a big increase in replacement costs that was a combination of two things, one of them being a big increase in -- a jump in construction costs, and two is a huge increase in land costs in virtually every market that we're in.

So I do think that this has changed the environment, because the overall replacement cost now has gone up dramatically across the board in virtually every market that we're in, particularly in cities like Washington and New York where we have very big positions.

So I think when you look at these assets, and if you imagine where these markets are going over the next three to five years, these trends I think are going be reinforced. And we are frankly looking at various acquisitions that are going to reflect that. That is an absolutely important criteria and a much more important criteria is the residual value than it has been in the past in terms of how you calculate value.

So you're saying you think the cap rate environment will persist?

Yes, I definitely do. And you've heard me say this before. It may be going up or down a little bit, but I must say to you in the general parameters of it I think it is going to continue. There is -- if anything, frankly, despite the fact that interest rates have moved up slightly, the ten-year treasury has moved a little bit, although if anybody had said we have a 420, 425 ten-year treasury today, I would frankly follow their financial advice for the rest of eternity. It's really quite surprising.

But even if you set that aside, the fact is that real estate as an independent class of assets I think has been fundamentally reevaluated and the cap rates in this sense of current income do reflect exactly the point that you're focusing on, which is a dramatically different reassessment of the residual value over almost any time period, five years, ten years, you name it.

That would suggest that the acquisition program you guys are going to go into going forward is going to be very limited.

Well, that all depends. It may be and it may not. There are situations, and they are always there, that we are very active in pursuing. And we're continuing to do that. It is certainly a much more limited acquisition environment, frankly particularly at the quality and scale of acquisitions that we have been very effective in these huge sort of buildings. The 399 Park, the Citigroup Center, the Embarcadero Center, the Prudential, the competition for that was really very different even as much as a couple of years ago than it is now.

But I think we understand where we are going and we understand what we have to do. We're going to do it to the extent that we do within a discipline structure. And frankly, if we feel that the pricing gets out beyond where we think it ought to be taking into account not just the replacement value, but as Ray Ritchey was suggesting before the assumptions for example on lease up and interest rates, we're just going to wait.

It is still a long-term game as far as we're concerned and we're not going to jump in and just to do things for the sake of doing things. We've never done that, and we were very aggressive when we thought it really made sense. There are certain situations that are going to come up that are going to take into account exactly what you are referring to, which is residual value because of the way we believe we can measure residual value with a degree of confidence in a risk assumptions. But there are others where we're just going to say good luck. If it works out --

Look, I have to tell you something. We were frankly quite, shall we say, skeptical of some of the acquisitions that were made, and we still are. And yet if you look at them, you look at what people are talking about with the Bank of America building out in San Francisco and you just have to -- because we thought it was a huge price when it was done just a year ago, and now they expect to get another huge price on top of it. So somebody is still there changing the overall calculations, and that is the nature of the market.

And I think in San Francisco there's been a fundamental shift in the estimates of residual value, and indeed of rent assumptions going forward, and not entirely unrelated to the marketplace. It may be the triumph of optimism over reality, to some extent, but not the way it was before. I think we're seeing a major move in rents going forward.

So I don't want to knock what other people are doing. It has just been a little bit too aggressive for our tastes at this point, but we're seeing situations coming up now -- we're in the midst of one now -- that is going to based essentially -- or more than in the past on exactly the point you're making, which is what we're in a position to estimate by way of residual value.

I think John Stewart has a question.

Just two quick follow-ups. Number one, on the East River Science Park, can you first of all give us a sense for when an announcement might come, and secondly confirm whether you are a finalist?

I think we are probably a finalist, and we will expect that there will be something decided on it within the next 60 to 90 days. Exactly what our role will be, we will just have to wait and see.

The special dividend will obviously be funded with cash off the balance sheet. In terms of the proceeds from the additional $300 million of asset sales will you contemplate a share repurchase with those proceeds?

Yes, if we don't have another use for it.

Thank you.

Steve Sakwa, Merrill Lynch.

Steve Sakwa I guess two questions. One, Doug, I was just curious about the Times Square Tower refinancing and why you kept that, I guess, as a floating rate piece of paper given the attractive interest rate environment. Does that say something about the additional lease up that you need to get done in order to put a permanent mortgage on or maybe your ability to have flexibility to sell that asset?

There are three aspects to it. The first is that we were basically able to reduce our existing floating rate loan from LIBOR plus 95 to LIBOR plus 50 effectively by doing virtually nothing other than doing the refinancing. And then we just added on the flexibility of the term. Clearly we could do a shorter medium-term swap and fix that at a current fixed-rate financing for up to five years and lock in long-term rates.

I think clearly the proceeds level will be significant -- could be significantly higher on that asset if we were to do a secured financing with the income from the resale in place. And I think you hit on another point, which is nothing is off the table in terms of our asset disposition viewpoints. That asset obviously has a little bit of an issue in terms of the broker-dealer issues that we have as a REIT, but it's certainly something we're considering as part of the entire portfolio.

Just with regard to the asset sales, kind of why sell off just the one hotel in Cambridge? Is it not more attractive to kind of do all three, or are there something about the other two Marriotts that make them not sellable, or are those just to come in the future?

The three hotels that we own have different operating trends associated with them. I would say our viewpoint would be that the Residence Inn probably has had the strongest short-term performance. There is -- the convention center that is slowly coming into operation is starting to have a little bit of a positive impact on the other full-service hotels. Clearly that's where people stay when they are doing city-wide activities.

And our perspective is that those hotels probably have some more rate expansion and occupancy expansion in them before they get to a point where we think we might be able to maximize them. And then again, it's a question of how many dollars worth of assets we sell at any one time.

The brokers didn't feel that there was any real advantage to be gained by selling them as a package. In fact, the kind of hotels they were, with the Residence Inn being very different than a full-service hotel probably made sense to sell separately in any event.

Last, and maybe Ray, could you just comment about the different land parcels and things that you're looking at in your different markets, and give us some flavor for how you're trying to build out the pipeline?

Are you talking about our existing portfolio, Steve or (multiple speakers)

No, I'm talking about kind of future things that may come online in '07, '08, '09.

In terms of new opportunities (multiple speakers)

New potential opportunities, yes.

As Mort said, the New York market for new development sites is extraordinarily challenging and Roberts (ph) is doing a great job beating the bushes to try any available site there. As you well know, we're competing not only against other office developers, but residential. It's clearly the highest and best use in New York, and that poses real problems for that type of use.

Here in Washington we're continuing to uncover opportunities both downtown and more likely in the suburban markets. The new brack (ph) dynamics have really turned the tables in terms of future office demand in the suburbs. We're trying to take advantage of that.

In suburban San Francisco we think we have the best site in the valley down at San Jose already. That market clearly doesn't justify new construction.

Up in Boston we have a great pipeline of development sites up there already. We continue to look downtown, although the demand fundamentals and certainly the rental rates don't justify new construction anytime soon there. But we're still looking at opportunities.

In Princeton, again we have already under option the best site in Princeton, although we continue to look for other opportunities. We're more focused candidly Steve on putting in play the outstanding inventory of development sites we have in the short-term rather than trying to find new, although if the right opportunity comes along we will certainly jump on it.

With the exception of New York we really have a much broader array of existing land sites that will provide new development possibilities I think than most people realize. We've got a lot of things that over the next couple of years are going to actually get underway in the greater Washington market. We're working -- we have a major site now on Pennsylvania Avenue which we're working through the process on that, which will start virtually as soon as that's done. And that's going to be one of -- probably the premier new developments in the central business district of Washington the day we get it into the ground. And we have a number of other sites there that are in very, very, very good shape for new construction.

Specifically, Mort, let me add out in Reston, the one that Doug mentioned earlier. We have tremendous interest at very preliminary stages albeit, but very strong interest at rental rates that clearly will justify new construction, consistent with the development yields we've realized in the past, which are double-digit, which also is to the point on the discussions on the acquisitions. As long as we're able to put in place hundreds of millions of dollars a year of return levels of 10, 12, 13%, much less pressure for me to go out and try to find deals that generate 5.

And I guess Ray you're talking about them putting into service to 40 acres that can do the 1.4 million feet in Reston?

The 40 acres? No, that's not 40 acres. It is a much more dense site than that. It's the Reston Town Center development. It's eventually going to be 600,000 square feet of commercial and retail and then 300,000 square feet of residential development.

Adjacent to our Freedom Square development.

That is an excellent site in Reston that we have, and as I say, we're really in that market with both feet. And I think we're going to continue to be very energetic in preparing ourselves for additional development. That is still a very, very strong market.

Brian Legg, Merrill Lynch.

Can you talk about market rent growth in your markets, specifically in San Francisco where I have seen some broker reports saying that they expect rents to spike in the CBD?

Brian, they've already spiked. Rents went from the mid-40s to the high 40s to the low 50s over the last six months. I would argue that that's a spike. You've got to remember, that number is the number that is being not supported necessarily by positive absorption in the marketplace, but by a change in viewpoint on tenants that they would rather now be in better states and better buildings than in what is referred to as ordinary or commodity buildings. So there's a much more bifurcated market in San Francisco today than there has been any time since we've owned the property.

Yes, and that's going to continue. The vacancy rate for view space in San Francisco, where we have one of the two or three best properties of vacant space is in single digits. And the demand is really strong there, the rents are getting up, and we I think will be breaking $60 in the next twelve months for that space. So that is a big, big increase. And while you can say it's a spike, it doesn't mean the spike is over.

The other place where we're clearly seeing what I think people with commonly refer to as a spike is in Northern Virginia, particularly in Reston where rents went from $25 to $26 a year ago, to -- there's virtually no space available, but if there were space available it would be leasing for somewhere between $38 and $42 a square foot. Obviously with $10 of operating expenses, that's a pretty big bump as well. And I guess the third place --

That's net, you're talking about now, Doug. Right?

Yes. The third place where I think we're actually seeing stronger rent growth is in suburban Boston in the higher quality space. There really are no longer any large blocks of space in suburban Massachusetts on 128 in excess of 50,000 square feet. So you have seen rents go from -- call it $21 to $22 up to $26 to $27 in a matter of five or six months.

Finally in midtown Manhattan, where again, the market has dramatically improved, I think we probably saw 10% bumps -- 10% increases over last year on average. In our portfolio the increases were larger than that. I think things are slightly slower in terms of what the growth rate is as of the second quarter, but that takes out (ph) the New York phenomenon where generally activity is just less between the months of June and August. But there just is not a lot of available space in the high-quality buildings in the midtown market, or in midtown West.

Carey Callaghan, Goldman Sachs.

Doug, what prompted the loan modification on the Gateway assets?

I thought I spoke to that one before, but basically we had the ability to -- and the lender had the desire to get the loan paid off, and we were agreeable to waving a very significant prepayment penalty. And knowing what we know about that marketplace and what our expectations were with Genentech, we felt it was a mutually beneficial negotiation to have.

Let me add to that quite candidly. This loan negotiation was done at a time when people were not terribly optimistic about the San Francisco market in general, as well as South San Francisco. We just made a very different evaluation, which has proven to be correct, that we would be in a position to benefit both from the lower interest rate of 3.5% going to the end of the year, and then the ability to finance or refinance, given our own financial position etc., without having to be obligated to a very big prepayment penalty. They were happy and we were happy. They came out whole and we were very happy with it. And we were right in terms of our assessment of the market.

Thanks. If you are able to put together an assemblage in New York, given Ray's comments on higher and better use, would you contemplate some residential element to any new development there?

Yes, we would.

Lastly, Mort, you've been very clear that development carries good returns. You're not seeing an economic opportunity in acquisitions. But how do you reconcile that with those who justify acquisitions as being at or below replacement cost? Is it a function of your land holdings that you have right now?

Yes, that's part of it for sure. We're also going to have to recognize that when you get into the kinds of valuations that are present in buildings, the rate of return on developments, given what you're going to have to pay for land and for the replacement costs of buildings, is not going to be in some of the markets like New York at the same kind of double-digit levels. But you have to look at it in a different way.

Let's just assume there is going to be clearly a higher return from development. It may not be 10 or 11, which we're -- I think we were at 9.6, 9.7 in the second building in Times Square, and I don't know, 11 or 12 in the first. But that may not be the range. But if you come in at 7.5 or 8 relative to where the market is for the resale, which may be 5, 5.5, you still have that gap between the cost of the development and its yield and the resale value of it, which provides you with an appropriate margin to reflect whatever risk you take as a developer.

Since those are risks we're very, very comfortable with, that we have managed very well for 35 years, we really feel comfortable in doing that. And you just have to look at it in market after market in terms of where the valuations are relative to what your ultimate total cost will be, even though you're paying much higher numbers for land.

Jim Sullivan, Greenstreet Advisers.

I think (technical difficulty) and (ph) understand why your bid and bids haven't risen to the top with respect to well-leased buildings in places like New York and Washington. But can you help me understand the dynamic as it relates to buildings that are a little bit more challenging, buildings that perhaps have some significant existing vacancy or near-term vacancy, assets that require perhaps some redevelopment or repositioning?

It seems given your superior operating and leasing skills that you'd be in a much better position than a lot of other bidders to really understand the risk involved and to price that risk appropriately. Yet we haven't seen you do any of those deals or many of those deals of size recently. Are buyers of properties that fit that mold --vacancy, near-term vacancy, repositioning -- are they mis-pricing the risk?

Let me address that if I could. I think what I'm seeing is that we may be handicapped by our expertise and experience and market knowledge in that we're much more critical of underwriting assumptions. We just saw a package -- was it in San Francisco, Doug? I think came in -- yes, it was in San Francisco, where they assumed 30% annual rent growth for the next three years in a market where we haven't seen 30% annual rent growth in the last three years cumulatively.

And it's just a situation where we're just, as we always have, going to stick to our discipline, not only in terms of total returns, but as I said earlier, most importantly the underwriting. And that really comes true in the second-tier commodity assets where we've never been big players and won't be. We'll stretch for the trophy assets in the class A locations in well-leased and well-constructed buildings. We're not going to compound the problem by doing that with class B assets.

Let me just give you an anecdote to illustrate what Ray was just talking about. We were considering selling an asset and having a discussion about that asset with one of the top sales brokers in the country. And the discussion boiled down to their advice to us not to lease vacant space before we sold the asset, because the people looking to buy that asset would underwrite through that vacancy and assume greater rental growth and greater rent than what we could achieve in the current market if we leased the space. So you have buyers that are simply just underwriting right through all of the assumptions that we would normally apply.

That's pretty interesting.

It sure it is.

I wanted to go back to the first question from quite some time ago, and that has to do with share repurchases. I'm still confused by the decision to pay the special dividend versus the alternative of buying back your stock. You said on the call that if you were to use cap rates in the 5 range for New York and something close to 5 for Washington, and something very aggressive per your last comment for your other markets as well.

Your stock trades at a material discount to its net asset value. It would seem that would present a terrific opportunity to buy your own portfolio on the cheap. What I missing? I think you have implied there was some tax issues related to the decision, maybe you can shed some more light on that.

The tax issue has to do with the gain that would have to be recognized on the sale of the assets we just sold. So returning that gain to the shareholders avoids having to pay a tax on that gain.

Okay. But what about the other consideration, which is you can buy your own portfolio on the cheap through Wall Street?

It's an absolutely valid objective on our part. It didn't happen to work out for various reasons this time, but it is something that we are fully aware of and fully interested in.

David Toti, Lehman Brothers.

I have three questions with regard to the Moynihan/Penn Station project.

That's not our project, right?

No. (multiple speakers) The question is why you think your proposal was knocked off the table relative to your competitors. Do you have any write-off costs associated with that proposal? And do you remain interested in the submarket after that?

Let me answer that. There was one fundamental difference between our competitors and us. They were able to do the following. There was one million square feet of development associated with that. Willy nilly --

New developments.

New developments, excuse me. That would have been a high-rise building on top of a portion of -- not the original Penn Station, but other portion of it. The other, the competitive -- it was between us and one other group, Vornado and Steve Ross of The Related Companies. They had a site virtually next door in which they were able to transfer the development rights to that and pay a huge price substantially in excess of $100 million, right now, for that.

We did not have a site adjacent to it, and therefore we couldn't transfer the development. We anticipated that we would do the development but it would take enough time for us to prepare the foundation for that and get that done so that we couldn't pay the $100 million-plus on it today. We were prepared to pay the same amount, but only when we in effect had a site on the site that we could then transform into a development site.

They had a dramatic competitive advantage, and good luck to them. They had the right sort of package of sites, not just this site but a site directly adjacent, to which they were able to immediately transfer these development rights, which they can then turned into a residential development and get it underway immediately. Therefore they could pay the well over $100 million. That was just one of the items they were able to put a lot more money on the table, on a present value basis than were we.

In answer to your question on the write-off, we did have a write-off of $200,000 but we actually budgeted what I will refer to as dead deal costs each quarter. So basically it didn't really have any effect in our (technical difficulty).

Do you remain interested in this area (multiple speakers)

Yes. Absolutely. We're in the midst of another assembly in the area, working with other people, and we have acquired at least one of the sites, but it is an assembly. If anybody has any exposure to the joys of assembly in the middle of Manhattan, believe me it is a long-term agonizing process, and we're still in the longer-term and in the agonizing part of the process. We think we will be successful, but it's still, shall we say, a work in progress.

John Guinee, Legg Mason.

John Guinee, Legg Mason. One comment, two questions. First, discussing cap rates is a little bit -- without discussing lease rollover price per pound and replacement costs, it is a bit like discussing bond yields without maturity dates (multiple speakers) etc. So we all have to bear that in mind. But Ray, to the extent possible, if you look at your all-in development costs for projects underway, including current land valuation versus your basis, can you give us a ballpark, say D.C., New York City, Reston, Virginia, in what you think your all-in current land valuation development costs would be?

Let me use an example. Mitch, you can jump in here as well. Mitch is our regional manager here in Washington. We have a project underway at 9th & E and our cost per square foot, Mitch, would be about 430 a foot?

Yes. In the low fours, yes.

About 430 a foot. And if we had conservatively value that upon completion, I think we're looking at something approaching $750 to $800 a square foot, applying today's cap rates to that projected income. So as we talked about before, the huge upside in development is clearly apparent. In suburban Washington, we're probably looking at something in Reston costing -- what Mitch, about 300 a foot, would you say?

About 320, 330.

Again, the values there with the kind of rental rates we expect to see -- achieve will be in excess of $450 to $500 a square foot. New York, Robert do you want to comment up there?

Times Square was about $550 a square foot, and it would be considerably more today. That land was a special leasehold acquisition with special tax abatements. And if we were competing for a site that had residential capability, it would be anywhere -- $300, $400 a square foot for land alone, which is part of the problem were having.

In other words, the overall total cost today, if you were building an office building in, shall we say, midtown New York, I would say you're going to bring it in at somewhere well north of $700 a foot, probably in the range of $800 a foot for the kind of building that we would build. This compares to when we built the first building in Times Square, I think our total cost came in a little bit over $500 a foot. For the second building it was a little bit under -- or in the range of $600 a foot. So you've seen a very big increase in replacement cost for a new building.

Now when we bought the sites in Times Square, we were basically paying $150 an FAR foot for the development. People thought we were a little nuts. Needless to say, it didn't work out that way. But beyond that, as Bob is suggesting, those costs per FAR foot are probably doubled.

That, by the way, compares to a residential site on the west side near Columbus Circle that sold, land alone, $800 an FAR foot. (multiple speakers)

One clarification. Ray, when you were discussing Reston, I'm assuming that's a structured parking deal.

Not only is it structured, and that to maximize the density which is clearly our objective here, we're putting two to three levels below grade, Mitch?

Two levels below grade, yes.

So in addition to structured parking above grade, we're actually going for the first time with some below grade parking and that to assure that we get the full 600,000 square feet of density. What we're seeing in that market is that because it is suburban, when the limitation isn't density it's capacity for parking. So we can absorb, in that specific market, higher costs per unit on the parking because we could get so much higher rents. (multiple speakers)

You are basically going down two levels, and that's probably adding $10 or $20 a foot per versus above grade structured parking?

That's about right.

One last question is, what do you think in the major markets the merchant builders are developing to? What kind of yield are they -- in the old days they were looking for 10, 11, as were you. What do you think your competition is doing when they are developing spec and are going to sell it to a pension fund at end of the day?

I can comment here on Washington very clearly that especially downtown, I think a hurdle rate -- if somebody could book an 8% first year cash on cash, that would be heroic. I think some of our friendly competitors are solving for even much lower cash on cash returns on that, knowing full well that to be able to turn around and immediately sell it for between 5, 5.5, 6 at the worst case. So they're getting easily a 20%, 30% profit swing going from 7 down to 5 on the exit.

(multiple speakers) The spread gain in Manhattan, I mean I think people are looking to 7, 7.5%. Obviously these are always estimates when you go into a development deal. But they're assuming that this is 30, 40, even 60% above what they can sell it for. (multiple speakers)

By the way, my comment was not to be critical. I can understand full well why they're doing it.

They can -- you can develop the 7, 7.5 and sell it for five (multiple speakers) margin.

Especially the merchant builders who have no skin in the game anyways. They're looking first of all at the fees. They pull out a tremendous amount of fees. They get the money management override and they get the PC upside. And a lot of our good friends here are very much fee-motivated, not necessarily investment-motivated.

Other people's money is a beautiful thing. Thank you very much.

Kevin Lampo, Edward Jones.

The dividend of (indiscernible) (technical difficulty) -- the special dividend, is it fair to assume that that will be considered all capital gain?

No. The special dividend will have a portion or a significant portion which will hopefully be classified as return of capital. As you know, the classification is dependent upon where our taxable income is at that beginning -- at the end of the year, and what our total tax dividends are, our capital gains dividends. And whatever is remaining will be return of capital.

I think recognizing the time, we've been on for about an hour and half, we should only take one or at most two more questions.

If I could follow up, (multiple speakers) if there is a significant portion that would be considered ordinary income, would that change your decision as far as the size of that dividend relative to maybe doing a partial buyback?

We have -- I don't want to start confusing people, but the Company has, obviously, ordinary taxable income that it would have had without the sales of these properties. These sales created capital gains income, which is obviously taxable to taxable investors. And to the extent that we're paying additional money out, that would be return of capital.

I think we know enough about our 2005 results so that there's -- we know where it is going to be from a taxable point of view. If that was the impact of your question or the intent of the question. (multiple speakers) We won't be surprised, in other words, and find out that we have more taxable income than we thought we did.

There are no further questions at this time. Please continue with any closing statements.

We appreciate everybody's patience, attention, and we hope this has been helpful. And we look forward to speaking with you again next quarter.

Ladies and gentlemen, that concludes the Boston Properties conference call. Thank you for connecting, you may now disconnect.