波士頓物產 (BXP) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Boston Properties third quarter 2006 results 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 [OPERATOR INSTRUCTIONS]. As a reminder this conference is being recorded today, Wednesday, October 25, 2006. I would now like to turn the conference over to Kathleen DiChiara, Head of Investor Relations. Please go ahead.

Good morning, everyone, and welcome to Boston Properties third 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 measure in accordance with [Reg G] requirements.

If you did not receive a copy, these documents are available on the Investor Relations section of our website at www.bostonproperties.com. Following this live call, an audio webcast will be available for 12 months in the Investor Relations section of our website. To be added to our quarterly distribution, please contact Investor Relations 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 obtained.

Factors and risks that cause actual results to differ materially from those expressed or implied by following 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 statements.

With us today I'd like to introduce Mort Zuckerman, Chairman of the Board; Doug Linde, Executive Vice President and Chief Financial Officer; Ray Ritchey, Executive Vice President and National Director of Acquisitions and Dispositions; and during the Q&A portion of the call, Mitch Norville and our regional management team will also be available.

And now I'd like to turn the call over to Doug Linde for his formal remarks.

Thank you, Kathleen. Good morning, everyone, and thanks for joining us once again for our third quarter conference call. As is traditional for this time of the year, we're going to begin to start talking about our 2007 outlook, and I believe everyone should have seen that we've provided some guidance for '07 in our press release last night.

We are also going to provide you with an analysis of our third quarter results and our operating trends. Before we get into those details, we thought we would review the acquisition/disposition strategy that Boston Properties has been following, because these investment activities do, in fact, have a short-term and a long-term impact on our earnings.

The operating fundamentals in all of our markets have shown dramatic improvement over the past twelve months, with the pace of rental rate growth and demand for high quality space continuing to accelerate. Base building construction costs continue to accelerate as well, either from scarcities of labor in markets like New York City and/or from continued rises in material costs.

The current slowdown in housing construction we hope will alleviate some of this pressure, but we don't anticipate a reduction in new commercial construction costs any time soon. Our core strategy has always been to operate in supply-constrained markets, so combining strong demand, increasing replacement costs and scarcity of supply, we expect our assets to continue to appreciate over time, sometimes dramatically when existing rents are below market on space rolling over in the relatively near-term.

Those factors are critical as we underwrite new developments and acquisitions. Now many individuals and institutions have recognized these same conditions and this has translated into a seemingly limitless supply of capital that continues to compete to own commercial real estate in the markets that we operate in.

Overall investment return expectations on acquisitions have been greatly reduced, so the question we continually ask ourselves is how we as a public company can profit in this environment. We remain concerned that making significant acquisitions at today's pricing levels will reduce our ability to enhance our long-term earnings growth rate, so we have chosen the path of selectively selling assets, reducing the overall size of the Company and focusing our more substantial investments on new development opportunities. In some cases, these development projects will be phased, long-term projects that extend over more than three or four years.

Consistent with this strategy, during 2006 we have sold $1.26 billion worth of assets. That follows sales of $838 million in 2005. In almost every instance, while we believe that the net operating income or the cashflow from those assets is going to improve over time, we also think that the forward-looking return expectations embedded in the current pricing justifies harvesting the significant value we have created, even at the expense of a reduction of our portfolio.

As we look forward into 2007 and 2008, we are working with a smaller operating portfolio than was anticipated 24 or even 12 months ago, and we are concentrating on a growing development pipeline. In 2005 we had development starts of $65 million. In 2006 we've started an additional $300 million and in 2007, we anticipate starting at least twice that amount.

Last quarter we noted that rental growth in a few of our suburban markets was approaching levels necessary to support new construction. As we announced in our press release last night, we have in fact begun a speculative development in suburban Boston and are looking at selective additional opportunities in that and other regions. We will provide some commentary on our future development pipeline in a few minutes.

We had a very solid quarter with continued improvement in market leasing conditions, strong asset valuations throughout all of our markets, and reported funds from operations at $1.16 per share, $0.06 above consensus estimates. This quarter our positive property rental rate revenue variance was about $800,000. We had about $700,000 of unanticipated ancillary service income associated with our buildings. Those are things like overtime , HVAC, work orders ,and the services that we provide our tenants on the operating portfolio.

We also had $1.2 million of lower operating expenses net of the reimbursements we received from our tenants on a quarterly basis. But the bulk of our variance comes from transactions where either the completion of the transaction itself or the quarter in which it occurred was pretty unpredictable.

We recorded $3.5 million of termination income in excess of our expectations this quarter. $1.8 million came from a single transaction in New York City. We were actually paid $3.5 million, but the remaining $1.7 million is going to be recognized during the fourth quarter. More importantly, this termination income was accompanied with a new lease with a starting rent $24 per square foot higher than that paid by the current tenant, the best of both worlds.

We completed two tax settlements and an eminent domain action which date back more than five years, and that totals almost $1 million. We repaid debt earlier than we expected, saving about $350,000 of interest expense; we had higher capitalized interest of $300,000 based upon our development activities; and our San Jose property purchase -- which I'll get to in a moment -- was accretive by about $300,000, and it wasn't budgeted in our projections last quarter.

Finally, again consistent with our accelerating development activity, we had a corresponding increase in our capitalized wages leading to a reduction in our G&A. Our quarterly run rate was up to $2.1 million per quarter from about $1.5 million last quarter. We would expect this to stay in this level or more on a going forward basis into 2007 and 2008.

Strong rental growth throughout the markets continued to be led by midtown Manhattan. We have now signed leases in each of our 53rd Street assets in excess of $100 per square foot. While we are not suggesting that all of our space would lease for triple digits -- at least not next year -- rents on average are up over 16% in Manhattan over the past 9 months. Rents continue to grow in Waltham and in Cambridge; the Back Bay of Boston; the Northern Peninsula and the Silicon Valley at rates in excess of 10% annually.

Washington, D.C. and northern Virginia continue to see increases albeit at a more measured pace. Our portfolio weighted average rent is about $42.75 at this point and our mark to market has increased yet again from $1.68 last quarter to $2.58 this quarter.

Our 2007 office lease expirations comprised only 5% of our portfolio and about 4.6% of our total gross revenues. If you add our R&D exposure in, you're adding about one more percentage on the portfolio square footage, but only another .4% of gross revenues.

Average expiring rents during '07, excluding our retail space are approximately $35.95. Our portfolio roll-down, assuming we released all the vacating space at market would be just under 7% for 2007. The bulk of this is in suburban Boston, which accounts for 31% of our 2007 roll-over, with an average expiring rent of about $31.80 and a market rent of $28.31, although frankly we think we'll see market increases throughout the year and this roll-down will be ameliorated.

San Francisco makes up 21% of lease expirations in '07, with an expiring rent of $44 and a market rent on the portfolio of $43, effectively flat. However, if you look forward a year and use our current market rents, our 2008 rollover will be up as much as 8% -- and that's using current market rents.

We should offer some commentary on our second generation leasing statistics this quarter. You will note 586,000 square feet of activity in New York City, which is probably very surprising, while we completed a 500,000 square foot 10-year lease extension at 599 Lexington Avenue. This is a lease extension, so the current cash rent doesn't change and the size of this transaction mutes all of our overall statistics. So if you exclude this transaction, the New York City rents would have been up 87% on a net basis and 56% on a gross basis during the quarter.

The San Francisco numbers are a little light too, and that's due to timing. We actually did about 190,000 square feet of leasing, but those leases don't commence until the first and the second quarters of 2007, so the stats won't show up until those two quarters.

We have completed about 1.7 million square feet of gross activity during the quarter, and that would spread over about 79 transactions. The activity would spread as follows: in New York City, 658,000 square feet -- again, that large lease renewal was the bulk of it; in Boston, we had 490,000 square feet; in D.C., 288,000 square feet; in San Francisco, 183,000; and in Princeton, about 33,000 square feet.

The average starting rents on all the Boston and San Francisco deals were about 10% greater than the average starting rents from those same markets that were included in the second generation statistics, illustrating the continued improvement in rental rates that we are achieving.

During our last call, one of the questions we received was whether or not there was anything we could do proactively, creating inventory to take advantage of the current leasing conditions. I think the question was in reference to our NYC portfolio, primarily.

This quarter we negotiated a buyout of a floor at Citigroup Center; we recaptured two floors at Times Square Tower; and we took back three floors at 599 Lexington Avenue for a total of 162,000 square feet. While it is unlikely we will be able to be this successful every quarter, all of our leasing teams aggressively seek out these opportunities.

Our total in-service portfolio occupancy ended the quarter at 93.8%. If you adjust for the quarterly sales of buildings like 265 Franklin Street and the acquisition of Zanker Road, and some of our new development deliveries, our same store occupancy decreased by about 40 basis points, and it was primarily due to one property. We lost 329,000 square feet of occupancy at our R&D property in Bedford, Massachusetts.

Our average remaining lease length accelerated this quarter; we're now up to eight years on average. Our second generation leasing costs came in at just under $20 for the quarter, which is obviously a lot lower than is typical. I think the reason you see that, again, is that 500,000 square foot transaction in New York City. If you take that number out, you get to about $25 per square foot on average for the other space during the quarter.

During this quarter we paid off a number of our secured financings with the proceeds from our convertible debt offering from last year. Year-to-date we have paid off about $361 million of debt, which had an average expiring debt [coupon] of about 7%. We also completed a four-year extension of our line of credit, reducing the anticipated spread over Libor by 10 basis points down to 70 basis points on a fully drawn basis.

We had some modest sales and acquisitions activity this quarter, which are outlined in the press release. But I do want to make a couple of comments on the San Jose acquisition, 3200 Zanker Road, which -- as Bob Pester likes to refer to it -- is located in the Golden Triangle of San Jose. This is a 25 acre campus, with only 543,000 square feet of current buildings that we believe is underutilized from a potential development perspective and is also leased well below market. Since the time we completed the acquisition in August, market rents for comparable space, including space just across the street, have grown to levels where the current lease is now 50% below market on that acquisition. So when you look at the returns that were put into the press release, you get a sense of why we were willing to accept what we consider to be a low going-in return.

Turning to our guidance, let's start with the remainder of '06. We anticipate retaining the taxable gain proceeds from the sale of 280 Park Avenue until January of 2007, when we will make a special distribution in combination with our ordinary quarterly distribution. The Board has not yet declared the exact amount or the timing of the dividend, but for modeling purposes you should assume $750 million or approximately $5.25 per share.

We expect flat same cash store results from the third to the fourth quarter, although our straightline rent and our FASB 141 will increase to a level of approximately $16 million as a direct result of the lease extensions in New York City that we discussed a few minutes ago.

We expect that the two remaining hotels will contribute about $7.2 million in the fourth quarter -- and please remember there's a seasonality component to the hotels, so the fourth quarter is always larger; so next quarter when you're looking at the first quarter, remember that the fourth quarter the year before had an extra period in it.

Contractual termination income will be $2.7 million during the quarter and again, that is already on the books. Our full year 2006 G&A expense will be between $57 and $58 million. Interest income and interest expense should run at approximately the same rate as the third quarter, after adjusting for the repayment of the mortgage debt associated with EC Three, Capital Galley and our Montvale Center, all of which were paid off during the quarter.

We are not anticipating any additional property sales to close during 2006. So if you take all of that into consideration, we are looking at fourth quarter Funds From Operation to be somewhere between $1.14 and $1.15, a pretty tight range, and our 2006 full year estimates will be $4.43 to $4.44, a 4.5% increase over 2005.

Turning to 2007 -- each year at this time we find ourself in the midst of establishing our property level business plans. What we do is we create space by space revenue projections for all of our vacant space and all of our 2007 rollover, and we review operating expenses for issues such as volatile energy expenses or the impacts of the shortage of worldwide catastrophic event insurance, which all could have some effect on either increasing operating expenses and therefore impacting our NOI.

Our annual 2007 income and operating budgets are generally finalized during the month of December, so this is slightly a work in progress. As is our practice, all of our guidance do not include any acquisitions or dispositions during the year.

Our budgets assume flat occupancy for 2007. If you take a critical look at our vacancy and where it lies, a significant portion falls in assets that are unlikely to impact 2007 results. Specifically, our largest single vacancy in any property is the 329,000 square feet, and that's Bedford Office Park.

We are, in fact, discussing a major lease with a tenant but the tenant's occupancy won't begin until 2008 -- January of '08. Our second largest exposure is at Embarcadero Center where we are doing a number of tenant relocations. In addition to the number of small suites throughout the center that roll over on a continuous basis, we're going to be left with two very high quality blocks of space -- 75,000 square feet at the top of EC 2, and 66,000 at the base of EC 4. But by the time the spaces are vacated, they're released and the improvements are all completed -- and we typically do all of our own improvements out in EC so we don't book revenue until a tenant is, in fact, actually in occupancy -- will most likely be in the early portion of 2008. New York City is basically at full occupancy and our only vacancy in Washington, D.C. is in Montgomery County, where absorption has not quite kept the same pace as the District or Northern Virginia.

Just as we were able to recapture space in New York City this quarter, we may have the opportunity, working cooperatively with Procter & Gamble, to take back some of the former Gillette space at the Prudential Tower during 2007, but we've not built any revenue impact from this into our 2007 projections. You will recall that the Gillette space encompasses the top 14 floors at the Prudential Tower and the lease expires in December 31 of 2009, and the tenant is currently paying $20 [triple net], or approximately $40 on a gross basis.

Comparing our same store portfolio then, from 2006 to 2007, we will have sold $1.26 billion of properties with an annualized Funds From Operation contribution before interest expense but including the investment interest income that we got from those proceeds during the year, of about $47 million. So that's what we're losing.

Even without any increases in our portfolio occupancy, we expect portfolio results, after adjusting for those sales and again, taking out termination income, which was about $8 million in '06, to grow between 2.5% and 4% in 2007 on a GAAP basis. Again, so that's 2.5% to 4% GAAP growth in the same store properties in '07. On a cash basis, we think that growth is going to be somewhere 4% and 5.5%. Included in the number on the GAAP side are straightline rents that are only 60% of our 2006 level. In our budgets we're budgeting about $1 million a quarter of termination income, which is typically what our practice has been.

Interest expense for '07 after adjusting for the repayment of debt during '06, the full year of our convertible debt issuance and the increases from placing new developments in service, anticipated refinancings and an increase in capitalized interest as we ramp-up our development, will be somewhere between $278 million and $283 million for the year 2007. Interest income is going to be reduced by $27 million, since in 2007 we expect to pay out a special dividend once we get past January.

Our G&A expense is anticipated to run between $61 and $63 million. A significant portion of the increase stems from the final ramp-up of vesting on our long-term equity compensation program. 2007 will be our 5th year of granting solely restricted equity, and all of our existing grants have had five year back-loaded vesting.

From this point forward, only increases to the total grant or a change in the vesting schedule will affect the earnings charge from this program. Capitalized wages are expected to be between $8 and $10 million in 2007 -- I believe they were about $5 million in 2005 and are projected to be somewhere around $7 million in 2006, increasing as we move along with our development efforts. Our G&A expense, again, is net of all capitalized wages. So we take our G&A number and we back out our capitalized wages to come to a net number, and that's the number I gave you.

Our third party management and development fee for 2007 is anticipated to be between $13 and $14 million. We are assuming a 5% to 10% increase in the contribution from the hotels to between $23 million and $24 million.

At the outset of my remarks I described our acquisition/disposition strategy. If you view it narrowly, our decision to sell assets and make a significant special dividend, and then shrink the Company's asset base, we'll have the short-term effect of dampening our year-to-year earnings growth. Had we completed 1031 exchanges in connection with the property sales and put those dollars into properties that yielded as little as 6% on a GAAP basis, I'd be telling you today that our 2007 estimates would range from $4.70 to $4.85, an 8% increase year-to-year.

However, when we consolidate the assumptions outlined over the last few minutes and we include the effect of the $5.25 special dividend in January, the 2007 guidance comes down to $4.40 to $4.55. We have, and we will continue to focus on development and selective acquisitions that create meaningful value. Experience has demonstrated that over the long run, focusing on value added development will create the best opportunity for sustained higher growth for Boston Properties.

And with that, I'm going to end my remarks and turn things over to Mort.

Well, we are, as I have, I think, referred before in these conference calls, in a very, very powerful phase of the commercial office building market. It doesn't require me to tell you what has happened to commercial real estate values and a compression of cap rates that, along with higher anticipated rents that has contributed to that. Since the core competency of this Company is basically in development, where we feel we can mix our management with our capital and bring about much higher yields, we are continuing to focus our efforts on building up our development activities.

This, in fact, is what we have done and what we are in the process of doing and what we will demonstrate over the next several years. We are working on two major projects in New York that will represent, oh, say, 1,700,000 feet in total space. We are involved in Virginia in about 1,300,000 square feet of space. In Washington, D.C. we're talking about almost 700,000 square feet of space in Chevy Chase; 300,000 square feet of space in Tower Oaks; 170,000 square feet of space in San Francisco. We are also looking at expanding our development activities, et cetera.

Now, my only point in just giving you a whole series of numbers is to indicate that we are on the verge, in the next year or two, of undertaking a much larger development program for the obvious reason that this is something that we have as the core competency of the Company, as I mentioned, and of course the much higher yields and the purchase of properties.

We are looking for acquisitions. We are making them on a selective basis. We intend to continue to look at that part of the spectrum of activities continuously and carefully, but we are going to focus primarily on the development business. We do not see any weakening, basically, in any of our markets -- quite the opposite. We see all of these markets continuing to strengthen.

The reason for that is fairly simple. Corporate America is extraordinarily profitable. That's the essential core center of gravity of our tenancies. They are hiring -- New York City is hiring, added a tremendous number of jobs. The vacancy has dropped to very low levels. This is true in Washington. The demand in Boston is continuing. We are continuing to see growth in the occupancy by individual tenants. We can't predict all of the changes that will be made, as we could not predict even for this year; but it is clear that the tenants are not only looking to expand but they are looking to precommit space so that they control the space. Therefore, we are seeing tenants who are looking to renew leases that come up in two and three years so that they can be assured that the space will be available and know what their costs are.

So in this sense I think we are always a little bit careful about how bullish to describe the forthcoming conditions, for all the obvious reasons that nothing in the future is totally predictable. We just know that it lies ahead. But we are very, very comfortable with what we can measure today as the prospects for future growth, primarily from development. That is what we're going to continue to focus on as we go forward.

We are consistently expanding our portfolio of development opportunities. There are a number of development opportunities, which I choose not to describe at this point because we are in that delicate phase of assembling the properties or trying to tie up the properties. These always take time, and so we tend to announce them only after all the aspects of it have been completed. But that this is going to be our principal focus should not be in doubt.

With this I will end my comments and move on to the next phase.

Operator, you can open up the questions, if you like.

(OPERATOR INSTRUCTIONS). Michael Bilerman, Citigroup.

John Litt is on with me as well. Doug, maybe you can talk a little bit more about that 500,000 square foot lease extension in New York at [flat Cash Rents]. Talk a little bit about the rationale behind that and when that was done?

Mort, you may want to chime in on this because you have been involved in this for the past five years. Our major tenant at 599 Lexington Avenue has lots of extension options or had lots of extension options. They also had the ability to take additional space and give back additional space. They also had all sorts of rights to look at where the rents were today versus where the rents might be in the future. We have been negotiating with them for, I want to say, three and a half years on a lease renewal.

We finally got everyone to have, I guess, expectations about what the future might be that were at least consistent with each other. So we agreed to -- in sort of big picture terms -- renew their lease on 500,000 square feet and take back 75,000 square feet as part of that. So we now have three floors that they were currently leasing in the mid '50s that we believe will lease somewhere between $90 and $100 a square foot, hopefully.

Then we did two extensions. Their lease was already going through 2012, so we extended it from 2012 to 2022. As you can see from the transaction cost, we basically did this on an as-is basis without the cost of capital associated with that. Mort, I don't know if you want to add any color to that?

No, I think the essential matter that you have pointed out is that there was a renewal option. That was the controlling factor in terms of the overall rents, but we were pleased to get it done and get it behind this. There are no renewal options going forward after this lease.

Where were those rents going to expire in 2012, at least?

Well, everything was on a net basis. I want to say -- and I don't have it on the top of my fingers -- but I want to say that the net rents were somewhere in the 45-ish dollar range.

You talked about the 162,000 square feet of recaptures in New York, where you have been able to boost the rents by $25, if I heard you right. When would those leases start and start getting earnings?

Well, I guess the first one sort of already started in that we booked the termination income or we're booking termination income on one floor. But the actual, the straightline rent and the new tenant's occupancy doesn't begin until the end of the fourth quarter. So that's the first.

The space we're taking back at 599 -- we have taken back one of those floors, and we are about to release it. Assuming we release it in '06, it will hit '06; if we don't release it until '07, it will hit in '07. The other two floors we're taking back in '07 and '08. One of them actually is leased until the beginning of '08 -- a sublet.

And then the other floors, which were over in Times Square Tower, that transaction will occur sometime in the middle of 2007 -- April. So it's part of what's in our 2007 projections for the reasons the same-store is going up. But none of those things have officially hit yet.

Doug, you talked about the $600 million of development starts as sort of a baseline in 2007. Can you talk a little bit about where could that go, depending on if some of these other projects hit? How much of that $600 million is definite, and then how far can it go when you start thinking about some of these other projects?

I think the way I would answer it is as follows. We have enough things going on excluding the sites that Mort at least referred to in New York City that we're very comfortable with the $600 million number. Now, obviously, as Mort described, 1.75 million square feet of space in Manhattan probably has a cost significantly in access of $200 a square foot. So that's not part of that $600 million. To the extent one of those things were to occur in 2007, the number would obviously be grossly larger than that.

How close are you at this point to one --

We don't want to get into speculations on terms of when we're going to start it, guys. Believe me, we're going as fast as we can. But I just think that there are too many variables in that to want to make a prediction. We think there's a real possibility that at least one will be able to be started next year and perhaps one the year after that. But these things are just too unpredictable to want to put out a specific timeline.

I had a question. Quite a while has passed, the 280 Park deal was announced, [with no sufficient] sales announced. Is there anything, any conclusions we can draw from that in terms of the ability to sell assets, the cap rates you want to sell them at, i.e., maybe that market [slipped] away from you a little bit?

No. There are no conclusions except, again, the situation that we are in is that we cannot make any announcements until we know the transactions have gone hard. That's sort of where we find ourselves. We are always looking at these things, and as soon as a transaction goes hard it's going to be announced. Until it goes hard we're reluctant to say anything.

Doug, I just have one final question. You had said same-store results were going to be roughly flat in '07.

'06.

Sorry, in '06. But then you said something about straightline and FAS being 15 million; is that right?

No, 16 million. That's where basically I said on a cash basis we're going to be flat third to fourth quarter. We're picking it up in basically straightline rent because of basically some of these leases that I was just describing.

What was the amount you were picking up?

I think, was it $2.5 million?

$2 million.

Matt Ostrower, Morgan Stanley.

Doug, on the TI front, you talked about how the number goes up significantly from the supplement if you take out the 500,000 square feet in midtown. But it's still -- by $25 a square foot that still looks like a pretty significant drop from where it was before. Should we read anything into that? Are you seeing any improvement on the concession side?

I think the answer is yes, we're seeing an improvement on the concession side. But as we push rents, we're being, I guess, reasonable about concessions at the same time. So, for example, if the cost of redoing tenant improvements are going up as they are, at a pretty significant rate, I would say that on a new transaction in one of our [CBD] locations, be it Washington, D.C., San Francisco, Boston or New York City, we're talking about somewhere between $45 and $50 a square foot for the [broker side].

Now, on renewals where we don't have to do a rebuild, obviously those transactions are significantly lower. So I would say that I still believe that our overall transaction cost -- and I think that we've been pretty consistent at this -- are somewhere in the high 20s, low 30s on average, on a consistent basis, based depends on where the rollover is.

Then the San Jose deal -- I guess you could sort of call that more like a yielding land play. Are you finding those deals -- sort of [thematically] are you finding those deals easier to come by in general? Or are those just as tough to do as sort of higher quality office buildings?

I think that any acquisition that is put onto the market, the open market, is very challenging to get your arms around because, as I said before, of just the amount of capital. We are working on some transactions that are, I guess, what you would refer to as off-market. We have been successful on some of them. We haven't been successful on others. Those are similar to what we're talking about now, where there is a building where either we think there's a lot of upside in the rent and/or some development potential associated with the existing improvement in the way the development program has been put together.

But I think if Bob Pester wants to comment on San Jose -- it's a feeding frenzy out there. We were fortunate to be able to figure out a way to buy Zanker, and I think we, to some degree, saw the market growing at a pretty rapid rate. But it's been growing at an even faster rate than we ever expected.

James Feldman, UBS Financial.

Can you talk a little bit about the expected yields on the $600 million of development in '07? That starts in '07?

What our typical perspective is is that the development yields, depending upon whether it's a speculative building or it's a fully leased building and whether or not it's land that we have at a very low-cost basis or land that we have bought more recently, are somewhere in the 8% to 10% range, depending upon the specific asset.

Of the list of developments that Mort had mentioned earlier, would most of these be speculative? In which markets are you more comfortable now, thinking speculative versus actually having a tenant?

I think there is a speculative nature to all of the developments. It ranges from, for example, in our building in Waltham, it's 100%. That's really based upon the market. The last time a built-to-suit was done in Waltham or the greater Boston area was a long, long time ago. It's just always been a show-me kind of a marketplace.

The building that we're going to likely start in Chevy Chase, which is a 300,000 square foot building -- Ray, you can comment. I would not be surprised if the building isn't 80% leased before we put a shovel into the ground.

We have had more activity on that Chevy Chase building in terms of previous activity than probably any other speculative building we've ever undertaken in Washington. We may be in a position where we have to tell some of our more important tenants on a national basis we don't have space there to accommodate them.

So, it really runs the gamut. In San Francisco, Bob is chasing a build-to-suit, that would be 100% leased; that's a 400,000 square foot asset. We're looking at another project in Boston that we think we might start that's 25% to 30% preleased before we put a shovel into the ground. So, it really runs the gamut.

John Guinee, Stifel Nicolaus.

A couple questions. First, on Zanker Drive in San Jose, is $126 million include the development rights associated with the 25-acre campus, or is that just for the building?

We paid $126 million for the entire site, lock, stock and barrel, and to the extent that we're able to provide additional development capacity on that site, it's all, I guess, free and it's not on the balance sheet.

You've got about a 50% coverage on that, so any additional development comes in the form of structured parking?

Bob, do you want to describe what you're thinking about?

Yes. We're looking right now at adding two buildings of approximately 150,000 square feet each with structured parking.

Second question. You're obviously taking a very aggressive blend-and-extend tactic for early renewals. Do you look at a cost of capital on the TI's that you [expend], either on new leases or renewals?

Absolutely.

What are you looking to get?

It depends upon the tenant. I'd say three years ago we were looking for somewhere between 10% and 11%. I'd say today that number is lower, but it certainly isn't lower than what the return expectation is on a new acquisition that is being made in today's environment.

The last question is, Doug, you had mentioned that you didn't think it would cost $200 to $300 per buildable foot to build in midtown. Do you have a sense as to what it cost today for office or residential in midtown?

Mort, do you want to answer that question?

Well, if you're just talking about -- well, I would say in terms of a new office building in the right location, you're talking $900 to $1,000 a foot, all in, everything included.

How much of that would you attribute to land versus --

It just varies all over the place. The land can go up as high as $400 or $500 a foot, and can be as low as $200 to $300 a foot. It all depends on the location.

Ross Nussbaum, Bank of America.

A question on the development site in terms of the staffing. It sounds like the G&A costs are going to be moving higher there. Are you where you need to be in terms of personnel staffing? Just comment on where you are on that front.

I'm going to let Mitch Norville, who is responsible for our operations, to comment on that one.

We're in pretty good shape. We've added probably three or four people in the last year, and we might be adding one or two people coming up but probably more on the junior side than the senior side. So I think we are in pretty good shape with that. We really didn't -- we never de-staffed, per se. All these projects that are coming to fruition now we've been working on for several years; it isn't like they just popped up this year and we put them on the book. So it's kind of a concerted effort to be active on the development side.

While I'm on development, the 355 acres you cite in the supplemental -- how much of that is already fully entitled?

That is going to be a very hard question to answer because it's all over the place. I would say the vast majority of it is entitled, other than the fact that you need a typical -- either a special permit or a building permit, which means you have to go through the process. But it's not like we don't have the right to build; it's just a question of going through the process of crossing your T's dotting your I's. That could take time, but it's entitled land.

The book value, $210 million, is land held for development. Any guesstimate as to what the market value there is?

I wouldn't even want to hazard a guess, but it's more than $210 million.

Same-store growth forecast for 2007 -- maybe you can just help me get to your numbers. If I heard you correctly, you were forecasting flat occupancy, I think you said a 7% rent rolldown on the space that's expired to roll next year. How are you getting to 2.5% to 4% GAAP growth?

Well, a couple of things. The 7% obviously is on the space that's rolling over, so some of the space that's rolling over may not get leased, and then we have other spaces currently vacant that's going to get leased. So, you can't just look at the 7% rolldown and say, ah hah, the portfolio is rolling down. So that's sort of -- those are data points that you have to use but you can't simply take those and push them through the system.

Number two is we have development properties that are going to be online for the full year in 2007 that were not on for a full year of 2006. Third, we do have spaces that are rolling over that will have significant increases in both current rent, cash rent and straightline rent. The New York City [stuff] that I was describing before is a pretty meaningful portion of that.

I would tell you that if you looked at each one of our regions, the contribution from New York City in 2007 is greater than the contribution from the other regions, although there is some positive contribution in terms of same-store increases in almost every one of our other regions.

Two quick questions here. There's been some talk that you may be looking at McGuire? Do you want to put that one to rest?

I think the appropriate thing would be to say that we don't talk about major acquisitions or dispositions until we have a deal in place.

But you can rest.

I can rest? Okay. Finally, 5 Times Square -- I may have missed it. Did you comment on the timing there? I think it's pretty common knowledge that it's on the block in New York.

We can't comment on these things until we have dates. When we have dates, we'll comment, but at this point we just can't.

Jay Habermann, Goldman Sachs.

I'm here with Sloan Bohlen as well. Just back to New York City and the two developments there. Are you thinking pure office, just given where rents are today? Or are you still contemplating some kind of mixed-use development?

I don't think we really want to comment on the developments until we are in a position to announce them. There are all kinds of reasons why that would be the case. I would say at least one of them will be an office building.

In addition, did you contemplate further asset sales? Are you thinking special dividends, share repurchase, possibly? Or is it really to fund development?

Again, I think that we have more than enough capital built into the Company to fund almost any development program we can imagine without even looking at the proceeds of these. So, that is sort of a separate issue from our point of view. We haven't had this discussion with the Board, and therefore I think we would be unable to give you guidance.

Just one more question. In terms of Boston and the Gillette lease, it's fair to say that lease is well below market?

Yes.

Yes.

Where is the market currently today?

Bryan, do you want to comment on that?

Yes, sure. It's probably -- for the Gillette space, which is the top 270,000 square feet, in the range of $55 to $65 a square foot.

Jordan Sadler, KeyBank.

Just in terms of the sales environment, would you say that your posture is still leaning towards additional asset sales? Do you think beyond the potential sale of 5 Times Square that we may see additional asset sales?

I think it's fair to say that we review the portfolio on a more than periodic basis. To the extent that we think that there are expectations that the market might have for growth in rental rates and/or total return expectations are greater than what we believe, we would consider selling some of those assets. Not to a point where we're putting the Company's operating platform in any jeopardy of not being what it is today, so it's all on an incremental basis. But we look at the portfolio very consistently and think about that.

Which markets do you think market expectations are most aggressive, relative to your expectations for market rent growth?

They are all very aggressive, I have to tell you. In the markets that we are in, all of which have barriers to entry, and given the quality of the assets that we have, they are all very, very strong. Obviously, in one sense, because of the valuations per square foot, New York still is the standard there. But they are all very strong.

Do you see any risks to midtown rents more in terms of with new potential development in downtown Jersey City, Long Island City?

I was speaking to a major investment banking firm, a CEO, just this week, and he was describing one of their attempts to build outside the city and, indeed, outside of midtown, where over 80% of his activity takes place. It's hard for me, really, to imagine that there's going to be an excess of supply -- quite the opposite. There's a huge amount of demand today that is unfilled. If I had the capacity to start two buildings of one million square feet each today on spec, I would do it, and we would do very well with it.

What are your views on development, either downtown or in some of these other submarkets outside of midtown?

Well, each one of them has to be looked at on their own basis. But I have always been wary of downtown compared to midtown. The midtown market, I think, works in the following way. It is much less of a price market than is downtown, and that means when there is an upward cycle in terms of activity, what you have is a dramatic increase in rent. So it's not just leasing the building out the first time around, which you can certainly do in these days in both markets; it's what happens when the market gets stronger and when the market gets weaker.

What happens downtown -- it's much more price sensitive, because most tenants, frankly, would like to be in midtown. Therefore, we find we do better in good markets in midtown and much better in bad markets. That's why we like to focus our efforts there.

Lastly, just on development yields, you mentioned 8 to 10, Doug. Does that include New York City?

Yes. I hope.

Michael Knott, Green Street Advisers.

I'm just wondering if you found that rents in San Francisco and Boston have grown faster than you expected -- market rents, that is.

I'll give you my perspective, and then I'll let Bob and Bryan speak. I think that the market growth in rents in San Francisco last year was much faster than we expected. I think it's been more normalized this year. I think Boston has caught up and that there's been a significant growth in 2006 in market rents in Boston that doesn't seem to be decelerating.

Some of these asset sales that have been made or are in the process of being made -- I know because I have seen the underwriting on many of these assets -- anticipate double-digit growth in rents on a consistent basis for a number of years.

Bob, do you want to start on your perspective in San Francisco?

Yes. Clearly, last year it grew faster than I think anyone anticipated. This year, although we've achieved as high as mid '60s to mid '70s on some deals here, it's been somewhat flat. I don't see a lot of pressure to push through those rates right now.

I do think down on the San Francisco Peninsula, we've been quite surprised at how quick rents are recovering and increasing there, as well as down in the Silicon Valley for major blocks of space.

I would echo the fact that we have caught up to San Francisco. Waltham, for example, we've had our twelfth consecutive quarter of positive absorption, 390 this year. Rents are up 20% in Waltham. In the Back Bay market we've seen increases as well, and I would say probably $5 a square foot jumps this year alone.

I don't think that anybody anticipated how powerful the turnaround would be and how dramatic it would be, even in New York. I think it's just been one of those accelerated trajectories that I think has surprised virtually everybody, and makes everybody feel that the deals that they made were great deals, and the only thing they regret are the deals they didn't make in terms of acquisition for developments.

So I followed this market pretty carefully, and no matter how carefully I followed it, I was still surprised.

Ray, could you just comment on your expectation for market rent growth in D.C., given the new supply there?

I think it's a market-by-market and a submarket-by-market analysis. I think the class A trophy blocks are still very tight, especially the larger you get in the tenant size, the more limited the options are. I see strong rent growth there. I think the lower-quality space and the smaller tenants still have a lot of options, and that's rent growth will not be as strong.

I think out in the suburbs, specifically in the market we know best, which is Reston, we are developing the [South of Market] and we're probably, at this point, 50% either leased or committed. We're just now coming out of the ground. Every single deal starts with a four in front of it, where the more generic space out in Herndon and the Dulles area is struggling. So as usual, it's a market-by-market and building-by-building type of analysis.

Sri Nagarajan, RBC Capital Markets.

Just a quick question on capitalized wages. Looking at your development in progress, is it fair to assume that capitalized wages are primarily because of predevelopment activities at this point in time? How should we think [about it] in '07 as well?

I think it's predevelopment and it's the stuff that's going on, the 65 that we started in '05 and the 300 that we started in '06. So there are construction managers and project managers that are associated with all those projects. Then the new projects that we're working on -- for example, 77 4th Avenue, which we just started, we have been capitalized wages for the last quarter or so because we have been getting going on finishing the plans, doing the bidding of the construction, et cetera, et cetera.

So I would say, depending upon the length of the development period, some of that stuff is predevelopment and some of it is actually under construction. I think that that will accelerate in 2007 and into 2008. We would expect the capitalize wages to be in access of $8 million on a run-rate basis in '06 and higher than that in '08.

Next question on the Capital Gallery expansion project. Is this already contributing to the top line, and what kind of rents are you getting there? Particularly.

It is contributing to the top line. It's been in service since April of 2006. It's slowly bleeding in from a rental rate perspective. Most of the rents -- Ray, correct me if I'm wrong -- were in the low 40s?

Low to mid-40s. At this point in time, in the expansion building itself, I think we only have 5,000 square feet left out of 330,000 square feet.

But the rent on a couple of those floors doesn't begin until the beginning of 2007?

Yes. The Smithsonian phase is in, and we do have some vacancy in the existing structure because of relocation from tenants to the new building. But as usual, Capital Gallery just has been a complete homerun for us.

Ian Weissman, Merrill Lynch.

Just to fall back on Boston for a second, we have heard a lot about the strength in the CBD market in Waltham, but it appears that at least investor demand in Cambridge is picking up. Maybe you could touch on the market dynamics, specifically in Cambridge as well as reports of your interest in bidding on 4 and 5 Cambridge?

I'll answer the general question and not comment on the specific. The Cambridge market has seen dramatic acceleration, dissimilar to what we have seen in Waltham. Asking rents and our assets in Cambridge were in the low 30s at the beginning of the year and are over $40 a square foot today. Now, we haven't done a $40 deal, but we have done some $37 deals.

The demand for space in Cambridge, I think, is coming from two places. One is that there has been space that has been taken out of inventory on the office side and been converted to lab space. Alexandria, we hear, for example, is taking 170 or 200,000 square feet of the space that was being developed by MIT as office space in Technology Square and creating lab space for that space. All of the demand at this point is in the high-quality space. A year ago all the demand was in the much lower-quality space.

The investor demand on the office site continues to be significant. Last year 55 Cambridge Parkway was sold, and rents were in the doldrums at that time. There were half a dozen bidders who were fighting tooth and nail for the last dollar. There are some assets that are being sold today that you talked about that are close to our heart. Obviously, we have an interest in them and we'll see what happens.

Is there any new supply of traditional office in Cambridge?

There is one potential place for new supply of space in Cambridge. Remember, the Kendall Square market is about 9 million square feet, and it's the market that supports MIT and is now supporting all the biotech infrastructure, lab investing, R&D investing, that's being put into Cambridge. About three quarters of a mile away on the other side, the McGrath and O'Brien Highway, which is not an insignificant difference in location, is a site called NorthPoint. NorthPoint is a site that is currently got some residential buildings under construction, and they have the ability over time to build somewhere between 750 and 1 million square feet of additional space.

So that would be, really, the only place for any significant office space to be built in the greater MIT Kendall Square area of Cambridge.

Some additional clarity for Cambridge is there's five tenants in the market right now, over 100,000 square feet. What makes it a little bit trickier to understand is that you have lab mixed in with that, and it becomes a little bit peculiar in terms of analyzing the market. The market statistically is only showing [quote] 6% increase this year, but we feel like there's really more implied growth than that. As Doug said, it's really become a $40 market.

John Guinee, Stifel Nicolaus.

A quick follow-up. There have been a lot of biotech lab space type transactions on the investment side in Cambridge and other parts of the country. Have you actively pursued that? And whether or not, do you have an opinion on that?

I think, going back to last year, that we pursued the East River Science Park. We were obviously not as aggressive as others were, and so we didn't ultimately move forward with that. Actually, I'm not sure anyone has moved forward with that at this point.

We looked at Tech Square, when Tech Square was on the market, and we've spent some time looking at the Center for Life Sciences along with Medical Center. Our perspective on lab and biotech space is that we are very cautious and concerned when we do our underwriting about the tenancies associated with those labs, because the infrastructure cost that you put into tenant improvements is significant, in access of $150 a square foot. So if you're not comfortable with the users and their longevity, you're not really sure because there hasn't been a strong enough market to know how those improvements may or may not fit for the next tenant.

But we've looked at it. We are believers in the biotech market. We are strong believers in Cambridge and strong believers and along with medical area as places where -- those are winning locations, based upon the medical institutions and the knowledge-based individuals who work in and around those places. At some point it's a question of yield expectation and risk-adjusted returns that has, I guess, pushed us into a position of not currently owning any of those assets.

Management, there are no further questions at this time. Please continue with any closing remarks you may have.

Well, we look forward to our regular dialogue with you all. Frankly, we're looking forward to the next -- not just quarter, but to the next phase in the real estate business. Thank you all very much.

Thanks a lot, everybody.

Thank you. Ladies and gentlemen, this concludes the Boston Properties third-quarter 2006 results conference call. If you would like to listen to a replay of today's conference call, please dial 303-590-3000 or 800-405-2236 with access code 11072412 followed by the pound sign. Once again, if you would like to listen to a replay of today's conference call, please dial 303-590-3000 or 800-405-2236 with access code 11072412 followed by the pound sign. You may now disconnect. Thank you.