September 16, 2009 

Notes I took:

Boston Properties at Barclays Capital Global Financial Services Conference - September 15, 2009.

Doug Linde - Boston Properties, Inc. - President


“Our portfolio is concentrated, as Ross said, in New York City, Washington DC, Boston and San Francisco, and you can see the various components to our NOI. We do have a concentration in New York City, which was a pretty awful thing to have a year ago. It's actually probably a pretty good thing to have today. We'll talk about that as well. We, again, are a company that is a CBD, central business district-related company. Most of our buildings are in the major”

“We started seeing cap rates going down. We started seeing valuations getting out of control from our perspective, and we started selling assets and sold, between 2005 and 2007, almost $4.5 billion worth of real estate.”

“Then in 2008, we stepped in, probably too early, and we purchased a portfolio of assets that was part of the undoing of the Macklowe organization, the General Motors building and a few of their other assets. We purchased those with two partners, a partnership of Middle Eastern money from Goldman Sachs, as well as a group called Meraas, which is from the Dubai Kingdom. And we purchased the General Motors building and three other buildings. And as I said, probably were too early but there were long-term assets, and again, very iconic assets.”

“Some markets are getting to a point where we think things are stabilized. Other markets we think it's going to be a long time before things really recover, but the downturn is continuing. And knowing that, it's very difficult to underwrite real estate. And it's very difficult to underwrite real estate, and it's very difficult to sort of put a good hard cash flow characteristic on those real estate incomes. And then coming up with a valuation is even more challenging when you don't really understand what the dynamics are on the ownership side of the people who currently control those buildings because they may not really be focusing on what's going on from an operating perspective.”

“The issue today is not availability of capital. The issue today is where values are and how much people are prepared to lend based upon those valuations.”

“there are two components to replacement costs. The first is land and the second is the tangible construction costs associated with it. I would say that the hard cost numbers got as high as, in a city like Manhattan, $500, $600 a square foot for that component of it. And that includes tenant improvement allowances and the brokerage commissions and the carry and things like that. The hard cost component of that $600 plus or minus a square foot is probably 60%. That number probably has come down 20% to 25% depending upon where you are in the cycle and if you hit the steel markets correctly, if you hit the mall markets correctly. The really hard part of this real estate morass that we are in today is what is land worth? And so what does replacement cost really mean today if you can't quite understand and figure out what land values are. We were building a building on 250 West 55th St. We shut it down because the tenant that we had just didn't come to terms with us from a leasing perspective and we realized the better part of valor was to stop. We are in that land for about $300 a square foot. And the total project cost was going to be somewhere around $900 a square foot. So you couldn't find rents today that would make it economical to support even the $600 a square foot, quite frankly, let alone the $300 a square foot of land value we have. So that's sort of the extreme on the urban side.”

“For Manhattan, rents got to between $115 and $140 a square foot for the best property and the highest quality stuff. And today, things are between low $60s to around $80 a square foot, in my estimation for midtown Manhattan for high-quality buildings. That's Park Ave., [Lexington] Avenue, in the $60s. And the peak would have been in December of 2007. in Boston our in-place rents are $50 a square foot on average. In Washington, DC, $50. In New York City, $84; that's where they're above market. In San Francisco about $51. And down in Princeton, $33. Those are all gross rents. ”

“With regard to cap rates, that is the question for the ages today. Let me say the following. One of the challenges of large assets is that the amount of capital necessary to capitalize the building is significant. And for the last decade, you could raise, either through a well structured first mortgage in the early portion of this decade to the latter couple years, first mortgage plus junior, first mortgages plus mezzanine mortgages, probably somewhere between 70% and 95% of that capital. And today, on the debt side, if you can raise 50% of the value of a building on a structured well thought-out, well underwritten mortgage, you are doing pretty well. And the ticket that you can write is a lot smaller. So a building that is $500 million of value probably needs three lenders to get you to $250 million loan, and there probably aren't three lenders who at the same time in the same month are necessarily prepared to do that loan today. So that's the challenge associated with that.

And because of that disconnect, the amount of equity that's going to be required to be invested in new buildings on a going forward basis is going to be very significant. Now, if you have a building like the SL Green situation that was just traded last month or I don't know if it's actually closed yet, on 3rd Avenue, where you have a building that had a $500 million mortgage approximately -- or $450 million mortgage and it was a $500 million purchase price, something like that. Those are deals that are sort of outside of the realm of what I'm talking about. Because there's history associated with it and some hair, if you want
to call it that, associated with the acquisition.

But on basic, unencumbered assets or buildings with a low loan to value, the question is going to be what's the right IRR? What kind of return is that person who's going to want to invest that large sum of capital going to need?” 

“I can tell you that the people from Decca are buying a building in Washington, DC that's got a 15-year lease with 2.5% increases in it for $800 a square foot, which is above replacement cost. And they're been paying a 6.3% cap rate on it. I don't understand how that math works for them, but clearly it met their IRR hurdles for their type of capital.”

He discusses the Hancock Building in Boston:

“It is a fantastic asset. It is an iconic building. It is a building that is never going to be reproduced in the city of Boston. They will never allow a 50-story building, let alone a 60-story building, probably not a 30-story building. So it's got really long-term value associated with it. There's a $640 million mortgage on the property, and the mortgage I think is at a rate of like 5.6%. And it goes through 2017. And I would be willing to wager that the current cash flow from the building is equivalent to the debt service necessary to service that mortgage, the first mortgage.

The building has, depending upon your perspective, somewhere between 350,000 and 375,000 square feet of vacant space. And the rents in the building are between -- current rents in the building are between the mid-30s and the low 50s, so it's marked to market rents. The sort of popular press view on the building was that the building sold for $640 million. Well that's not true because the folks that purchased the building had already purchased the mezzanine debt and the most messed to senior level. And then they also purchased the debt that was below that in order to protect their interests. And I think most people think that they've got an investment of somewhere in the neighborhood of I don't know, $85 million to $115 million, so call it $100 million. So it goes
from $640 million to $740 million.

The capital necessary to put 375,000 square feet of tenants in the building is going to be pick a number, you know, $75, $85, $100 a square foot. Use $100 a square foot just to make the math simple. So that's another $37 million, so you're up to $775 million, $778 million. Purportedly, there's some capital that's going to be put in the building so redo the lobbies and HVAC systems, things like that.  Unfortunately, these real estate buildings that we all love are very capital-intensive. It's just a fact of life. So assume another $25 million. So you are up $800 million.

And then, there is carry. If I'm a hedge fund or an opportunity fund and I've invested $100 million, I assume I need a return on that money. And the -- I don't know what the right number is. But I assume that the opportunity fund model is still in the mid to high teens, I don't know, 15%. So on their incremental $100 million, they're looking for $15 million a year, and then any money that they're putting in on top of that, they are also looking for an incremental return on. So that is compounding as well. And, the challenge is that there are no tenants in the marketplace who have a 2009 lease expiration. As I sort of described to you, large tenants generally get in front of their leases further out. There probably aren't very many, if any, tenants who are -- have 2010 lease expirations. Now in Boston there are tenants who have 2011 lease expirations. So they're going to be having carried the building for least two years with no additional income in it. So at the end of the day, the question you have to ask yourself is not how much was the mortgage, but how much are they going to have invested in the building; and what do you think that it will be able to rent the rest of the space for; and what kind of a return is that going to generate while they are holding that property? And so I think the jury is out on where rents are in Boston right now. I don't think rents are $80 a square foot. I think rents, as I said earlier, in the high $30s to the very low $60s. And so if they are in the middle of that, and operating expenses are at the low point, $20 a square foot, maybe as much as $25 a square foot, you are talking about net rents of $20 to $25 a square foot. You multiply that by the square footage. You add that to the income that I said was there to support the mortgage and you are -- it's hard to say that that was the bottom.  I hope that they are -- for the purposes of looking at the overall marketplace -- I hope that the market rents recover and that they are able to get $80 a square foot. Right now I don't think you can achieve $80 a square foot. And so at the end of the day, the question will be what's the cap rate that they can achieve on a cash on cash return in terms of what their overall investment is.

And I don't know what that number is going to be. I do know that the number that they are going to be in for is going to be significantly higher than $640 million or $350 a square foot, which is sort of the number that's been bandied around as for what the building traded for.”