Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2015

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number: 1-13087

 

 

BOSTON PROPERTIES, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   04-2473675
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

Prudential Center, 800 Boylston Street, Suite 1900, Boston, Massachusetts 02199-8103

(Address of principal executive offices) (Zip Code)

(617) 236-3300

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  x   Accelerated filer  ¨
Non-accelerated filer  ¨ (Do not check if a smaller reporting  company)   Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common Stock, par value $0.01 per share   153,573,619
(Class)   (Outstanding on August 3, 2015)

 

 

 


Table of Contents

BOSTON PROPERTIES, INC.

FORM 10-Q

for the quarter ended June 30, 2015

TABLE OF CONTENTS

 

          Page  

PART I. FINANCIAL INFORMATION

  

ITEM 1.

  

Financial Statements (unaudited)

     1   
  

a) Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014

     1   
  

b) Consolidated Statements of Operations for the three and six months ended June 30, 2015 and 2014

     2   
  

c) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2015 and 2014

     3   
  

d) Consolidated Statements of Stockholders’ Equity for the six months ended June 30, 2015 and 2014

     4   
  

e) Consolidated Statements of Cash Flows for the six months ended June 30, 2015 and 2014

     5   
  

f) Notes to the Consolidated Financial Statements

     7   

ITEM 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      29   

ITEM 3.

   Quantitative and Qualitative Disclosures about Market Risk      78   

ITEM 4.

   Controls and Procedures      79   

PART II. OTHER INFORMATION

  

ITEM 1.

   Legal Proceedings      80   

ITEM 1A.

   Risk Factors      80   

ITEM 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      80   

ITEM 3.

   Defaults Upon Senior Securities      80   

ITEM 4.

   Mine Safety Disclosures      80   

ITEM 5.

   Other Information      80   

ITEM 6.

   Exhibits      81   

SIGNATURES

     82   


Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1—Financial Statements.

BOSTON PROPERTIES, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

     June 30,
      2015      
    December 31,
      2014      
 
     (in thousands, except for share and
par value amounts)
 
ASSETS     

Real estate, at cost

   $ 18,207,934      $ 18,231,978   

Construction in progress

     880,996        736,311   

Land held for future development

     277,327        268,114   

Less: accumulated depreciation

     (3,753,926     (3,547,659
  

 

 

   

 

 

 

Total real estate

     15,612,331        15,688,744   

Cash and cash equivalents

     1,342,751        1,763,079   

Cash held in escrows

     252,558        487,321   

Investments in securities

     20,953        19,459   

Tenant and other receivables (net of allowance for doubtful accounts of $1,061 and $1,142, respectively)

     55,183        46,595   

Accrued rental income (net of allowance of $1,219 and $1,499, respectively)

     730,797        691,999   

Deferred charges, net

     771,419        831,744   

Prepaid expenses and other assets

     117,993        164,432   

Investments in unconsolidated joint ventures

     209,974        193,394   
  

 

 

   

 

 

 

Total assets

   $ 19,113,959      $ 19,886,767   
  

 

 

   

 

 

 
LIABILITIES AND EQUITY     

Liabilities:

    

Mortgage notes payable

   $ 4,269,808      $ 4,309,484   

Unsecured senior notes (net of discount of $11,497 and $12,296, respectively)

     5,288,503        5,287,704   

Unsecured line of credit

     —          —     

Mezzanine notes payable

     309,148        309,796   

Outside members’ notes payable

     180,000        180,000   

Accounts payable and accrued expenses

     231,900        243,263   

Dividends and distributions payable

     112,892        882,472   

Accrued interest payable

     178,548        163,532   

Other liabilities

     448,480        502,255   
  

 

 

   

 

 

 

Total liabilities

     11,019,279        11,878,506   
  

 

 

   

 

 

 

Commitments and contingencies

     —          —     
  

 

 

   

 

 

 

Noncontrolling interests:

    

Redeemable preferred units of the Operating Partnership

     —          633   
  

 

 

   

 

 

 

Redeemable interest in property partnership

     106,233        104,692   
  

 

 

   

 

 

 

Equity:

    

Stockholders’ equity attributable to Boston Properties, Inc.:

    

Excess stock, $.01 par value, 150,000,000 shares authorized, none issued or outstanding

     —          —     

Preferred stock, $.01 par value, 50,000,000 shares authorized;

    

5.25% Series B cumulative redeemable preferred stock, $.01 par value, liquidation preference $2,500 per share, 92,000 shares authorized, 80,000 shares issued and outstanding at June 30, 2015 and December 31, 2014

     200,000        200,000   

Common stock, $.01 par value, 250,000,000 shares authorized, 153,552,831 and 153,192,845 issued and 153,473,931 and 153,113,945 outstanding at June 30, 2015 and December 31, 2014, respectively

     1,535        1,531   

Additional paid-in capital

     6,293,556        6,270,257   

Dividends in excess of earnings

     (711,239     (762,464

Treasury common stock at cost, 78,900 shares at June 30, 2015 and December 31, 2014

     (2,722     (2,722

Accumulated other comprehensive income (loss)

     1,848        (9,304
  

 

 

   

 

 

 

Total stockholders’ equity attributable to Boston Properties, Inc.

     5,782,978        5,697,298   

Noncontrolling interests:

    

Common units of the Operating Partnership

     614,988        603,171   

Property partnerships

     1,590,481        1,602,467   
  

 

 

   

 

 

 

Total equity

     7,988,447        7,902,936   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 19,113,959      $ 19,886,767   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

1


Table of Contents

BOSTON PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2015     2014     2015     2014  
     (in thousands, except for per share amounts)  

Revenue

        

Rental

        

Base rent

   $ 486,609      $ 463,239      $ 977,291      $ 918,257   

Recoveries from tenants

     86,795        81,382        175,388        163,316   

Parking and other

     26,552        26,300        51,340        50,633   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total rental revenue

     599,956        570,921        1,204,019        1,132,206   

Hotel revenue

     13,403        12,367        22,488        20,560   

Development and management services

     4,862        6,506        10,190        11,722   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     618,221        589,794        1,236,697        1,164,488   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

        

Operating

        

Rental

     214,464        202,646        435,814        409,034   

Hotel

     8,495        7,315        16,071        14,112   

General and administrative

     22,284        23,271        51,075        53,176   

Transaction costs

     208        661        535        1,098   

Depreciation and amortization

     167,844        154,628        322,067        308,898   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     413,295        388,521        825,562        786,318   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     204,926        201,273        411,135        378,170   

Other income (expense)

        

Income from unconsolidated joint ventures

     3,078        2,834        17,912        5,650   

Interest and other income

     1,293        2,109        2,700        3,420   

Gains (losses) from investments in securities

     (24     662        369        948   

Interest expense

     (108,534     (110,977     (217,291     (224,531
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before gains on sales of real estate

     100,739        95,901        214,825        163,657   

Gains on sales of real estate

     —          —          95,084        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     100,739        95,901        309,909        163,657   

Net income attributable to noncontrolling interests

        

Noncontrolling interests in property partnerships

     (9,264     (7,553     (24,472     (11,907

Noncontrolling interest—redeemable preferred units of the Operating Partnership

     (3     (320     (6     (939

Noncontrolling interest—common units of the Operating Partnership

     (9,394     (8,883     (29,530     (15,010
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Boston Properties, Inc.

     82,078        79,145        255,901        135,801   

Preferred dividends

     (2,618     (2,618     (5,207     (5,207
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Boston Properties, Inc. common shareholders

   $ 79,460      $ 76,527      $ 250,694      $ 130,594   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share attributable to Boston Properties, Inc. common shareholders:

        

Net income

   $ 0.52      $ 0.50      $ 1.63      $ 0.85   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of common shares outstanding

     153,450        153,078        153,341        153,054   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share attributable to Boston Properties, Inc. common shareholders:

        

Net income

   $ 0.52      $ 0.50      $ 1.63      $ 0.85   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of common and common equivalent shares outstanding

     153,815        153,238        153,845        153,203   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

2


Table of Contents

BOSTON PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2015     2014     2015     2014  
     (in thousands)  

Net income

   $ 100,739      $ 95,901      $ 309,909      $ 163,657   

Other comprehensive income:

        

Effective portion of interest rate contracts

     15,639        —          12,106        —     

Amortization of interest rate contracts(1)

     628        624        1,255        1,253   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

     16,267        624        13,361        1,253   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

     117,006        96,525        323,270        164,910   

Net income attributable to noncontrolling interests

     (18,661     (16,756     (54,008     (27,856

Other comprehensive income attributable to noncontrolling interests

     (2,512     (64     (2,209     (126
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to Boston Properties, Inc.

   $ 95,833      $ 79,705      $ 267,053      $ 136,928   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Amounts reclassified from comprehensive income primarily to interest expense within the Company’s Consolidated Statements of Operations.

The accompanying notes are an integral part of these consolidated financial statements.

 

3


Table of Contents

BOSTON PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited and in thousands)

 

   

 

Common Stock

    Preferred
Stock
    Additional
Paid-in
Capital
    Dividends  in
Excess of
Earnings
    Treasury
Stock,
at cost
    Accumulated
Other
Comprehensive
Income (Loss)
    Noncontrolling
Interests
    Total  
    Shares     Amount                

Equity, December 31, 2014

    153,114      $ 1,531      $ 200,000      $ 6,270,257      $ (762,464   $ (2,722   $ (9,304   $ 2,205,638      $ 7,902,936   

Redemption of operating partnership units to common stock

    322        4        —          10,839        —          —          —          (10,843     —     

Allocated net income for the year

    —          —          —          —          255,901        —          —          49,561        305,462   

Dividends/distributions declared

    —          —          —          —          (204,676     —          —          (23,578     (228,254

Shares issued pursuant to stock purchase plan

    2        —          —          313        —          —          —          —          313   

Net activity from stock option and incentive plan

    36        —          —          3,407        —          —          —          24,155        27,562   

Contributions from noncontrolling interests in property partnerships

    —          —          —          —          —          —          —          1,089        1,089   

Distributions to noncontrolling interests in property partnerships

    —          —          —          —          —          —          —          (34,022     (34,022

Effective portion of interest rate contracts

    —          —          —          —          —          —          10,027        2,079        12,106   

Amortization of interest rate contracts

    —          —          —          —          —          —          1,125        130        1,255   

Reallocation of noncontrolling interest

    —          —          —          8,740        —          —          —          (8,740     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Equity, June 30, 2015

    153,474      $ 1,535      $ 200,000      $ 6,293,556      $ (711,239   $ (2,722   $ 1,848      $ 2,205,469      $ 7,988,447   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Equity, December 31, 2013

    152,983      $ 1,530      $ 200,000      $ 5,662,453      $ (108,552   $ (2,722   $ (11,556   $ 1,302,465      $ 7,043,618   

Redemption of operating partnership units to common stock

    66        1        —          2,240        —          —          —          (2,241     —     

Conversion of redeemable preferred units to common units

    —          —          —          —          —          —          —          33,306        33,306   

Allocated net income for the year

    —          —          —          —          135,801        —          —          20,448        156,249   

Dividends/distributions declared

    —          —          —          —          (204,178     —          —          (22,673     (226,851

Shares issued pursuant to stock purchase plan

    4        —          —          357        —          —          —          —          357   

Net activity from stock option and incentive plan

    40        —          —          3,543        —          —          —          12,899        16,442   

Contributions from noncontrolling interests in property partnerships

    —          —          —          —          —          —          —          1,675        1,675   

Distributions to noncontrolling interests in property partnerships

    —          —          —          —          —          —          —          (12,149     (12,149

Amortization of interest rate contracts

    —          —          —          —          —          —          1,127        126        1,253   

Reallocation of noncontrolling interest

    —          —          —          10,985        —          —          —          (10,985     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Equity, June 30, 2014

    153,093      $ 1,531      $ 200,000      $ 5,679,578      $ (176,929   $ (2,722   $ (10,429   $ 1,322,871      $ 7,013,900   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4


Table of Contents

BOSTON PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     For the six months ended
June 30,
 
     2015     2014  
     (in thousands)  

Cash flows from operating activities:

    

Net income

   $ 309,909      $ 163,657   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     322,067        308,898   

Non-cash compensation expense

     16,480        16,899   

Income from unconsolidated joint ventures

     (17,912     (5,650

Distributions of net cash flow from operations of unconsolidated joint ventures

     5,769        2,205   

Gains from investments in securities

     (369     (948

Non-cash portion of interest expense

     (21,852     (18,171

Settlement of accreted debt discount on repurchases of unsecured exchangeable senior notes

     —          (92,979

Gains on sales of real estate

     (95,084     —     

Change in assets and liabilities:

    

Cash held in escrows

     (175     (2,047

Tenant and other receivables, net

     (8,588     8,116   

Accrued rental income, net

     (40,173     (21,984

Prepaid expenses and other assets

     63,545        51,442   

Accounts payable and accrued expenses

     (5,973     (4,704

Accrued interest payable

     15,016        (11,499

Other liabilities

     (56,580     (39,253

Tenant leasing costs

     (43,004     (44,989
  

 

 

   

 

 

 

Total adjustments

     133,167        145,336   
  

 

 

   

 

 

 

Net cash provided by operating activities

     443,076        308,993   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Construction in progress

     (154,430     (206,603

Building and other capital improvements

     (48,133     (37,285

Tenant improvements

     (51,444     (53,935

Proceeds from sales of real estate

     194,821        —     

Proceeds from sales of real estate placed in escrow

     (200,612     —     

Proceeds from sales of real estate released from escrow

     441,903        —     

Cash placed in escrow for land sale contracts

     (7,111     —     

Cash released from escrow for land sale contracts

     758        —     

Deposit on real estate

     (5,000     —     

Capital contributions to unconsolidated joint ventures

     (14,989     (47,767

Capital distributions from unconsolidated joint ventures

     24,527        357   

Investments in securities, net

     (1,125     (1,338
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     179,165        (346,571
  

 

 

   

 

 

 

 

5


Table of Contents

BOSTON PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     For the six months ended
June 30,
 
     2015     2014  
     (in thousands)  

Cash flows from financing activities:

    

Repayments of mortgage notes payable

     (12,909     (12,207

Repayment of unsecured exchangeable senior notes

     —          (654,521

Proceeds from real estate financing transaction

     6,000        —     

Payments on real estate financing transaction

     (1,523     —     

Deferred financing costs

     (163     (31

Net proceeds from equity transactions

     332        1,162   

Redemption of preferred units

     (633     —     

Dividends and distributions

     (997,840     (612,612

Contributions from noncontrolling interests in property partnerships

     1,089        1,675   

Distributions to noncontrolling interests in property partnerships

     (36,922     (14,449
  

 

 

   

 

 

 

Net cash used in financing activities

     (1,042,569     (1,290,983
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (420,328     (1,328,561

Cash and cash equivalents, beginning of period

     1,763,079        2,365,137   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 1,342,751      $ 1,036,576   
  

 

 

   

 

 

 

Supplemental disclosures:

    

Cash paid for interest

   $ 240,942      $ 379,766   
  

 

 

   

 

 

 

Interest capitalized

   $ 16,815      $ 32,586   
  

 

 

   

 

 

 

Non-cash investing and financing activities:

    

Additions to real estate included in accounts payable and accrued expenses

   $ 17,604      $ 4,831   
  

 

 

   

 

 

 

Dividends and distributions declared but not paid

   $ 112,892      $ 112,420   
  

 

 

   

 

 

 

Conversions of noncontrolling interests to stockholders’ equity

   $ 10,843      $ 2,241   
  

 

 

   

 

 

 

Conversions of redeemable preferred units to common units

   $ —        $ 33,306   
  

 

 

   

 

 

 

Issuance of restricted securities to employees

   $ 43,363      $ 27,445   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

1. Organization

Boston Properties, Inc. (the “Company”), a Delaware corporation, is a self-administered and self-managed real estate investment trust (“REIT”). The Company is the sole general partner of Boston Properties Limited Partnership (the “Operating Partnership”) and at June 30, 2015 and December 31, 2014 owned an approximate 89.5% general and limited partnership interest in the Operating Partnership. Partnership interests in the Operating Partnership are denominated as “common units of partnership interest” (also referred to as “OP Units”), “long term incentive units of partnership interest” (also referred to as “LTIP Units”) or “preferred units of partnership interest” (also referred to as “Preferred Units”). In addition, in February 2012, the Company issued LTIP Units in connection with the granting to employees of outperformance awards (also referred to as “2012 OPP Units”). On February 6, 2015, the measurement period for the Company’s 2012 OPP Unit awards expired and the Company’s total return to shareholders (“TRS”) was sufficient for employees to earn and therefore become eligible to vest in a portion of the 2012 OPP Unit awards (See Notes 7 and 10). In February 2013, February 2014 and February 2015, the Company issued LTIP Units in connection with the granting to employees of multi-year, long-term incentive program (“MYLTIP”) awards (also referred to as “2013 MYLTIP Units,” “2014 MYLTIP Units” and “2015 MYLTIP Units,” respectively, and collectively as “MYLTIP Units”). Because the rights, preferences and privileges of MYLTIP Units differ from other LTIP Units granted to employees as part of the annual compensation process, unless specifically noted otherwise, all references to LTIP Units exclude MYLTIP Units (See Notes 7 and 10).

Unless specifically noted otherwise, all references to OP Units exclude units held by the Company. A holder of an OP Unit may present such OP Unit to the Operating Partnership for redemption at any time (subject to restrictions agreed upon at the time of issuance of OP Units to particular holders that may restrict such redemption right for a period of time, generally one year from issuance). Upon presentation of an OP Unit for redemption, the Operating Partnership is obligated to redeem such OP Unit for cash equal to the value of a share of common stock of the Company (“Common Stock”) at such time. In lieu of a cash redemption, the Company may elect to acquire such OP Unit for one share of Common Stock. Because the number of shares of Common Stock outstanding at all times equals the number of OP Units that the Company owns, one share of Common Stock is generally the economic equivalent of one OP Unit, and the quarterly distribution that may be paid to the holder of an OP Unit equals the quarterly dividend that may be paid to the holder of a share of Common Stock. An LTIP Unit is generally the economic equivalent of a share of restricted common stock of the Company. LTIP Units, whether vested or not, will receive the same quarterly per unit distributions as OP Units, which equal per share dividends on Common Stock (See Note 8).

At June 30, 2015, there was one series of Preferred Units outstanding (i.e., Series B Preferred Units). The Series B Preferred Units were issued to the Company on March 27, 2013 in connection with the Company’s issuance of 80,000 shares (8,000,000 depositary shares each representing 1/100th of a share) of 5.25% Series B Cumulative Redeemable Preferred Stock (the “Series B Preferred Stock”). The Company contributed the net proceeds from the offering to the Operating Partnership in exchange for 80,000 Series B Preferred Units having terms and preferences generally mirroring those of the Series B Preferred Stock (See Note 8).

All references herein to the Company refer to Boston Properties, Inc. and its consolidated subsidiaries, including the Operating Partnership, collectively, unless the context otherwise requires.

Properties

At June 30, 2015, the Company owned or had interests in a portfolio of 170 commercial real estate properties (the “Properties”) aggregating approximately 46.3 million net rentable square feet, including thirteen properties under construction/redevelopment totaling approximately 4.2 million net rentable square feet. In

 

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addition, the Company has structured parking for approximately 43,341 vehicles containing approximately 14.7 million square feet. At June 30, 2015, the Properties consisted of:

 

   

162 office properties, including 131 Class A office properties (including twelve properties under construction/redevelopment) and 31 Office/Technical properties;

 

   

one hotel;

 

   

five retail properties (including one property under construction); and

 

   

two residential properties.

The Company owns or controls undeveloped land parcels totaling approximately 484.4 acres.

The Company considers Class A office properties to be centrally located buildings that are professionally managed and maintained, attract high-quality tenants and command upper-tier rental rates, and that are modern structures or have been modernized to compete with newer buildings. The Company considers Office/Technical properties to be properties that support office, research and development, laboratory and other technical uses. The Company’s definitions of Class A Office and Office/Technical properties may be different than those used by other companies.

2. Basis of Presentation and Summary of Significant Accounting Policies

Boston Properties, Inc. does not have any other significant assets, liabilities or operations, other than its investment in the Operating Partnership, nor does it have employees of its own. The Operating Partnership, not Boston Properties, Inc., generally executes all significant business relationships other than transactions involving securities of Boston Properties, Inc. All majority-owned subsidiaries and joint ventures over which the Company has financial and operating control and variable interest entities (“VIEs”) in which the Company has determined it is the primary beneficiary are included in the consolidated financial statements. All significant intercompany balances and transactions have been eliminated in consolidation. The Company accounts for all other unconsolidated joint ventures using the equity method of accounting. Accordingly, the Company’s share of the earnings of these joint ventures and companies is included in consolidated net income.

The accompanying interim financial statements are unaudited; however, the financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting solely of normal recurring matters) necessary for a fair statement of the financial statements for these interim periods have been included. The results of operations for the interim periods are not necessarily indicative of the results to be obtained for other interim periods or for the full fiscal year. The year-end consolidated balance sheet data was derived from audited financial statements, but does not include all disclosure required by accounting principles generally accepted in the United States of America. These financial statements should be read in conjunction with the Company’s financial statements and notes thereto contained in the Company’s Annual Report in the Company’s Form 10-K for its fiscal year ended December 31, 2014.

Fair Value of Financial Instruments

The Company follows the authoritative guidance for fair value measurements when valuing its financial instruments for disclosure purposes. The Company determines the fair value of its unsecured senior notes using market prices. The inputs used in determining the fair value of the Company’s unsecured senior notes are categorized at a level 1 basis (as defined in the accounting standards for Fair Value Measurements and Disclosures) due to the fact that the Company uses quoted market rates to value these instruments. However, the inputs used in determining the fair value could be categorized at a level 2 basis (as defined in the accounting standards for Fair Value Measurements and Disclosures) if trading volumes are low. The Company determines

 

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the fair value of its mortgage notes payable using discounted cash flow analyses by discounting the spread between the future contractual interest payments and hypothetical future interest payments on mortgage debt based on current market rates for similar securities. In determining the current market rates, the Company adds its estimates of market spreads to the quoted yields on federal government treasury securities with similar maturity dates to its debt. The inputs used in determining the fair value of the Company’s mortgage notes payable and mezzanine notes payable are categorized at a level 3 basis (as defined in the accounting standards for Fair Value Measurements and Disclosures) due to the fact that the Company considers the rates used in the valuation techniques to be unobservable inputs.

Because the Company’s valuations of its financial instruments are based on these types of estimates, the actual fair values of its financial instruments may differ materially if the Company’s estimates do not prove to be accurate. The following table presents the aggregate carrying value of the Company’s indebtedness and the Company’s corresponding estimate of fair value as of June 30, 2015 and December 31, 2014 (in thousands):

 

     June 30, 2015      December 31, 2014  
     Carrying
Amount
     Estimated
Fair Value
     Carrying
Amount
     Estimated
Fair Value
 

Mortgage notes payable

   $ 4,269,808       $ 4,401,756       $ 4,309,484       $ 4,449,541   

Mezzanine notes payable

     309,148         306,130         309,796         306,156   

Unsecured senior notes

     5,288,503         5,602,523         5,287,704         5,645,819   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 9,867,459       $ 10,310,409       $ 9,906,984       $ 10,401,516   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company uses interest rate swap agreements to manage its interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. To comply with the provisions of ASC 820, the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. However, as of June 30, 2015, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

Out-of-Period Adjustment

During the three months ended June 30, 2014, the Company recorded an additional allocation of net income to the noncontrolling interest holder in its Fountain Square consolidated joint venture totaling approximately $2.4 million related to the cumulative non-cash adjustment to the accretion of the changes in the redemption value of the noncontrolling interest. This resulted in the overstatement of Noncontrolling Interests in Property Partnerships by approximately $2.4 million during the three months ended June 30, 2014 and in the understatement of Noncontrolling Interests in Property Partnerships in the aggregate amount of approximately $2.4 million in previous periods. Because this adjustment was not material to the prior periods’ consolidated financial statements and the impact of recording the adjustment in the then-current period was not material to the Company’s consolidated financial statements, the Company recorded the related adjustment during the three months ended June 30, 2014.

Recent Accounting Pronouncements

On April 10, 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of

 

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an Entity” (“ASU 2014-08”). ASU 2014-08 clarifies that discontinued operations presentation applies only to disposals representing a strategic shift that has (or will have) a major effect on an entity’s operations and financial results (e.g., a disposal of a major geographical area, a major line of business, a major equity method investment or other major parts of an entity). ASU 2014-08 is effective prospectively for reporting periods beginning after December 15, 2014. Early adoption is permitted, and the Company early adopted ASU 2014-08 during the first quarter of 2014. The Company’s adoption of ASU 2014-08 resulted in the operating results and gain on sale of real estate from the operating property sold during the six months ended June 30, 2015 not being reflected as Discontinued Operations in the Company’s Consolidated Statements of Operations (See Note 3).

In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis” (“ASU 2015-02”). ASU 2015-02 affects reporting entities that are required to evaluate whether they should consolidate certain legal entities. ASU 2015-02 modifies the evaluation of whether limited partnerships and similar legal entities are VIEs or voting interest entities, eliminates the presumption that a general partner should consolidate a limited partnership and affects the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships. ASU 2015-02 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. A reporting entity may apply the amendments in ASU 2015-02 using: (a) a modified retrospective approach by recording a cumulative-effect adjustment to equity as of the beginning of the fiscal year of adoption; or (b) by applying the amendments retrospectively. The Company is currently assessing the potential impact that the adoption of ASU 2015-02 will have on its consolidated financial statements.

In April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs(“ASU 2015-03”), which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs is not affected. ASU 2015-03 is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years and shall be applied on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. Early adoption is permitted for financial statements that have not been previously issued. The Company does not expect the adoption of ASU 2015-03 to have a material impact on its consolidated financial statements.

3. Real Estate Activity During the Six Months Ended June 30, 2015

Dispositions

On February 19, 2015, the Company completed the sale of a parcel of land within its Washingtonian North property located in Gaithersburg, Maryland for a gross sale price of $8.7 million. Net cash proceeds totaled approximately $8.3 million, resulting in a gain on sale of real estate totaling approximately $3.7 million. The parcel contains approximately 8.5 acres of the Company’s approximately 27 acre property.

On March 17, 2015, the Company completed the sale of its Residences on The Avenue property located in Washington, DC for a gross sale price of $196.0 million. Net cash proceeds totaled approximately $192.5 million, resulting in a gain on sale of real estate totaling approximately $91.4 million. The Company has agreed to provide net operating income support of up to $6.0 million should the property’s net operating income fail to achieve certain thresholds. This amount has been recorded as a reduction to the gain on sale. The Residences on The Avenue is comprised of 335 apartment units and approximately 50,000 net rentable square feet of retail space, subject to a ground lease that expires on February 1, 2068. The Residences on The Avenue contributed approximately $1.1 million of net income to the Company for the period from January 1, 2015 through March 16, 2015 and $0.9 million and $1.7 million for the three and six months ended June 30, 2014, respectively.

Redevelopment

On May 1, 2015, the Company commenced the redevelopment of Reservoir Place North, a Class A office project with approximately 73,000 net rentable square feet located in Waltham, Massachusetts.

 

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4. Investments in Unconsolidated Joint Ventures

The investments in unconsolidated joint ventures consist of the following at June 30, 2015:

 

               Carrying Value of
Investment(1)
 

Entity

  

Properties

  Nominal %
Ownership
    June 30,
2015
    December 31,
2014
 
               (in thousands)  

Square 407 Limited Partnership

   Market Square North     50.0   $ (10,161   $ (8,022

The Metropolitan Square Associates LLC

   Metropolitan Square     51.0     9,188        8,539   

BP/CRF 901 New York Avenue LLC

   901 New York Avenue     25.0 %(2)      (12,411     (1,080

WP Project Developer LLC

   Wisconsin Place Land and Infrastructure     33.3 %(3)      44,597        45,514   

Annapolis Junction NFM, LLC

   Annapolis Junction     50.0 %(4)      26,812        25,246   

540 Madison Venture LLC

   540 Madison Avenue     60.0     68,627        68,128   

500 North Capitol LLC

   500 North Capitol Street, NW     30.0     (2,755     (2,250

501 K Street LLC

   1001 6th Street     50.0 %(5)      42,704        41,736   

Podium Developer LLC

   North Station (Phase I—Air Rights)     50.0     6,609        4,231   

1265 Main Office JV LLC

   1265 Main Street     50.0     2,209        N/A   

BNY Tower Holdings LLC

   Dock72 at the Brooklyn Navy Yard     50.0     9,228        N/A   
      

 

 

   

 

 

 
       $ 184,647      $ 182,042   
      

 

 

   

 

 

 

 

(1) Investments with deficit balances aggregating approximately $25.3 million and $11.4 million at June 30, 2015 and December 31, 2014, respectively, have been reflected within Other Liabilities on the Company’s Consolidated Balance Sheets.
(2) The Company’s economic ownership has increased based on the achievement of certain return thresholds.
(3) The Company’s wholly-owned entity that owns the office component of the project also owns a 33.3% interest in the entity owning the land, parking garage and infrastructure of the project.
(4) The joint venture owns two in-service buildings, two buildings under construction and two undeveloped land parcels.
(5) Under the joint venture agreement, the partner will be entitled to up to two additional payments from the venture based on increases in total square footage of the project above 520,000 square feet and achieving certain project returns at stabilization.

Certain of the Company’s unconsolidated joint venture agreements include provisions whereby, at certain specified times, each partner has the right to initiate a purchase or sale of its interest in the joint ventures at an agreed upon fair value. Under these provisions, the Company is not compelled to purchase the interest of its outside joint venture partners.

The combined summarized balance sheets of the Company’s unconsolidated joint ventures are as follows:

 

     June 30,
2015
    December 31,
2014
 
     (in thousands)  
ASSETS     

Real estate and development in process, net

   $ 1,038,567      $ 1,034,552   

Other assets

     243,773        264,097   
  

 

 

   

 

 

 

Total assets

   $ 1,282,340      $ 1,298,649   
  

 

 

   

 

 

 
LIABILITIES AND MEMBERS’/PARTNERS’ EQUITY     

Mortgage and notes payable

   $ 832,860      $ 830,075   

Other liabilities

     35,483        34,211   

Members’/Partners’ equity

     413,997        434,363   
  

 

 

   

 

 

 

Total liabilities and members’/partners’ equity

   $ 1,282,340      $ 1,298,649   
  

 

 

   

 

 

 

Company’s share of equity

   $ 212,065      $ 209,828   

Basis differentials(1)

     (27,418     (27,786
  

 

 

   

 

 

 

Carrying value of the Company’s investments in unconsolidated joint ventures(2)

   $ 184,647      $ 182,042   
  

 

 

   

 

 

 

 

(1)

This amount represents the aggregate difference between the Company’s historical cost basis and the basis reflected at the joint venture level, which is typically amortized over the life of the related assets and

 

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  liabilities. Basis differentials occur from impairment of investments and upon the transfer of assets that were previously owned by the Company into a joint venture. In addition, certain acquisition, transaction and other costs may not be reflected in the net assets at the joint venture level.
(2) Investments with deficit balances aggregating approximately $25.3 million and $11.4 million at June 30, 2015 and December 31, 2014, respectively, have been reflected within Other Liabilities on the Company’s Consolidated Balance Sheets.

The combined summarized statements of operations of the Company’s unconsolidated joint ventures are as follows:

 

     For the three months
ended June 30,
     For the six months
ended June 30,
 
     2015      2014      2015     2014  
     (in thousands)  

Total revenue(1)

   $ 39,152       $ 38,437       $ 78,684      $ 76,471   

Expenses

          

Operating

     15,824         15,461         32,099        30,925   

Depreciation and amortization

     8,951         9,167         18,022        18,259   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total expenses

     24,775         24,628         50,121        49,184   
  

 

 

    

 

 

    

 

 

   

 

 

 

Operating income

     14,377         13,809         28,563        27,287   

Other expense

          

Interest expense

     7,986         7,984         15,966        15,996   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income

   $ 6,391       $ 5,825       $ 12,597      $ 11,291   
  

 

 

    

 

 

    

 

 

   

 

 

 

Company’s share of net income

   $ 2,902       $ 2,578       $ 17,544 (2)    $ 5,203   

Basis differential

     176         256         368        447   
  

 

 

    

 

 

    

 

 

   

 

 

 

Income from unconsolidated joint ventures

   $ 3,078       $ 2,834       $ 17,912      $ 5,650   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) Includes straight-line rent adjustments of approximately $0.3 million and $0.3 million for the three months ended June 30, 2015 and 2014, respectively, and approximately $2.0 million and $0.9 million for the six months ended June 30, 2015 and 2014. Includes net above-/below-market rent adjustments of approximately $(0.1) million and $(0.1) million for the three months ended June 30, 2015 and 2014, respectively, and approximately $(0.1) million and $0.0 million for the six months ended June 30, 2015 and 2014, respectively.
(2) During the six months ended June 30, 2015, the Company received a distribution of approximately $24.5 million, which was generated from the excess loan proceeds from the refinancing of 901 New York Avenue’s mortgage loan to a new 10-year mortgage loan totaling $225.0 million. The Company’s allocation of income and distributions for the six months ended June 30, 2015 was not proportionate to its nominal ownership interest as a result of the achievement of specified investment return thresholds, as provided for in the joint venture agreement.

On May 8, 2015, the Company entered into a joint venture with an unrelated third party to redevelop an existing building into a Class A office building totaling approximately 115,000 net rentable square feet at 1265 Main Street in Waltham, Massachusetts. The joint venture partner contributed real estate and improvements, with an aggregate fair value of approximately $9.4 million, for its initial 50% interest in the joint venture. For its initial 50% interest, the Company will contribute cash totaling approximately $9.4 million as the joint venture incurs costs. The joint venture has entered into a fifteen-year lease with a tenant to occupy 100% of the building.

On June 26, 2015, the Company entered into a joint venture with an unrelated third party to develop Dock72, an office building totaling approximately 670,000 net rentable square feet located at the Brooklyn Navy Yard in Brooklyn, New York. Each partner contributed cash totaling approximately $9.1 million for their initial 50% interest in the joint venture. The joint venture entered into a 96-year ground lease, comprised of an initial

 

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term of 46 years, which may be extended by the joint venture to 2111, subject to certain conditions. The joint venture also entered into a 20-year lease with a tenant to occupy approximately 222,000 net rentable square feet at the building. In addition, the joint venture entered into an option agreement pursuant to which it may lease an additional land parcel at the site, which could support between 600,000 and 1,000,000 net rentable square feet of development. In connection with the execution of the option agreement, the joint venture paid a non-refundable option payment of $1.0 million.

5. Derivative Instruments and Hedging Activities

On February 19, 2015, the Company commenced a planned interest rate hedging program. The Company entered into eight forward-starting interest rate swap contracts during the six months ended June 30, 2015, which fix the 10-year swap rate at a weighted-average rate of approximately 2.458% per annum on notional amounts aggregating $325.0 million. These interest rate swap contracts were entered into in advance of a financing with a target commencement date in September 2016 and maturity in September 2026 (See Note 12). In addition, 767 Fifth Partners LLC, which is the consolidated entity (in which the Company has a 60% interest and owns 767 Fifth Avenue (the General Motors Building) in New York City), entered into five forward-starting interest rate swap contracts during the six months ended June 30, 2015, which fix the 10-year swap rate at a weighted-average rate of approximately 2.793% per annum on notional amounts aggregating $150.0 million. These interest rate swap contracts were entered into in advance of a financing with a target commencement date in June 2017 and maturity in June 2027 (See Note 12). The Company’s interest rate swap contracts consisted of the following at June 30, 2015:

 

Derivative Instrument

  Notional
Amount
    Effective Date   Maturity Date   Strike
Rate
    Balance Sheet
Location
  Fair Value  
    (in thousands)                       (in thousands)  
Boston Properties Limited Partnership:            

Interest Rate Swap

  $ 50,000      September 1, 2016   September 1, 2026     2.571   Prepaid Expenses

and Other Assets

  $ 1,003   

Interest Rate Swap

    75,000      September 1, 2016   September 1, 2026     2.476   Prepaid Expenses
and Other Assets
    2,172   

Interest Rate Swap

    50,000      September 1, 2016   September 1, 2026     2.523   Prepaid Expenses
and Other Assets
    1,215   

Interest Rate Swap

    50,000      September 1, 2016   September 1, 2026     2.480   Prepaid Expenses
and Other Assets
    1,402   

Interest Rate Swap

    25,000      September 1, 2016   September 1, 2026     2.348   Prepaid Expenses
and Other Assets
    1,008   

Interest Rate Swap

    25,000      September 1, 2016   September 1, 2026     2.249   Prepaid Expenses
and Other Assets
    1,208   

Interest Rate Swap

    25,000      September 1, 2016   September 1, 2026     2.242   Prepaid Expenses
and Other Assets
    1,242   

Interest Rate Swap

    25,000      September 1, 2016   September 1, 2026     2.541   Prepaid Expenses
and Other Assets
    567   
 

 

 

       

 

 

     

 

 

 
  $ 325,000            2.458     $ 9,817   

767 Fifth Partners LLC:

  

         

Interest Rate Swap

  $ 25,000      June 7, 2017   June 7, 2027     2.683   Prepaid Expenses
and Other Assets
  $ 618   

Interest Rate Swap

    50,000      June 7, 2017   June 7, 2027     2.677   Prepaid Expenses
and Other Assets
    1,261   

Interest Rate Swap

    25,000      June 7, 2017   June 7, 2027     2.913   Prepaid Expenses
and Other Assets
    123   

Interest Rate Swap

    25,000      June 7, 2017   June 7, 2027     2.857   Prepaid Expenses
and Other Assets
    244   

Interest Rate Swap

    25,000      June 7, 2017   June 7, 2027     2.950   Prepaid Expenses
and Other Assets
    43   
 

 

 

       

 

 

     

 

 

 
  $ 150,000            2.793     $ 2,289   
 

 

 

           

 

 

 
  $ 475,000              $ 12,106   
 

 

 

           

 

 

 

 

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The Company entered into the interest rate swap contracts designated and qualifying as cash flow hedges to reduce its exposure to the variability in future cash flows attributable to changes in the 10-year swap rate in contemplation of obtaining 10-year fixed-rate financing in September 2016. The Company’s 767 Fifth Partners LLC consolidated entity entered into the interest rate swap contracts designated and qualifying as cash flow hedges to reduce its exposure to the variability in future cash flows attributable to changes in the 10-year swap rate in contemplation of obtaining 10-year fixed-rate financing in June 2017. The Company has formally documented all of its relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. The Company also assesses and documents, both at the hedging instrument’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows associated with the hedged items. All components of the forward-starting interest rate swap contracts were included in the assessment of hedge effectiveness. The Company has agreements with each of its derivative counterparties that contain a provision where the Company could be declared in default on its derivative obligations if repayment of the Company’s indebtedness is accelerated by the lender due to the Company’s default on the indebtedness. As of June 30, 2015, the fair value of derivatives in a net asset position, which excludes any adjustment for nonperformance risk and excludes accrued interest, related to these agreements was approximately $12.1 million. As of June 30, 2015, the Company has not posted any collateral related to these agreements. If the Company had breached any of these provisions at June 30, 2015, it could have been required to settle its obligations under the agreements at their termination value and would have received approximately $12.1 million. The Company accounts for the effective portion of changes in the fair value of a derivative in accumulated other comprehensive income (loss) and subsequently reclassifies the effective portion to earnings over the term that the hedged transaction affects earnings. The Company accounts for the ineffective portion of changes in the fair value of a derivative directly in earnings. During the six months ended June 30, 2015, the Company has recorded the changes in fair value of the swap contracts related to the effective portion of the interest rate contracts aggregating approximately $12.1 million in Prepaid Expenses and Other Assets and Accumulated Other Comprehensive Income (Loss) within the Company’s Consolidated Balance Sheets. During the six months ended June 30, 2015, the Company did not record any hedge ineffectiveness. The Company does not expect to reclassify into earnings any amounts recorded within Accumulated Other Comprehensive Income (Loss) relating to the forward-starting interest rate swap contracts within the next twelve months.

The following table presents the location in the financial statements of the gains or losses recognized related to the Company’s cash flow hedges for the three and six months ended June 30, 2015 and 2014:

 

     Three months
ended June 30,
    Six months ended
June 30,
 
     2015     2014     2015     2014  
    

(in thousands)

 

Amount of gain related to the effective portion recognized in other comprehensive income (loss)

   $ 15,639      $ —        $ 12,106      $ —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Amount of loss related to the effective portion subsequently reclassified to earnings(1)

   $ (628   $ (624   $ (1,255   $ (1,253
  

 

 

   

 

 

   

 

 

   

 

 

 

Amount of gain (loss) related to the ineffective portion and amount excluded from effectiveness testing

   $ —        $ —        $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Consists of amounts from previous interest rate hedging programs.

 

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The following table reflects the changes in accumulated other comprehensive income (loss) for the six months ended June 30, 2015 and 2014 (in thousands):

 

Balance at December 31, 2014

   $ (9,304

Effective portion of interest rate contracts

     12,106   

Amortization of interest rate contracts(1)

     1,255   

Other comprehensive income attributable to noncontrolling interests

     (2,209
  

 

 

 

Balance at June 30, 2015

   $ 1,848   
  

 

 

 

Balance at December 31, 2013

   $ (11,556

Amortization of interest rate contracts(1)

     1,253   

Other comprehensive income attributable to noncontrolling interests

     (126
  

 

 

 

Balance at June 30, 2014

   $ (10,429
  

 

 

 

 

(1) Consists of amounts from previous interest rate hedging programs.

6. Commitments and Contingencies

General

In the normal course of business, the Company guarantees its performance of services or indemnifies third parties against its negligence. In addition, in the normal course of business, the Company guarantees to certain tenants the obligations of its subsidiaries for the payment of tenant improvement allowances and brokerage commissions in connection with their leases and limited costs arising from delays in delivery of their premises.

The Company has letter of credit and performance obligations related to lender and development requirements that total approximately $23.5 million.

Certain of the Company’s joint venture agreements include provisions whereby, at certain specified times, each partner has the right to initiate a purchase or sale of its interest in the joint ventures. With limited exception, under these provisions, the Company is not compelled to purchase the interest of its outside joint venture partners (See also Note 7). Under certain of the Company’s joint venture agreements, if certain return thresholds are achieved the partners will be entitled to an additional promoted interest or payments.

In connection with the assumption of 767 Fifth Avenue’s (the General Motors Building) secured loan by the Company’s consolidated entity, 767 Venture, LLC, the Company guaranteed the consolidated joint venture’s obligation to fund various escrows, including tenant improvements, taxes and insurance in lieu of cash deposits. As of June 30, 2015, the maximum funding obligation under the guarantee was approximately $29.5 million. The Company earns a fee from the joint venture for providing the guarantee and has an agreement with the outside partners to reimburse the joint venture for their share of any payments made under the guarantee.

In connection with 767 Fifth Partners LLC entering into interest rate swap contracts (See Note 5), the Company guaranteed 767 Fifth Partners LLC’s obligations under the hedging agreements in favor of each hedge counterparty. 767 Fifth Partners LLC is the entity that owns 767 Fifth Avenue (the General Motors Building). It is a subsidiary of 767 Venture, LLC, a consolidated entity in which the Company has a 60% interest. The Company earns a fee from the joint venture for providing the guarantee and has an agreement with the outside partners to reimburse the joint venture for their share of any payments made under the guarantee.

In connection with the mortgage financing collateralized by the Company’s 200 Clarendon Street (formerly the John Hancock Tower) property located in Boston, Massachusetts, the Company has agreed to guarantee approximately $25.3 million related to its obligations to provide funds for certain tenant re-leasing costs. The mortgage financing will mature on January 6, 2017.

 

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In connection with the mortgage financing collateralized by the Company’s consolidated joint venture’s Fountain Square property located in Reston, Virginia, the Company has agreed to guarantee approximately $0.7 million related to its obligation to provide funds for certain tenant re-leasing costs. The mortgage financing will mature on October 11, 2016.

From time to time, the Company (or the applicable joint venture) has also agreed to guarantee portions of the principal, interest or other amounts in connection with other unconsolidated joint venture borrowings. In addition to the financial guarantees referenced above, the Company has agreed to customary environmental indemnifications and nonrecourse carve-outs (e.g., guarantees against fraud, misrepresentation and bankruptcy) on certain of its unconsolidated joint venture loans.

In 2009, the Company filed a general unsecured creditor’s claim against Lehman Brothers, Inc. for approximately $45.3 million related to its rejection of a lease at 399 Park Avenue in New York City. On January 10, 2014, the trustee for the liquidation of the business of Lehman Brothers allowed the Company’s claim in the amount of approximately $45.2 million. During 2014, the Company received an initial distribution totaling approximately $7.7 million. On March 11, 2015, the Company received a second interim distribution totaling approximately $4.5 million, which is included in Base Rent in the accompanying Consolidated Statements of Operations for the six months ended June 30, 2015, leaving a remaining claim of approximately $33.0 million. The Company will continue to evaluate whether to attempt to sell the remaining claim or wait until the trustee distributes proceeds from the Lehman Brothers estate. Given the inherent uncertainties in bankruptcy proceedings, there can be no assurance as to the timing or amount of proceeds, if any, that the Company may ultimately realize on the remaining claim, whether by sale to a third party or by one or more distributions from the trustee. Accordingly, the Company has not recorded any estimated recoveries associated with this gain contingency within its consolidated financial statements at June 30, 2015.

Insurance

The Company carries insurance coverage on its properties of types and in amounts and with deductibles that it believes are in line with coverage customarily obtained by owners of similar properties. In response to the uncertainty in the insurance market following the terrorist attacks of September 11, 2001, the Federal Terrorism Risk Insurance Act (as amended, “TRIA”) was enacted in November 2002 to require regulated insurers to make available coverage for “certified” acts of terrorism (as defined by the statute). The expiration date of TRIA was extended to December 31, 2014 by the Terrorism Risk Insurance Program Reauthorization Act of 2007 and further extended to December 31, 2020 by the Terrorism Risk Insurance Program Reauthorization Act of 2015 (“TRIPRA”), and the Company can provide no assurance that it will be extended further. Currently, the Company’s property insurance program per occurrence limits are $1.0 billion for its portfolio insurance program, including coverage for acts of terrorism other than nuclear, biological, chemical or radiological terrorism (“Terrorism Coverage”). The Company also carries $250 million of Terrorism Coverage for 601 Lexington Avenue, New York, New York (“601 Lexington Avenue”) in excess of the $1.0 billion of coverage in the Company’s property insurance program. Certain properties, including the General Motors Building located at 767 Fifth Avenue in New York, New York (“767 Fifth Avenue”), are currently insured in separate insurance programs. The property insurance program per occurrence limits for 767 Fifth Avenue are $1.625 billion, including Terrorism Coverage. The Company also currently carries nuclear, biological, chemical and radiological terrorism insurance coverage for acts of terrorism certified under TRIA (“NBCR Coverage”), which is provided by IXP as a direct insurer, for the properties in our portfolio, including 767 Fifth Avenue, but excluding certain other properties owned in joint ventures with third parties or which the Company manages. The per occurrence limit for NBCR Coverage is $1.0 billion. Under TRIA, after the payment of the required deductible and coinsurance, the NBCR Coverage provided by IXP is backstopped by the Federal Government if the aggregate industry insured losses resulting from a certified act of terrorism exceed a “program trigger.” In 2015, the program trigger is $100 million and the coinsurance is 15%, however, both will increase in subsequent years pursuant to TRIPRA. If the Federal Government pays out for a loss under TRIA, it is mandatory that the Federal Government recoup the full amount of the loss from insurers offering TRIA coverage after the payment of the loss pursuant to a formula in TRIPRA. The Company may elect to terminate the NBCR Coverage if the Federal

 

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Government seeks recoupment for losses paid under TRIA, if there is a change in its portfolio or for any other reason. The Company intends to continue to monitor the scope, nature and cost of available terrorism insurance and maintain terrorism insurance in amounts and on terms that are commercially reasonable.

The Company also currently carries earthquake insurance on its properties located in areas known to be subject to earthquakes in an amount and subject to self-insurance that the Company believes is commercially reasonable. In addition, this insurance is subject to a deductible in the amount of 5% of the value of the affected property. Specifically, the Company currently carries earthquake insurance which covers its San Francisco region (excluding Salesforce Tower) with a $170 million per occurrence limit (increased on March 1, 2015 from $120 million), and a $170 million annual aggregate limit (increased on March 1, 2015 from $120 million), $20 million of which is provided by IXP, as a direct insurer. The builders risk policy maintained for the development of Salesforce Tower in San Francisco includes a $60 million per occurrence and annual aggregate limit of earthquake coverage. The amount of the Company’s earthquake insurance coverage may not be sufficient to cover losses from earthquakes. In addition, the amount of earthquake coverage could impact the Company’s ability to finance properties subject to earthquake risk. The Company may discontinue earthquake insurance or change the structure of its earthquake insurance program on some or all of its properties in the future if the premiums exceed the Company’s estimation of the value of the coverage.

IXP, a captive insurance company which is a wholly-owned subsidiary of the Company, acts as a direct insurer with respect to a portion of the Company’s earthquake insurance coverage for its Greater San Francisco properties and the Company’s NBCR Coverage. Insofar as the Company owns IXP, it is responsible for its liquidity and capital resources, and the accounts of IXP are part of the Company’s consolidated financial statements. In particular, if a loss occurs which is covered by the Company’s NBCR Coverage but is less than the applicable program trigger under TRIA, IXP would be responsible for the full amount of the loss without any backstop by the Federal Government. IXP would also be responsible for any recoupment charges by the Federal Government in the event losses are paid out and its insurance policy is maintained after the payout by the Federal Government. If the Company experiences a loss and IXP is required to pay under its insurance policy, the Company would ultimately record the loss to the extent of the required payment. Therefore, insurance coverage provided by IXP should not be considered as the equivalent of third-party insurance, but rather as a modified form of self-insurance. In addition, the Operating Partnership has issued a guarantee to cover liabilities of IXP in the amount of $20.0 million.

The mortgages on the Company’s properties typically contain requirements concerning the financial ratings of the insurers who provide policies covering the property. The Company provides the lenders on a regular basis with the identity of the insurance companies in the Company’s insurance programs. The ratings of some of the Company’s insurers are below the rating requirements in some of the Company’s loan agreements and the lenders for these loans could attempt to claim that an event of default has occurred under the loan. The Company believes it could obtain insurance with insurers which satisfy the rating requirements. Additionally, in the future, the Company’s ability to obtain debt financing secured by individual properties, or the terms of such financing, may be adversely affected if lenders generally insist on ratings for insurers or amounts of insurance which are difficult to obtain or which result in a commercially unreasonable premium. There can be no assurance that a deficiency in the financial ratings of one or more of the Company’s insurers will not have a material adverse effect on the Company.

The Company continues to monitor the state of the insurance market in general, and the scope and costs of coverage for acts of terrorism and California earthquake risk in particular, but the Company cannot anticipate what coverage will be available on commercially reasonable terms in future policy years. There are other types of losses, such as from wars, for which the Company cannot obtain insurance at all or at a reasonable cost. With respect to such losses and losses from acts of terrorism, earthquakes or other catastrophic events, if the Company experiences a loss that is uninsured or that exceeds policy limits, the Company could lose the capital invested in the damaged properties, as well as the anticipated future revenues from those properties. Depending on the specific circumstances of each affected property, it is possible that the Company could be liable for mortgage indebtedness or other obligations related to the property. Any such loss could materially and adversely affect the Company’s business and financial condition and results of operations.

 

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7. Noncontrolling Interests

Noncontrolling interests relate to the interests in the Operating Partnership not owned by the Company and interests in consolidated property partnerships not wholly-owned by the Company. As of June 30, 2015, the noncontrolling interests in the Operating Partnership consisted of 16,192,518 OP Units, 1,839,555 LTIP Units (including 216,960 2012 OPP Units), 309,818 2013 MYLTIP Units, 476,320 2014 MYLTIP Units and 368,415 2015 MYLTIP Units held by parties other than the Company.

Noncontrolling Interest—Redeemable Preferred Units of the Operating Partnership

On June 25, 2015, the Company’s Operating Partnership redeemed the remaining 12,667 Series Four Preferred Units for cash totaling approximately $0.6 million, plus accrued and unpaid distributions. The Series Four Preferred Units bore a preferred distribution equal to 2.00% per annum on a liquidation preference of $50.00 per unit and were not convertible into OP Units. The holders of Series Four Preferred Units had the right, at certain times and subject to certain conditions set forth in the Certificate of Designations establishing the rights, limitations and preferences of the Series Four Preferred Units, to require the Operating Partnership to redeem all of their units for cash at the redemption price of $50.00 per unit. The Operating Partnership also had the right, at certain times and subject to certain conditions, to redeem all of the Series Four Preferred Units for cash at the redemption price of $50.00 per unit. In order to secure the performance of certain post-issuance obligations by the holders, all of such outstanding Series Four Preferred Units were subject to forfeiture pursuant to the terms of a pledge agreement and not eligible for redemption until and unless such security interest was released. On May 19, 2014, the Company’s Operating Partnership released to the holders 319,687 Series Four Preferred Units that were previously subject to the security interest. On July 3, 2014, the Company’s Operating Partnership redeemed such units for cash totaling approximately $16.0 million, plus accrued and unpaid distributions. On October 16, 2014, the Company’s Operating Partnership released to the holders 27,773 Series Four Preferred Units that were previously subject to the security interest under the pledge agreement. On November 5, 2014, the Company’s Operating Partnership redeemed such units for cash totaling approximately $1.4 million. Due to the holders’ redemption option existing outside the control of the Company, the Series Four Preferred Units were presented outside of permanent equity in the Company’s Consolidated Balance Sheets.

On February 17, 2015, the Operating Partnership paid a distribution on its outstanding Series Four Preferred Units of $0.25 per unit. On May 15, 2015, the Operating Partnership paid a distribution on its outstanding Series Four Preferred Units of $0.25 per unit.

The following table reflects the activity of the noncontrolling interests—redeemable preferred units of the Operating Partnership for the six months ended June 30, 2015 and 2014 (in thousands):

 

Balance at December 31, 2014

   $ 633   

Net income

     6   

Distributions

     (6

Redemption of redeemable preferred units (Series Four Preferred Units)

     (633
  

 

 

 

Balance at June 30, 2015

   $ —     
  

 

 

 

Balance at December 31, 2013

   $ 51,312   

Net income

     939   

Distributions

     (939

Conversion of redeemable preferred units (Series Two Preferred Units) to common units

     (33,306
  

 

 

 

Balance at June 30, 2014

   $ 18,006   
  

 

 

 

Noncontrolling Interest—Redeemable Interest in Property Partnership

On October 4, 2012, the Company completed the formation of a joint venture that owns and operates Fountain Square located in Reston, Virginia. The joint venture partner contributed the property valued at

 

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approximately $385.0 million and related mortgage indebtedness totaling approximately $211.3 million for a nominal 50% interest in the joint venture. The Company contributed cash totaling approximately $87.0 million for its nominal 50% interest, which cash was distributed to the joint venture partner. Pursuant to the joint venture agreement (i) the Company has rights to acquire the partner’s nominal 50% interest and (ii) the partner has the right to cause the Company to acquire the partner’s interest on January 4, 2016, in each case at a fixed price totaling approximately $102.0 million in cash. The fixed price option rights expire on January 31, 2016 (See Note 12). The Company is consolidating this joint venture due to the Company’s right to acquire the partner’s nominal 50% interest. The Company recorded the noncontrolling interest at its acquisition-date fair value as temporary equity, due to the redemption option existing outside the control of the Company. The Company accretes the changes in the redemption value quarterly over the period from the acquisition date to the earliest redemption date using the effective interest method. The Company records the accretion after the allocation of net income and distributions of cash flow to the noncontrolling interest account balance.

The following table reflects the activity of the noncontrolling interest—redeemable interest in property partnership in the Company’s Fountain Square consolidated entity for the six months ended June 30, 2015 and 2014 (in thousands):

 

Balance at December 31, 2014

   $ 104,692   

Net loss

     (24

Distributions

     (2,900

Adjustment to reflect redeemable interest at redemption value

     4,465   
  

 

 

 

Balance at June 30, 2015

   $ 106,233   
  

 

 

 

Balance at December 31, 2013

   $ 99,609   

Net loss

     (240

Distributions

     (2,300

Adjustment to reflect redeemable interest at redemption value

     6,709 (1) 
  

 

 

 

Balance at June 30, 2014

   $ 103,778   
  

 

 

 

 

(1) Includes an out-of-period adjustment totaling approximately $2.4 million (See Note 2).

Noncontrolling Interest—Common Units of the Operating Partnership

During the six months ended June 30, 2015, 321,700 OP Units were presented by the holders for redemption (including 57,701 OP Units issued upon conversion of LTIP Units) and were redeemed by the Company in exchange for an equal number of shares of Common Stock.

At June 30, 2015, the Company had outstanding 309,818 2013 MYLTIP Units, 476,320 2014 MYLTIP Units and 368,415 2015 MYLTIP Units. Prior to the measurement date (February 4, 2016 for 2013 MYLTIP Units, February 3, 2017 for 2014 MYLTIP Units and February 4, 2018 for 2015 MYLTIP Units), holders of MYLTIP Units will be entitled to receive per unit distributions equal to one-tenth (10%) of the regular quarterly distributions payable on an OP Unit, but will not be entitled to receive any special distributions. After the measurement date, the number of MYLTIP Units, both vested and unvested, that MYLTIP award recipients have earned, if any, based on the establishment of a performance pool, will be entitled to receive distributions in an amount per unit equal to distributions, both regular and special, payable on an OP Unit.

On February 6, 2015, the measurement period for the Company’s 2012 OPP Unit awards ended and the Company’s TRS performance was sufficient for employees to earn and therefore become eligible to vest in a portion of the 2012 OPP Unit awards. The final outperformance pool was determined to be approximately $32.1 million, or approximately 80% of the total maximum outperformance pool of $40.0 million. As a result, 174,549 2012 OPP Units were automatically forfeited.

 

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On January 28, 2015, the Operating Partnership paid a special cash distribution on the OP Units and LTIP Units in the amount of $4.50 per unit, a regular quarterly cash distribution on the OP Units and LTIP Units in the amount of $0.65 per unit, and a regular quarterly distribution on the 2012 OPP Units, 2013 MYLTIP Units and 2014 MYLTIP Units in the amount of $0.065 per unit, to holders of record as of the close of business on December 31, 2014. The special cash distribution was in addition to the regular quarterly distribution on the OP Units and LTIP Units. Unless and until they are earned, holders of OPP Units and MYLTIP Units are not entitled to receive any special distributions. On April 30, 2015, the Operating Partnership paid a distribution on the OP Units and LTIP Units in the amount of $0.65 per unit, a distribution on the 2012 OPP Units in the amount of $0.416 per unit (representing a blended rate for periods prior to and after February 6, 2015, which was the valuation date for the 2012 Outperformance Plan), and a distribution on the 2013 MYLTIP Units, 2014 MYLTIP Units and 2015 MYLTIP Units in the amount of $0.065 per unit, to holders of record as of the close of business on March 31, 2015. On June 17, 2015, Boston Properties, Inc., as general partner of the Operating Partnership, declared a distribution on the OP Units and LTIP Units (including the 2012 OPP Units) in the amount of $0.65 per unit and a distribution on the 2013 MYLTIP Units, 2014 MYLTIP Units and 2015 MYLTIP Units in the amount of $0.065 per unit, in each case payable on July 31, 2015 to holders of record as of the close of business on June 30, 2015.

A holder of an OP Unit may present such OP Unit to the Operating Partnership for redemption at any time (subject to restrictions agreed upon at the time of issuance of OP Units to particular holders that may restrict such redemption right for a period of time, generally one year from issuance). Upon presentation of an OP Unit for redemption, the Operating Partnership must redeem such OP Unit for cash equal to the then value of a share of common stock of the Company. The Company may, in its sole discretion, elect to assume and satisfy the redemption obligation by paying either cash or issuing one share of Common Stock. The value of the OP Units not owned by the Company and LTIP Units (including the 2012 OPP Units) assuming that all conditions had been met for the conversion thereof had all of such units been redeemed at June 30, 2015 was approximately $2.2 billion based on the closing price of the Company’s common stock of $121.04 per share on June 30, 2015. The Company’s calculation of Noncontrolling Interest—Common Units of the Operating Partnership in the Company’s Consolidated Statements of Operations includes OP Units and vested LTIP Units (including vested 2012 OPP Units).

Noncontrolling Interests—Property Partnerships

The noncontrolling interests in property partnerships consist of the outside equity interests in ventures that are consolidated with the financial results of the Company because the Company exercises control over the entities that own the properties. The equity interests in these ventures that are not owned by the Company, totaling approximately $1.6 billion at June 30, 2015 and December 31, 2014, are included in Noncontrolling Interests—Property Partnerships on the accompanying Consolidated Balance Sheets.

The following table reflects the activity of the noncontrolling interests in property partnerships for the six months ended June 30, 2015 and 2014 (in thousands):

 

Balance at December 31, 2014

   $ 1,602,467   

Capital contributions

     1,089   

Net income

     20,031   

Accumulated other comprehensive income

     916   

Distributions

     (34,022
  

 

 

 

Balance at June 30, 2015

   $ 1,590,481   
  

 

 

 

Balance at December 31, 2013

   $ 726,132   

Capital contributions

     1,675   

Net income

     5,438   

Distributions

     (12,149
  

 

 

 

Balance at June 30, 2014

   $ 721,096   
  

 

 

 

 

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8. Stockholders’ Equity

As of June 30, 2015, the Company had 153,473,931 shares of Common Stock outstanding.

On June 3, 2014, the Company established an “at the market” (“ATM”) stock offering program through which it may sell from time to time up to an aggregate of $600.0 million of its common stock through sales agents over a three-year period. The Company intends to use the net proceeds from any offering for general business purposes, which may include investment opportunities and debt reduction. No shares of common stock have been issued under this ATM stock offering program since its inception.

During the six months ended June 30, 2015, the Company issued 321,700 shares of Common Stock in connection with the redemption of an equal number of redeemable OP Units from third parties.

During the six months ended June 30, 2015, the Company issued 11,447 shares of Common Stock upon the exercise of options to purchase Common Stock by certain employees.

On January 28, 2015, the Company paid a special cash dividend and regular quarterly dividend aggregating $5.15 per share of Common Stock to shareholders of record as of the close of business on December 31, 2014. On April 30, 2015, the Company paid a dividend of $0.65 per share of Common Stock to shareholders of record as of the close of business on March 31, 2015. On June 17, 2015, the Company’s Board of Directors declared a dividend of $0.65 per share of Common Stock payable on July 31, 2015 to shareholders of record as of the close of business on June 30, 2015.

As of June 30, 2015, the Company had 80,000 shares (8,000,000 depositary shares each representing 1/100th of a share) outstanding of its 5.25% Series B Cumulative Redeemable Preferred Stock with a liquidation preference of $2,500.00 per share ($25.00 per depositary share). The Company pays cumulative cash dividends on the Series B Preferred Stock at a rate of 5.25% per annum of the $2,500.00 liquidation preference per share. The Company may not redeem the Series B Preferred Stock prior to March 27, 2018, except in certain circumstances relating to the preservation of the Company’s REIT status. On or after March 27, 2018, the Company, at its option, may redeem the Series B Preferred Stock for a cash redemption price of $2,500.00 per share ($25.00 per depositary share), plus all accrued and unpaid dividends. The Series B Preferred Stock is not redeemable by the holders, has no maturity date and is not convertible into any other security of the Company or its affiliates.

On February 17, 2015, the Company paid a dividend on its outstanding Series B Preferred Stock of $32.8125 per share. On May 15, 2015, the Company paid a dividend on its outstanding Series B Preferred Stock of $32.8125 per share. On June 17, 2015, the Company’s Board of Directors declared a dividend of $32.8125 per share of Series B Preferred Stock payable on August 17, 2015 to shareholders of record as of the close of business on August 5, 2015.

 

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9. Earnings Per Share

The following table provides a reconciliation of both the net income attributable to Boston Properties, Inc. common shareholders and the number of common shares used in the computation of basic earnings per share (“EPS”), which is calculated by dividing net income attributable to Boston Properties, Inc. common shareholders by the weighted-average number of common shares outstanding during the period. Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are also participating securities. As such, unvested restricted common stock of the Company, LTIP Units, 2012 OPP Units and MYLTIP Units are considered participating securities. Participating securities are included in the computation of basic EPS of the Company using the two-class method. Participating securities are included in the computation of diluted EPS of the Company using the if-converted method if the impact is dilutive. Because the 2012 OPP Units required and the MYLTIP Units require the Company to outperform absolute and relative return thresholds, unless such thresholds have been met by the end of the applicable reporting period, the Company excludes such units from the diluted EPS calculation. Other potentially dilutive common shares, including stock options, restricted stock and other securities of the Operating Partnership that are exchangeable for the Company’s Common Stock, and the related impact on earnings, are considered when calculating diluted EPS.

 

     For the three months ended June 30, 2015  
     Income
(Numerator)
     Shares
(Denominator)
     Per Share
Amount
 
     (in thousands, except for per share amounts)  

Basic Earnings:

     

Net income attributable to Boston Properties, Inc. common shareholders

   $ 79,460         153,450       $ 0.52   

Effect of Dilutive Securities:

     

Stock Based Compensation

     —           365         —     
  

 

 

    

 

 

    

 

 

 

Diluted Earnings:

     

Net income attributable to Boston Properties, Inc. common shareholders

   $ 79,460         153,815       $ 0.52   
  

 

 

    

 

 

    

 

 

 

 

     For the three months ended June 30, 2014  
     Income
(Numerator)
     Shares
(Denominator)
     Per Share
Amount
 
     (in thousands, except for per share amounts)  

Basic Earnings:

     

Net income attributable to Boston Properties, Inc. common shareholders

   $ 76,527         153,078       $ 0.50   

Effect of Dilutive Securities:

     

Stock Based Compensation

     —           160         —     
  

 

 

    

 

 

    

 

 

 

Diluted Earnings:

     

Net income attributable to Boston Properties, Inc. common shareholders

   $ 76,527         153,238       $ 0.50   
  

 

 

    

 

 

    

 

 

 

 

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     For the six months ended June 30, 2015  
     Income
(Numerator)
    Shares
(Denominator)
     Per Share
Amount
 
     (in thousands, except for per share amounts)  

Basic Earnings:

    

Net income attributable to Boston Properties, Inc. common shareholders

   $ 250,694        153,341       $ 1.63   

Allocation of undistributed earnings to participating securities

     (141     —           —     
  

 

 

   

 

 

    

 

 

 

Net income attributable to Boston Properties, Inc. common shareholders

   $ 250,553        153,341       $ 1.63   

Effect of Dilutive Securities:

    

Stock Based Compensation

     —          504         —     
  

 

 

   

 

 

    

 

 

 

Diluted Earnings:

    

Net income attributable to Boston Properties, Inc. common shareholders

   $ 250,553        153,845       $ 1.63   
  

 

 

   

 

 

    

 

 

 

 

     For the six months ended June 30, 2014  
     Income
(Numerator)
     Shares
(Denominator)
     Per Share
Amount
 
     (in thousands, except for per share amounts)  

Basic Earnings:

     

Net income attributable to Boston Properties, Inc. common shareholders

   $ 130,594         153,054       $ 0.85   

Effect of Dilutive Securities:

     

Stock Based Compensation

     —           149         —     
  

 

 

    

 

 

    

 

 

 

Diluted Earnings:

     

Net income attributable to Boston Properties, Inc. common shareholders

   $ 130,594         153,203       $ 0.85   
  

 

 

    

 

 

    

 

 

 

10. Stock Option and Incentive Plan

On January 21, 2015, the Company’s Compensation Committee approved the 2015 Multi-Year, Long-Term Incentive Program awards under the Company’s 2012 Plan to certain officers and employees of the Company. The 2015 MYLTIP awards utilize TRS over a three-year measurement period, on an annualized, compounded basis, as the performance metric. Earned awards will be based on the Company’s TRS relative to (i) the Cohen & Steers Realty Majors Portfolio Index (50% weight) and (ii) the NAREIT Office Index adjusted to exclude the Company (50% weight). Earned awards will range from $0 to a maximum of approximately $40.8 million depending on the Company’s TRS relative to the two indices, with three tiers (threshold: approximately $8.2 million; target: approximately $16.3 million; high: approximately $40.8 million) and linear interpolation between tiers. Earned awards measured on the basis of relative TRS performance are subject to an absolute TRS component in the form of relatively simple modifiers that (A) reduce the level of earned awards in the event the Company’s annualized TRS is less than 0% and (B) cause some awards to be earned in the event the Company’s annualized TRS is more than 12% even though on a relative basis alone the Company’s TRS would not result in any earned awards.

Earned awards (if any) will vest 50% on February 4, 2018 and 50% on February 4, 2019, based on continued employment. Vesting will be accelerated in the event of a change in control, termination of employment by the Company without cause, or termination of employment by the award recipient for good reason, death, disability or retirement. If there is a change of control prior to February 4, 2018, earned awards will be calculated based on TRS performance up to the date of the change of control. The 2015 MYLTIP awards are in the form of LTIP Units issued on the grant date which (i) are subject to forfeiture to the extent awards are not earned and (ii) prior to the performance measurement date are only entitled to one-tenth (10%) of the regular quarterly distributions payable on common partnership units.

 

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Under the FASB’s Accounting Standards Codification (“ASC”) 718 “Compensation-Stock Compensation,” the 2015 MYLTIP awards have an aggregate value of approximately $15.7 million, which amount will generally be amortized into earnings over the four-year plan period under the graded vesting method.

On February 6, 2015, the measurement period for the Company’s 2012 OPP Unit awards ended and the Company’s TRS performance was sufficient for employees to earn and therefore become eligible to vest in a portion of the 2012 OPP Unit awards. The final outperformance pool was determined to be approximately $32.1 million, or approximately 80% of the total maximum outperformance pool of $40.0 million. As a result, 174,549 2012 OPP Units were automatically forfeited.

During the six months ended June 30, 2015, the Company issued 34,150 shares of restricted common stock, 190,563 LTIP Units (including 85,962 LTIP Units issued on January 1, 2015 to Mortimer B. Zuckerman, non-executive Chairman of the Board, pursuant to the Transition Benefits Agreement dated March 10, 2013) and 375,000 2015 MYLTIP Units to employees and non-employee directors under the 2012 Plan. Employees and non-employee directors paid $0.01 per share of restricted common stock and $0.25 per LTIP Unit and 2015 MYLTIP Unit. An LTIP Unit is generally the economic equivalent of a share of restricted stock in the Company. The aggregate value of the LTIP Units is included in noncontrolling interests in the Consolidated Balance Sheets. Grants of restricted stock and LTIP Units to employees vest in four equal annual installments. Restricted stock is measured at fair value on the date of grant based on the number of shares granted, as adjusted for forfeitures, and the closing price of the Company’s Common Stock on the date of grant as quoted on the New York Stock Exchange. Such value is recognized as an expense ratably over the corresponding employee service period. The shares of restricted stock granted during the six months ended June 30, 2015 were valued at approximately $4.8 million ($140.88 per share weighted-average). The LTIP Units granted (excluding the number issued to Mr. Zuckerman, as discussed above) were valued at approximately $13.5 million ($128.94 per unit weighted-average fair value) using a Monte Carlo simulation method model. The per unit fair values of the LTIP Units granted were estimated on the dates of grant and for a substantial majority of such units were valued using the following assumptions: an expected life of 5.7 years, a risk-free interest rate of 1.47% and an expected price volatility of 26%. The value of the LTIP Units issued to Mr. Zuckerman was expensed between March 2013 and July 2014 in accordance with the vesting schedule set forth in the Transition Benefits Agreement. As the 2012 OPP Units, 2013 MYLTIP Units, 2014 MYLTIP Units and 2015 MYLTIP Units are subject to both a service condition and a market condition, the Company recognizes the compensation expense related to the 2012 OPP Units, 2013 MYLTIP Units, 2014 MYLTIP Units and 2015 MYLTIP Units under the graded vesting attribution method. Under the graded vesting attribution method, each portion of the award that vests at a different date is accounted for as a separate award and recognized over the period appropriate to that portion so that the compensation cost for each portion should be recognized in full by the time that portion vests. Dividends paid on both vested and unvested shares of restricted stock are charged directly to Dividends in Excess of Earnings in the Consolidated Balance Sheets. Aggregate stock-based compensation expense associated with restricted stock, non-qualified stock options, LTIP Units, 2012 OPP Units, 2013 MYLTIP Units, 2014 MYLTIP Units and 2015 MYLTIP Units was approximately $5.1 million and $6.2 million for the three months ended June 30, 2015 and 2014, respectively, and approximately $15.2 million and $16.0 million for the six months ended June 30, 2015 and 2014, respectively. At June 30, 2015, there was $23.3 million of unrecognized compensation expense related to unvested restricted stock and LTIP Units and $24.1 million of unrecognized compensation expense related to unvested 2012 OPP Units, 2013 MYLTIP Units, 2014 MYLTIP Units and 2015 MYLTIP Units that is expected to be recognized over a weighted-average period of approximately 2.7 years.

11. Segment Information

The Company’s segments are based on the Company’s method of internal reporting which classifies its operations by both geographic area and property type. The Company’s segments by geographic area are Boston, New York, San Francisco and Washington, DC. Segments by property type include: Class A Office, Office/Technical, Residential and Hotel.

 

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Asset information by segment is not reported because the Company does not use this measure to assess performance. Therefore, depreciation and amortization expense is not allocated among segments. Interest and other income, development and management services income, general and administrative expenses, transaction costs, interest expense, depreciation and amortization expense, gains (losses) from investments in securities, income from unconsolidated joint ventures, gains on sales of real estate, noncontrolling interests and preferred dividends are not included in Net Operating Income as internal reporting addresses these items on a corporate level.

Net Operating Income is not a measure of operating results or cash flows from operating activities as measured by accounting principles generally accepted in the United States of America, and it is not indicative of cash available to fund cash needs and should not be considered an alternative to cash flows as a measure of liquidity. All companies may not calculate Net Operating Income in the same manner. The Company considers Net Operating Income to be an appropriate supplemental measure to net income because it helps both investors and management to understand the core operations of the Company’s properties. The Company’s management also uses Net Operating Income to evaluate regional property level performance and to make decisions about resource allocations. Further, the Company believes Net Operating Income is useful to investors as a performance measure because, when compared across periods, Net Operating Income reflects the impact on operations from trends in occupancy rates, rental rates, operating costs and acquisition and development activity on an unleveraged basis, providing perspectives not immediately apparent from net income attributable to Boston Properties, Inc. common shareholders.

Information by geographic area and property type (dollars in thousands):

For the three months ended June 30, 2015:

 

     Boston     New York     San
Francisco
    Washington,
DC
    Total  

Rental Revenue:

          

Class A Office

   $ 174,894      $ 246,432      $ 68,781      $   91,489      $   581,596   

Office/Technical

     6,042        —          5,554        2,953        14,549   

Residential

     1,131        —          —          2,680        3,811   

Hotel

     13,403        —          —          —          13,403   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     195,470        246,432        74,335        97,122        613,359   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Grand Totals

     31.87     40.18     12.12     15.83     100.00

Rental Expenses:

          

Class A Office

     67,874        85,661        23,416        32,180        209,131   

Office/Technical

     1,779        —          999        1,024        3,802   

Residential

     511        —          —          1,020        1,531   

Hotel

     8,495        —          —          —          8,495   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     78,659        85,661        24,415        34,224        222,959   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Grand Totals

     35.28     38.42     10.95     15.35     100.00
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net operating income

   $ 116,811      $ 160,771      $ 49,920      $ 62,898      $ 390,400   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Grand Totals

     29.92     41.18     12.79     16.11     100.00

 

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Table of Contents

For the three months ended June 30, 2014:

 

     Boston     New York     San
Francisco
    Washington,
DC
    Total  

Rental Revenue:

          

Class A Office

   $ 173,128      $ 223,899      $   57,450      $ 94,222      $ 548,699   

Office/Technical

     5,912        —          6,341        3,671        15,924   

Residential

     1,089        —          —          5,209        6,298   

Hotel

     12,367        —          —          —          12,367   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     192,496        223,899        63,791        103,102        583,288   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Grand Totals

     33.00     38.39     10.94     17.67     100.00

Rental Expenses:

          

Class A Office

     65,818        74,962        21,282        32,481        194,543   

Office/Technical

     1,736        —          1,308        1,123        4,167   

Residential

     544        —          —          3,392        3,936   

Hotel

     7,315        —          —          —          7,315   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     75,413        74,962        22,590        36,996        209,961   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Grand Totals

     35.92     35.70     10.76     17.62     100.00
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net operating income

   $ 117,083      $ 148,937      $ 41,201      $ 66,106      $   373,327   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Grand Totals

     31.36     39.89     11.04     17.71     100.00

For the six months ended June 30, 2015:

 

     Boston     New York     San
Francisco
    Washington,
DC
    Total  

Rental Revenue:

          

Class A Office

   $ 344,801      $ 499,530      $ 135,033      $ 184,620      $ 1,163,984   

Office/Technical

     12,162        —          11,213        5,995        29,370   

Residential

     2,309        —          —          8,356        10,665   

Hotel

     22,488        —          —          —          22,488   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     381,760        499,530        146,246        198,971        1,226,507   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Grand Totals

     31.13     40.73     11.92     16.22     100.00

Rental Expenses:

          

Class A Office

     142,339        170,722        45,325        64,460        422,846   

Office/Technical

     3,765        —          1,911        2,215        7,891   

Residential

     1,020        —          —          4,057        5,077   

Hotel

     16,071        —          —          —          16,071   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     163,195        170,722        47,236        70,732        451,885   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Grand Totals

     36.12     37.78     10.45     15.65     100.00
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net operating income

   $ 218,565      $ 328,808      $ 99,010      $ 128,239      $ 774,622   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Grand Totals

     28.22     42.45     12.78     16.55     100.00

 

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Table of Contents

For the six months ended June 30, 2014:

 

     Boston     New York     San
Francisco
    Washington,
DC
    Total  

Rental Revenue:

          

Class A Office

   $ 344,070      $ 441,207      $ 112,058      $ 191,270      $ 1,088,605   

Office/Technical

     11,732        —          12,558        7,331        31,621   

Residential

     2,252        —          —          9,728        11,980   

Hotel

     20,560        —          —          —          20,560   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     378,614        441,207        124,616        208,329        1,152,766   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Grand Totals

     32.84     38.28     10.81     18.07     100.00

Rental Expenses:

          

Class A Office

     137,216        149,333        40,595        65,920        393,064   

Office/Technical

     3,425        —          2,522        2,325        8,272   

Residential

     992        —          —          6,706        7,698   

Hotel

     14,112        —          —          —          14,112   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     155,745        149,333        43,117        74,951        423,146   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Grand Totals

     36.81     35.29     10.19     17.71     100.00
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net operating income

   $ 222,869      $ 291,874      $ 81,499      $ 133,378      $ 729,620   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Grand Totals

     30.55     40.00     11.17     18.28     100.00

The following is a reconciliation of Net Operating Income to net income attributable to Boston Properties, Inc. common shareholders:

 

     Three months ended
June 30,
     Six months ended
June 30,
 
     2015     2014      2015      2014  
     (in thousands)  

Net Operating Income

   $ 390,400      $ 373,327       $ 774,622       $ 729,620   

Add:

          

Development and management services income

     4,862        6,506         10,190         11,722   

Income from unconsolidated joint ventures

     3,078        2,834         17,912         5,650   

Interest and other income

     1,293        2,109         2,700         3,420   

Gains (losses) from investments in securities

     (24     662         369         948   

Gains on sales of real estate

     —          —           95,084         —     

Less:

          

General and administrative expense

     22,284        23,271         51,075         53,176   

Transaction costs

     208        661         535         1,098   

Depreciation and amortization expense

     167,844        154,628         322,067         308,898   

Interest expense

     108,534        110,977         217,291         224,531   

Noncontrolling interests in property partnerships

     9,264        7,553         24,472         11,907   

Noncontrolling interest—redeemable preferred units of the Operating Partnership

     3        320         6         939   

Noncontrolling interest—common units of the Operating Partnership

     9,394        8,883         29,530         15,010   

Preferred dividends

     2,618        2,618         5,207         5,207   
  

 

 

   

 

 

    

 

 

    

 

 

 

Net income attributable to Boston Properties, Inc. common shareholders

   $ 79,460      $ 76,527       $ 250,694       $ 130,594   
  

 

 

   

 

 

    

 

 

    

 

 

 

 

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12. Subsequent Events

From July 1, 2015 through August 7, 2015, 767 Fifth Partners LLC, which is the consolidated entity (in which the Company has a 60% interest and owns 767 Fifth Avenue (the General Motors Building) in New York City), entered into four forward-starting interest rate swap contracts which fix the 10-year swap rate at a weighted-average rate of 2.813% per annum on notional amounts aggregating $100.0 million. The interest rate swap contracts were entered into in advance of a financing with a target commencement date in June 2017 and maturity in June 2027 (See Note 5). In addition, the Company entered into one forward-starting interest rate swap contract which fixes the 10-year swap rate at a rate of 2.532% per annum on a notional amount of $25.0 million. The interest rate swap contract was entered into in advance of a financing with a target commencement date in September 2016 and maturity in September 2026 (See Note 5).

On July 29, 2015, a consolidated entity in which the Company has a 50% interest executed a binding agreement for the sale of 505 9th Street, N.W. located in Washington, DC, for approximately $318.0 million (which exceeds its carrying value), including the assumption by the buyer of approximately $117.0 million of mortgage indebtedness. 505 9th Street, N.W. is an approximately 322,000 net rentable square foot Class A office building. The sale is subject to the satisfaction of customary closing conditions and there can be no assurance that the sale will be consummated on the terms currently contemplated or at all.

On July 31, 2015, the Company entered into a 99-year ground and air rights lease (the “Lease”) with the Massachusetts Department of Transportation (“MDOT”) with respect to the parking garage located at 100 Clarendon Street (the “Clarendon Garage”) and the concourse level of the Massachusetts Bay Transportation Authority’s Back Bay Station (the “Station”). The Lease amends and restates the air rights lease which the Company had assumed in 2010 at the time it acquired its interests in both the Clarendon Garage and the office tower located at 200 Clarendon Street (formerly the John Hancock Tower). The previous lease had 45 years remaining in its term. Upon execution of the Lease, the Company made a $5.0 million option payment which provides the Company with options under the Lease to acquire certain air rights above both the Clarendon Garage and the Station; the amount of developable square footage associated with the air rights will be determined at a later date. In consideration for MDOT entering into the new Lease, the Company has agreed to make improvements to the Station in an amount of $32.0 million, which amount will be credited against the Company’s rental obligations under the Lease.

On August 6, 2015, the Company executed an amendment to the joint venture agreement for its Fountain Square property located in Reston, Virginia. The amendment requires the Company to acquire its partner’s nominal 50% interest on September 15, 2015 for approximately $100.9 million in cash (See Note 7).

 

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ITEM 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations

As used herein, the terms “we,” “us,” “our” and the “Company” refer to Boston Properties, Inc., a Delaware corporation organized in 1997, individually or together with its subsidiaries, including Boston Properties Limited Partnership, a Delaware limited partnership, and our predecessors.

This Quarterly Report on Form 10-Q, including the documents incorporated by reference, contains forward-looking statements within the meaning of the federal securities laws, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We intend these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and are including this statement for purposes of complying with those safe harbor provisions. Such statements are contained principally, but not only, under the captions “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We caution investors that any such forward-looking statements are based on beliefs and on assumptions made by, and information currently available to, our management. When used, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “project,” “result,” “should,” “will” and similar expressions which do not relate solely to historical matters are intended to identify forward-looking statements. Such statements are subject to risks, uncertainties and assumptions and are not guarantees of future performance, which may be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected by the forward-looking statements. We caution you that, while forward-looking statements reflect our good-faith beliefs when we make them, they are not guarantees of future performance and are impacted by actual events when they occur after we make such statements. Accordingly, investors should use caution in relying on forward-looking statements, which are based on results and trends at the time they are made, to anticipate future results or trends.

Some of the risks and uncertainties that may cause our actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include, among others, the following:

 

   

If there is a negative change in the economy including but not limited to a reversal of current job growth trends and an increase in unemployment, it could have a negative effect on the following, among other things:

 

   

the fundamentals of our business, including overall market occupancy, tenant space utilization, and rental rates;

 

   

the financial condition of our tenants, many of which are financial, legal, media/telecommunication, technology and other professional firms, our lenders, counterparties to our derivative financial instruments and institutions that hold our cash balances and short-term investments, which may expose us to increased risks of default by these parties; and

 

   

the value of our real estate assets, which may limit our ability to dispose of assets at attractive prices or obtain or maintain debt financing secured by our properties or on an unsecured basis;

 

   

general risks affecting the real estate industry (including, without limitation, the inability to enter into or renew leases, tenant space utilization, dependence on tenants’ financial condition, and competition from other developers, owners and operators of real estate);

 

   

failure to manage effectively our growth and expansion into new markets and sub-markets or to integrate acquisitions and developments successfully;

 

   

the ability of our joint venture partners to satisfy their obligations;

 

   

risks and uncertainties affecting property development and construction (including, without limitation, construction delays, increased construction costs, cost overruns, inability to obtain necessary permits, tenant accounting considerations that may result in negotiated lease provisions that limit a tenant’s liability during construction, and public opposition to such activities);

 

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risks associated with the availability and terms of financing and the use of debt to fund acquisitions and developments or refinance existing indebtedness, including the impact of higher interest rates on the cost and/or availability of financing;

 

   

risks associated with forward interest rate contracts and the effectiveness of such arrangements;

 

   

risks associated with downturns in the national and local economies, increases in interest rates, and volatility in the securities markets;

 

   

risks associated with actual or threatened terrorist attacks;

 

   

costs of compliance with the Americans with Disabilities Act and other similar laws;

 

   

potential liability for uninsured losses and environmental contamination;

 

   

risks associated with security breaches through cyber attacks, cyber intrusions or otherwise, as well as other significant disruptions of our information technology (IT) networks and related systems, which support our operations and our buildings;

 

   

risks associated with our potential failure to qualify as a REIT under the Internal Revenue Code of 1986, as amended;

 

   

possible adverse changes in tax and environmental laws;

 

   

the impact of newly adopted accounting principles on our accounting policies and on period-to-period comparisons of financial results;

 

   

risks associated with possible state and local tax audits;

 

   

risks associated with our dependence on key personnel whose continued service is not guaranteed; and

 

   

the other risk factors identified in our most recently filed Annual Report on Form 10-K, including those described under the caption “Risk Factors.”

The risks set forth above are not exhaustive. Other sections of this report may include additional factors that could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all risk factors, nor can it assess the impact of all risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. Investors should also refer to our most recent Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q for future periods and Current Reports on Form 8-K as we file them with the SEC, and to other materials we may furnish to the public from time to time through Forms 8-K or otherwise, for a discussion of risks and uncertainties that may cause actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements. We expressly disclaim any responsibility to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events, or otherwise, and you should not rely upon these forward-looking statements after the date of this report.

Overview

We are a fully integrated self-administered and self-managed REIT and one of the largest owners and developers of Class A office properties in the United States. Our properties are concentrated in four markets-Boston, New York, San Francisco and Washington, DC. We generate revenue and cash primarily by leasing Class A office space to our tenants. Factors we consider when we lease space include the creditworthiness of the tenant, the length of the lease, the rental rate to be paid at inception and throughout the lease term, the costs of tenant improvements and other landlord concessions, current and anticipated operating costs and real estate taxes, our current and anticipated vacancy, current and anticipated future demand for office space and general economic factors. From time to time, we also generate cash through the sale of assets.

 

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Our core strategy has always been to own, operate and develop properties in supply-constrained markets with high barriers-to-entry and to focus on executing long-term leases with financially strong tenants. Historically, this combination has tended to reduce our exposure in down cycles and enhance revenues as market conditions improve. To be successful in any leasing environment, we believe all aspects of the tenant-landlord relationship must be considered. In this regard, we believe that our understanding of tenants’ short- and long-term space utilization and amenity needs in the local markets in which we operate, our relationships with local brokers, our reputation as a premier developer, owner and operator of Class A office properties, our financial strength and our ability to maintain high building standards provide us with a competitive advantage.

Our overall leasing activity in the second quarter was in line with our ten-year average of leasing approximately 1.0 million square feet per quarter, and our occupancy improved from 90.3% at the end of the first quarter to 91.1% at June 30, 2015. We expect our occupancy to be relatively stable for the remainder of 2015. In addition, we saw roll-up in rents on second generation leases in Boston, San Francisco, New York City and Reston, Virginia.

New York continues to be a healthy market with solid leasing activity. However, we have limited current vacancy and limited rollover exposure through the end of 2015. Most of our current negotiations relate to future availability with the exception of 250 West 55th Street, where we completed eight new leases in the second quarter to bring the building to 89% leased. At 601 Lexington Avenue, we have approximately 140,000 square feet expiring in 2016 and are contemplating a repositioning of the retail and the low rise office space at that property. This vacancy and repositioning will result in a diminution of 2016 occupancy and revenue, but we believe it will significantly enhance the value of the asset over the long term. At 767 Fifth Avenue (the General Motors Building), we accelerated the lease expiration of a retail tenant that occupied approximately 60,000 square feet in order to allow an existing tenant to use the space on a temporary basis as it reconfigures its existing operations. This will reduce the revenue from this space in 2015 and 2016, but we believe it will position this building for even stronger performance over the long term.

In our Washington, DC region, the overall leasing activity continues to be slow, though we were able to complete approximately 191,000 square feet of leasing in the second quarter. For the first time in a number of quarters, there was positive absorption in the Washington, DC Central Business District (“CBD”). However, the Washington, DC CBD continues to be very competitive because there has not been any significant increase in demand and there is uncertainty with regard to the large amount of GSA-related expirations between 2015 and 2017. Public sector and defense contractor demand continues to be adversely impacted by continued federal budgetary uncertainty, corresponding risk of reductions in discretionary spending programs and mandated GSA occupancy densification. We have one near-term expiration at our 1330 Connecticut Avenue building for which we are actively involved in lease extension negotiations. Our development at 601 Massachusetts Avenue is scheduled to be delivered in September 2015 and is 83% leased. Our joint venture assets, including Market Square North, 901 New York Avenue and Metropolitan Square, face approximately 200,000 square feet of lease expirations in late 2015. Reston Town Center continues to be the best performing submarket in our Washington, DC region with vacancy of approximately 3% and rents significantly greater than other submarkets in Northern Virginia. We continue to see expansion with our existing tenants and strong tenant demand due to the combination of walkable retail, high-quality new multifamily, community programming and improving access to the Metro.

In the Boston region, the expansion of the life sciences and technology industry continues to positively impact each of the submarkets in which we operate. The lack of available supply in Cambridge is a challenge given the continued organic growth of the companies looking to grow within their existing market. While there are companies migrating to the Back Bay, Financial District, Seaport and suburban markets, Kendall Center (formerly Cambridge Center) continues to dramatically outperform the rest of the Boston submarkets. Our Cambridge portfolio is essentially 100% leased and we have no short-term availability or near-term expirations. However, there are a number of large expansion requirements in the market, including some from our own tenants. We are working on increasing our developable square footage at Kendall Center (formerly Cambridge Center) which we are hopeful will provide us the ability to develop an additional 600,000 square feet of office

 

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and 400,000 square feet of residential space. In the Back Bay, our repositioning and rebranding at 120 St. James Street, where we have approximately 170,000 square feet of availability, is underway and activity is positive. We also have approximately 150,000 square feet expiring at the top of 200 Clarendon Street (formerly the John Hancock Tower) which will not be in market ready condition until the end of 2015, with rent commencement likely not occurring on both of these spaces until the end of 2016 or 2017. Based on current market rates, when fully leased, we expect the incremental contribution from the available space at 120 St. James Street and 200 Clarendon Street (formerly the John Hancock Tower) to be approximately $25 million. Our development at 888 Boylston Street continues on schedule and we have signed another full floor lease bringing the total office space leased to 71%. We also have significant interest in the 65,000 square feet of retail space and are negotiating our first major lease. At 100 Federal Street, a property in which we have a 55% interest, we are in active discussions with two existing tenants to restack their existing space in order to accommodate a major lease with a new tenant. These transactions involve more than 1.0 million square feet and would bring the building to 100% leased. However, we do not expect revenue recognition to occur in the currently available space until late 2016 or 2017. We believe these transactions will enhance the value of the assets even though they will have a negative impact on our short-term financial performance. Our Waltham submarket also continues to get stronger, driven by the expansion of life science and technology tenants, much of this from organic growth. We are currently in negotiations for all of the remaining space at our 10 CityPoint project that will deliver in mid 2016 at rents that are 25% higher than they were 18 months ago.

Leasing activity in the San Francisco CBD and Silicon Valley submarkets remains healthy and, given the regulations surrounding zoning in San Francisco, will likely continue to face available supply limitations. Other than new developments, there are extremely limited large blocks of space available in the city. At Embarcadero Center, where we are currently approximately 95% leased, we completed approximately 112,000 square feet of office leasing during the quarter. The largest deal was for approximately 75,000 square feet with substantial markup in the rental rate which will have a positive impact throughout the remainder of 2015. We are also actively engaged with additional full floor tenants with 2016 and 2017 expirations. In total, we have over 1.0 million square feet of lease expirations at Embarcadero Center, through the end of 2017, where we believe the current market rents are well in excess of the expiring rents. In Mountain View, the lack of available supply has led to an increase in market rents, and at 3100-3130 Zanker Road we have a number of active full building prospects as well as the potential to expand the project by up to 500,000 square feet. At Gateway, we expect our largest tenant to vacate between 185,000 and 285,000 square feet in early 2016. We believe the upgrade to the Caltrain station and its proximity to our Gateway properties will enhance our leasing prospects. At 535 Mission Street, we have completed additional leasing bringing us to 81% leased and we continue to have strong activity. Lastly, there is a continuous flow of users that have expressed interest at Salesforce Tower, our approximately 1.4 million square foot Class A office tower currently under construction with an estimated initial occupancy in the second quarter of 2017.

 

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The table below details the leasing activity during the three and six months ended June 30, 2015:

 

     Three Months Ended
June 30, 2015
    Six Months Ended
June 30, 2015
 
     Square Feet  
    

Vacant space available at the beginning of the period

     4,011,639        3,442,468   

Property dispositions/properties taken out of service

     (73,258     (73,258

Properties placed in-service

     25,945        58,220   

Leases expiring or terminated during the period

     1,256,792        3,218,234   
  

 

 

   

 

 

 

Total space available for lease

     5,221,118        6,645,664   
  

 

 

   

 

 

 

1st generation leases

     159,367        294,521   

2nd generation leases with new tenants

     1,043,237        1,479,642   

2nd generation lease renewals

     343,902        1,196,889   
  

 

 

   

 

 

 

Total space leased

     1,546,506        2,971,052   
  

 

 

   

 

 

 

Vacant space available for lease at the end of the period

     3,674,612        3,674,612   
  

 

 

   

 

 

 

Second generation leasing information:(1)

    

Leases commencing during the period, in square feet

     1,387,139        2,676,531   

Average Lease Term

     87 Months        96 Months   

Average Free Rent Period

     40 Days        41 Days   

Total Transaction Costs Per Square Foot(2)

   $ 39.18      $ 40.90   

Increase in Gross Rents(3)

     14.56     5.21

Increase in Net Rents(4)

     22.30     7.21

 

(1) Second generation leases are defined as leases for space that had previously been leased. Of the 1,387,139 and 2,676,531 square feet of second generation leases that commenced during the three and six months ended June 30, 2015, respectively, leases for 1,223,146 and 2,085,576 square feet were signed in prior periods for the three and six months ended June 30, 2015, respectively.
(2) Total transaction costs include tenant improvements and leasing commissions and exclude free rent concessions and other inducements in accordance with GAAP.
(3) Represents the increase in gross rent (base rent plus expense reimbursements) on the new vs. expired leases on the 896,470 and 2,015,641 square feet of second generation leases (1) that had been occupied within the prior 12 months and (2) for which the new lease term is greater than six months for the three and six months ended June 30, 2015, respectively.
(4) Represents the increase in net rent (gross rent less operating expenses) on the new vs. expired leases on the 896,470 and 2,015,641 square feet of second generation leases (1) that had been occupied within the prior 12 months and (2) for which the new lease term is greater than six months for the three and six months ended June 30, 2015, respectively.

Investor enthusiasm for real estate assets remains robust as positive rent growth, a significant yield gap and the potential for an appreciating U.S. dollar attracts both domestic and foreign investors to high-quality office assets in our core markets. We continue to actively underwrite acquisitions, but acquiring high-quality assets at acceptable returns is challenging in the current environment. We intend to remain disciplined in our underwriting and may seek to acquire existing buildings in ventures with private capital sources and enhance our returns through fees earned for providing our real estate management expertise.

The same factors that create challenges to acquiring assets present opportunities for us to continue to review our portfolio to identify properties that may have limited opportunities for cash flow growth, no longer fit within our portfolio strategy or can attract premium pricing in the current market environment as potential sales candidates. We expect to continue to recycle capital from the sales of our properties into new development or redevelopment projects with higher returns. For example, in July 2015, we announced that we had executed an agreement to sell 505 9th Street, an approximately 322,000 square foot Class A office building in Washington,

 

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DC in which we have a 50% interest, for approximately $318 million. We are also considering additional asset sales, targeting total sales volume for 2015 of approximately $750 million. Due to the uncertainties inherent in marketing assets for sale, there can be no assurance as to the amount or timing of future asset sales activity. In general, we structure asset sales for possible inclusion in like-kind exchanges within the meaning of Section 1031 of the Internal Revenue Code. The ability to complete a like-kind exchange depends on many factors, including, among others, identifying and acquiring suitable replacement property within limited time periods and the ownership structure of the properties being sold and acquired, and therefore we are not always able to sell an asset as part of a like-kind exchange. When successful, a like-kind exchange enables us to defer the taxable gain on the asset sold and thus limit our REIT distribution requirement and preserve capital. If we are unable to identify and acquire suitable replacement property in a like-kind exchange, then we expect to distribute at least the amount of proceeds necessary to avoid paying a corporate level tax on the gain realized from the sale (See “Liquidity and Capital Resources—REIT Tax Distribution Considerations—Application of Recent Regulations”).

During the second quarter, we commenced three new development projects. The most significant is Dock72, in which we have a 50% interest, an approximately 670,000 square foot, 16-story building located in the Brooklyn Navy Yard. We have pre-leased approximately 33% of the building to a tenant for 20 years and we expect to deliver the building in the first half of 2018. We believe this investment could lead to additional development opportunities in Brooklyn, a new sub-market which presents opportunities for us to expand our presence in New York and build long-term relationships with growth companies. In addition, we recently formed a joint venture to develop 1265 Main Street in Waltham, Massachusetts, another project in which we have a 50% interest. 1265 Main Street will be a three-story, approximately 115,000 square foot building that is 100% pre-leased. Importantly, this investment in Waltham provides us an opportunity to develop up to an additional 1.0 million square feet of commercial space on a site adjacent to our CityPoint portfolio. The last of the three projects is a redevelopment of Reservoir Place North, our approximately 73,000 square foot building in Waltham, Massachusetts. Although the incremental cost to us is only approximately $25 million, we again expect to generate returns that exceed the returns we could expect by acquiring an existing office building.

With these new projects, as of June 30, 2015, our current development pipeline consists of 14 projects totaling approximately 4.2 million square feet. Our share of the total projected investment is approximately $2.4 billion, of which approximately $1.3 billion remains to be funded. Additionally, we are working on several new developments in each of our markets, including land parcels, options on sites or existing asset redevelopment opportunities, some of which could commence later in 2015. These include the first phase of North Station consisting of 360,000 square feet of retail and loft office space in Boston, a 160,000 square foot residential development located in Kendall Center (formerly Cambridge Center) in Cambridge, a 600,000 square foot residential and retail development located in Reston Town Center, three different potential office build-to-suit opportunities in our Washington, DC region representing over 1.3 million square feet and significant improvement projects at 601 Lexington Avenue in New York City and 100 Federal Street in Boston, which will enhance and add high-value retail amenities to the buildings. The actual amount and timing of new development activities will depend on the completion of the entitlement and planning processes and in many cases some level of pre-leasing.

Consistent with our core strategy and philosophy, we make decisions with a long-term view to maximizing the value of individual assets and the portfolio. As discussed above, we have made decisions to reposition certain assets and facilitate lease transitions and building “restackings” to accommodate tenants, which will negatively impact our Same Property Portfolio Net Operating Income in 2016. We expect the downtime associated with a tenant vacating approximately 140,000 square feet at 601 Lexington Avenue, the rent differential and downtime from the retail tenant vacating 767 Fifth Avenue (the General Motors Building) for a temporary user during part of 2016 and the lease transition at 100 Federal Street in Boston, combined with the loss of approximately 200,000 square feet of occupancy in our Washington, DC joint venture properties and the leases expiring at our Gateway properties in South San Francisco, to reduce our 2016 net operating income by approximately $35 million. This reflects specific tenant activity at a small subset of our properties that will impact our 2016 Same Property Portfolio Net Operating Income performance but is not an indication of the projected performance of

 

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the portfolio as a whole. We believe certain events may offset this reduction, including growth from the completion of the lease up of 250 West 55th Street in New York City and 535 Mission Street in San Francisco, as well as the delivery of approximately $850 million of new developments through the end of 2016. We do not, however, expect to realize the full impact of these deliveries in 2016 because several of the projects will not deliver until late in 2016 and they will be in lease up. We project this pipeline of near-term deliveries to stabilize by the end of 2017, and based on projected market rental rates, estimate that they will generate approximately $70 million of net operating income at stabilization. In addition, we expect our organic growth to accelerate in late 2016 and into 2017 with the lease up of our vacant space at 200 Clarendon Street (formerly the John Hancock Tower) and 100 Federal Street in Boston, the releasing of the retail space at 767 Fifth Avenue (the General Motors Building) and the roll up on expiring leases at Embarcadero Center.

Transactions during the three months ended June 30, 2015 included the following:

 

   

During the three months ended June 30, 2015, we entered into three forward-starting interest rate swap contracts, which fix the 10-year swap rate on notional amounts aggregating $75.0 million. We have now entered into a total of nine forward-starting interest rate swap contracts, including one contract entered into subsequent to June 30, 2015, which fix the 10-year swap rate at a weighted-average rate of approximately 2.463% per annum on notional amounts aggregating $350.0 million. The interest rate swap contracts were entered into in advance of a financing with a target commencement date in September 2016 and maturity in September 2026.

In addition, 767 Fifth Partners LLC, which is the consolidated entity (in which we have a 60% interest and owns 767 Fifth Avenue (the General Motors Building) in New York City), entered into nine forward-starting interest rate swap contracts, including four contracts entered into subsequent to June 30, 2015, which fix the 10-year swap rate at a weighted-average rate of approximately 2.801% per annum on notional amounts aggregating $250.0 million. These interest rate swap contracts were entered into in advance of a financing with a target commencement date in June 2017 and maturity in June 2027.

 

   

On May 1, 2015, we commenced the redevelopment of Reservoir Place North, a Class A office project with approximately 73,000 net rentable square feet located in Waltham, Massachusetts.

 

   

On May 8, 2015, we entered into a joint venture with an unrelated third party to redevelop an existing building into a Class A office building totaling approximately 115,000 net rentable square feet at 1265 Main Street in Waltham, Massachusetts. The joint venture partner contributed real estate and improvements, with an aggregate fair value of approximately $9.4 million, for its initial 50% interest in the joint venture. For our initial 50% interest, we will contribute cash totaling approximately $9.4 million as the joint venture incurs costs. The joint venture has entered into a fifteen-year lease with a tenant to occupy 100% of the building.

 

   

On June 25, 2015, our Operating Partnership redeemed the remaining 12,667 Series Four Preferred Units for cash totaling approximately $0.6 million.

 

   

On June 26, 2015, we entered into a joint venture with an unrelated third party to develop Dock72, an office building totaling approximately 670,000 net rentable square feet located at the Brooklyn Navy Yard in Brooklyn, New York. Each partner contributed cash totaling approximately $9.1 million for their initial 50% interest in the joint venture. The joint venture entered into a 96-year ground lease, comprised of an initial term of 49 years, which may be extended by the joint venture to 2111, subject to certain conditions. The joint venture also entered into a 20-year lease with a tenant to occupy approximately 222,000 net rentable square feet at the building. In addition, the joint venture entered into an option agreement pursuant to which it may lease an additional land parcel at the site, which could support between 600,000 and 1,000,000 net rentable square feet of development. In connection with the execution of the option agreement, the joint venture paid a non-refundable option payment of $1.0 million.

 

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Transactions completed subsequent to June 30, 2015 included the following:

 

   

On July 29, 2015, a consolidated entity in which we have a 50% interest executed a binding agreement for the sale of 505 9th Street, N.W. located in Washington, DC, for approximately $318.0 million (which exceeds its carrying value), including the assumption by the buyer of approximately $117.0 million of mortgage indebtedness. 505 9th Street, N.W. is an approximately 322,000 net rentable square foot Class A office building. The sale is subject to the satisfaction of customary closing conditions and, although there can be no assurance that the sale will be consummated on the terms currently contemplated or at all, it is expected to close by the end of the third quarter of 2015.

 

   

On July 31, 2015, we entered into a 99-year ground and air rights lease (the “Lease”) with the Massachusetts Department of Transportation (“MDOT”) with respect to the parking garage located at 100 Clarendon Street (the “Clarendon Garage”) and the concourse level of the Massachusetts Bay Transportation Authority’s Back Bay Station (the “Station”). The Lease amends and restates the air rights lease which we had assumed in 2010 at the time we acquired an interest in both the Clarendon Garage and the office tower located at 200 Clarendon Street (formerly the John Hancock Tower). The previous lease had 45 years remaining in its term. Upon execution of the Lease, we made a $5.0 million option payment which provides us with options under the Lease to acquire certain air rights above both the Clarendon Garage and the Station; the amount of developable square footage associated with the air rights will be determined at a later date. In consideration for MDOT entering into the new Lease, we have agreed to make improvements to the Station in an amount of $32.0 million, which amount will be credited against our rental obligations under the Lease.

 

   

On August 6, 2015, we executed an amendment to the joint venture agreement for our Fountain Square property located in Reston, Virginia. The amendment requires us to acquire our partner’s nominal 50% interest on September 15, 2015 for approximately $100.9 million in cash (See Note 7 to the Consolidated Financial Statements).

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, or GAAP, requires management to use judgment in the application of accounting policies, including making estimates and assumptions. We base our estimates on historical experience and on various other assumptions believed to be reasonable under the circumstances. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied resulting in a different presentation of our financial statements. From time to time, we evaluate our estimates and assumptions. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information. Below is a discussion of accounting policies that we consider critical in that they may require complex judgment in their application or require estimates about matters that are inherently uncertain.

Real Estate

Upon acquisitions of real estate that constitutes a business, which includes the consolidation of previously unconsolidated joint ventures, we assess the fair value of acquired tangible and intangible assets, (including land, buildings, tenant improvements, “above-” and “below-market” leases, leasing and assumed financing origination costs, acquired in-place leases, other identified intangible assets and assumed liabilities) and allocate the purchase price to the acquired assets and assumed liabilities, including land and buildings as if vacant. We assess and consider fair value based on estimated cash flow projections that utilize discount and/or capitalization rates that we deem appropriate, as well as available market information. Estimates of future cash flows are based on a number of factors including the historical operating results, known and anticipated trends, and market and economic conditions.

 

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The fair value of the tangible assets of an acquired property considers the value of the property as if it were vacant. We also consider an allocation of purchase price of other acquired intangibles, including acquired in-place leases that may have a customer relationship intangible value, including (but not limited to) the nature and extent of the existing relationship with the tenants, the tenants’ credit quality and expectations of lease renewals. Based on our acquisitions to date, our allocation to customer relationship intangible assets has been immaterial.

We record acquired “above-” and “below-market” leases at their fair values (using a discount rate which reflects the risks associated with the leases acquired) equal to the difference between (1) the contractual amounts to be paid pursuant to each in-place lease and (2) management’s estimate of fair market lease rates for each corresponding in-place lease, measured over a period equal to the remaining term of the lease for above-market leases and the initial term plus the term of any below-market fixed rate renewal options for below-market leases. Acquired “above-” and “below-market” lease values have been reflected within Prepaid Expenses and Other Assets and Other Liabilities, respectively, in our Consolidated Balance Sheets. Other intangible assets acquired include amounts for in-place lease values that are based on our evaluation of the specific characteristics of each tenant’s lease. Factors to be considered include estimates of carrying costs during hypothetical expected lease-up periods considering current market conditions, and costs to execute similar leases. In estimating carrying costs, we include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods, depending on local market conditions. In estimating costs to execute similar leases, we consider leasing commissions, legal and other related expenses.

Management reviews its long-lived assets for impairment every quarter and when there is an event or change in circumstances that indicates an impairment in value. An impairment loss is recognized if the carrying amount of its assets is not recoverable and exceeds its fair value. If such criteria are present, an impairment loss is recognized based on the excess of the carrying amount of the asset over its fair value. The evaluation of anticipated cash flows is highly subjective and is based in part on assumptions regarding anticipated hold periods, future occupancy, rental rates and capital requirements that could differ materially from actual results in future periods. Since cash flows on properties considered to be “long-lived assets to be held and used” are considered on an undiscounted basis to determine whether an asset has been impaired, our established strategy of holding properties over the long term directly decreases the likelihood of recording an impairment loss. If our hold strategy changes or market conditions otherwise dictate an earlier sale date, an impairment loss may be recognized and such loss could be material. If we determine that an impairment has occurred, the affected assets must be reduced to their fair value, less cost to sell.

Guidance in Accounting Standards Codification (“ASC”) 360 “Property Plant and Equipment” (“ASC 360”) requires that qualifying assets and liabilities and the results of operations that have been sold, or otherwise qualify as “held for sale,” be presented as discontinued operations in all periods presented if the property operations are expected to be eliminated and we will not have significant continuing involvement following the sale. The components of the property’s net income that is reflected as discontinued operations include the net gain (or loss) upon the disposition of the property held for sale, operating results, depreciation and interest expense (if the property is subject to a secured loan). We generally consider assets to be “held for sale” when the transaction has been approved by our Board of Directors, or a committee thereof, and there are no known significant contingencies relating to the sale, such that a sale of the property within one year is considered probable. Following the classification of a property as “held for sale,” no further depreciation is recorded on the assets, and the asset is written down to the lower of carrying value or fair market value, less cost to sell. On April 10, 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity” (“ASU 2014-08”). ASU 2014-08 clarifies that discontinued operations presentation applies only to disposals representing a strategic shift that has (or will have) a major effect on an entity’s operations and financial results (e.g., a disposal of a major geographical area, a major line of business, a major equity method investment or other major parts of an entity). ASU 2014-08 is effective prospectively for reporting periods beginning after December 15, 2014. Early adoption is permitted, and we early adopted ASU 2014-08 during the first quarter of 2014. Our adoption of ASU 2014-08 resulted in the operating results and gain on sale of real

 

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estate from the operating property sold during the six months ended June 30, 2015 not being reflected as Discontinued Operations in our Consolidated Statements of Operations (See Note 3 to the Consolidated Financial Statements).

Real estate is stated at depreciated cost. A variety of costs are incurred in the acquisition, development and leasing of properties. The cost of buildings and improvements includes the purchase price of property, legal fees and other acquisition costs. We expense costs that we incur to effect a business combination such as legal, due diligence and other closing related costs. Costs directly related to the development of properties are capitalized. Capitalized development costs include interest, internal wages, property taxes, insurance, and other project costs incurred during the period of development. After the determination is made to capitalize a cost, it is allocated to the specific component of a project that is benefited. Determination of when a development project commences and capitalization begins, and when a development project is substantially complete and held available for occupancy and capitalization must cease, involves a degree of judgment. Our capitalization policy on development properties is guided by guidance in ASC 835-20 “Capitalization of Interest” and ASC 970 “Real Estate-General.” The costs of land and buildings under development include specifically identifiable costs.

The capitalized costs include pre-construction costs necessary to the development of the property, development costs, construction costs, interest costs, real estate taxes, salaries and related costs and other costs incurred during the period of development. We begin the capitalization of costs during the pre-construction period which we define as activities that are necessary to the development of the property. We consider a construction project as substantially completed and held available for occupancy upon the completion of tenant improvements, but no later than one year from cessation of major construction activity. We cease capitalization on the portion (1) substantially completed, (2) occupied or held available for occupancy, and we capitalize only those costs associated with the portion under construction or (3) if activities necessary for the development of the property have been suspended.

Investments in Unconsolidated Joint Ventures

We consolidate variable interest entities (“VIEs”) in which we are considered to be the primary beneficiary. VIEs are entities in which the equity investors do not have sufficient equity at risk to finance their endeavors without additional financial support or that the holders of the equity investment at risk do not have a controlling financial interest. The primary beneficiary is defined by the entity having both of the following characteristics: (1) the power to direct the activities that, when taken together, most significantly impact the variable interest entity’s performance, and (2) the obligation to absorb losses and right to receive the returns from the variable interest entity that would be significant to the variable interest entity. For ventures that are not VIEs we consolidate entities for which we have significant decision making control over the ventures’ operations. Our judgment with respect to our level of influence or control of an entity involves the consideration of various factors including the form of our ownership interest, our representation in the entity’s governance, the size of our investment (including loans), estimates of future cash flows, our ability to participate in policy making decisions and the rights of the other investors to participate in the decision making process and to replace us as manager and/or liquidate the venture, if applicable. Our assessment of our influence or control over an entity affects the presentation of these investments in our consolidated financial statements. In addition to evaluating control rights, we consolidate entities in which the outside partner has no substantive kick-out rights to remove us as the managing member.

Accounts of the consolidated entity are included in our accounts and the non-controlling interest is reflected on the Consolidated Balance Sheets as a component of equity or in temporary equity between liabilities and equity. Investments in unconsolidated joint ventures are recorded initially at cost, and subsequently adjusted for equity in earnings and cash contributions and distributions. Any difference between the carrying amount of these investments on the balance sheet and the underlying equity in net assets is amortized as an adjustment to equity in earnings of unconsolidated joint ventures over the life of the related asset. Under the equity method of accounting, our net equity investment is reflected within the Consolidated Balance Sheets, and our share of net

 

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income or loss from the joint ventures is included within the Consolidated Statements of Operations. The joint venture agreements may designate different percentage allocations among investors for profits and losses; however, our recognition of joint venture income or loss generally follows the joint venture’s distribution priorities, which may change upon the achievement of certain investment return thresholds. We may account for cash distributions in excess of our investment in an unconsolidated joint venture as income when we are not the general partner in a limited partnership and when we have neither the requirement nor the intent to provide financial support to the joint venture. Our investments in unconsolidated joint ventures are reviewed for impairment periodically and we record impairment charges when events or circumstances change indicating that a decline in the fair values below the carrying values has occurred and such decline is other-than-temporary. The ultimate realization of the investment in unconsolidated joint ventures is dependent on a number of factors, including the performance of each investment and market conditions. We will record an impairment charge if we determine that a decline in the value below the carrying value of an investment in an unconsolidated joint venture is other-than-temporary.

To the extent that we contribute assets to a joint venture, our investment in the joint venture is recorded at our cost basis in the assets that were contributed to the joint venture. To the extent that our cost basis is different than the basis reflected at the joint venture level, the basis difference is amortized over the life of the related asset and included in our share of equity in net income of the joint venture. In accordance with the provisions of ASC 970-323 “Investments-Equity Method and Joint Ventures” (“ASC 970-323”), we will recognize gains on the contribution of real estate to joint ventures, relating solely to the outside partner’s interest, to the extent the economic substance of the transaction is a sale.

The combined summarized financial information of the unconsolidated joint ventures is disclosed in Note 4 to the Consolidated Financial Statements.

Revenue Recognition

In general, we commence rental revenue recognition when the tenant takes possession of the leased space and the leased space is substantially ready for its intended use. Contractual rental revenue is reported on a straight-line basis over the terms of our respective leases. We recognize rental revenue of acquired in-place “above-” and “below-market” leases at their fair values over the original term of the respective leases. Accrued rental income as reported on the Consolidated Balance Sheets represents rental income recognized in excess of rent payments actually received pursuant to the terms of the individual lease agreements.

For the three and six months ended June 30, 2015, the impact of the net adjustments of rents from “above-” and “below-market” leases increased rental revenue by approximately $13.6 million and $23.6 million, respectively. For the three and six months ended June 30, 2015, the impact of the straight-line rent adjustment increased rental revenue by approximately $17.8 million and $43.7 million, respectively. Those amounts exclude the adjustment of rents from “above-” and “below-market” leases and straight-line income from unconsolidated joint ventures, which are disclosed in Note 4 to the Consolidated Financial Statements.

Our leasing strategy is generally to secure creditworthy tenants that meet our underwriting guidelines. Furthermore, following the initiation of a lease, we continue to actively monitor the tenant’s creditworthiness to ensure that all tenant related assets are recorded at their realizable value. When assessing tenant credit quality, we:

 

   

review relevant financial information, including:

 

   

financial ratios;

 

   

net worth;

 

   

revenue;

 

   

cash flows;

 

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leverage; and

 

   

liquidity;

 

   

evaluate the depth and experience of the tenant’s management team; and

 

   

assess the strength/growth of the tenant’s industry.

As a result of the underwriting process, tenants are then categorized into one of three categories:

 

  (1) acceptable-risk tenants;

 

  (2) the tenant’s credit is such that we may require collateral, in which case we:

 

   

may require a security deposit; and/or

 

   

may reduce upfront tenant improvement investments; or

 

  (3) the tenant’s credit is below our acceptable parameters.

We consistently monitor the credit quality of our tenant base. We provide an allowance for doubtful accounts arising from estimated losses that could result from the tenant’s inability to make required current rent payments and an allowance against accrued rental income for future potential losses that we deem to be unrecoverable over the term of the lease.

Tenant receivables are assigned a credit rating of 1 through 4. A rating of 1 represents the highest possible rating and no allowance is recorded. A rating of 4 represents the lowest credit rating, in which case we record a full reserve against the receivable balance. Among the factors considered in determining the credit rating include:

 

   

payment history;

 

   

credit status and change in status (credit ratings for public companies are used as a primary metric);

 

   

change in tenant space needs (i.e., expansion/downsize);

 

   

tenant financial performance;

 

   

economic conditions in a specific geographic region; and

 

   

industry specific credit considerations.

If our estimates of collectability differ from the cash received, the timing and amount of our reported revenue could be impacted. The average remaining term of our in-place tenant leases, including unconsolidated joint ventures, was approximately 6.7 years as of June 30, 2015. The credit risk is mitigated by the high quality of our existing tenant base, reviews of prospective tenants’ risk profiles prior to lease execution and consistent monitoring of our portfolio to identify potential problem tenants.

Recoveries from tenants, consisting of amounts due from tenants for common area maintenance, real estate taxes and other recoverable costs, are recognized as revenue in the period during which the expenses are incurred. Tenant reimbursements are recognized and presented in accordance with guidance in ASC 605-45 “Principal Agent Considerations” (“ASC 605-45”). ASC 605-45 requires that these reimbursements be recorded on a gross basis, as we are generally the primary obligor with respect to purchasing goods and services from third-party suppliers, have discretion in selecting the supplier and have credit risk. We also receive reimbursement of payroll and payroll related costs from third parties which we reflect on a net basis.

Our parking revenues are derived from leases, monthly parking and transient parking. We recognize parking revenue as earned.

Our hotel revenues are derived from room rentals and other sources such as charges to guests for telephone service, movie and vending commissions, meeting and banquet room revenue and laundry services. Hotel revenues are recognized as earned.

 

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We receive management and development fees from third parties. Property management fees are recorded and earned based on a percentage of collected rents at the properties under management, and not on a straight-line basis, because such fees are contingent upon the collection of rents. We review each development agreement and record development fees as earned depending on the risk associated with each project. Profit on development fees earned from joint venture projects are recognized as revenue to the extent of the third-party partners’ ownership interest.

Gains on sales of real estate are recognized pursuant to the provisions included in ASC 360-20 “Real Estate Sales” (“ASC 360-20”). The specific timing of the sale is measured against various criteria in ASC 360-20 related to the terms of the transaction and any continuing involvement in the form of management or financial assistance associated with the properties. If the sales criteria for the full accrual method are not met, we defer some or all of the gain recognition and account for the continued operations of the property by applying the finance, leasing, profit sharing, deposit, installment or cost recovery methods, as appropriate, until the sales criteria are met.

Depreciation and Amortization

We compute depreciation and amortization on our properties using the straight-line method based on estimated useful asset lives. We allocate the acquisition cost of real estate to its components and depreciate or amortize these assets over their useful lives. The amortization of acquired “above-” and “below-market” leases and acquired in-place leases is recorded as an adjustment to revenue and depreciation and amortization, respectively, in the Consolidated Statements of Operations.

Fair Value of Financial Instruments

The carrying values of cash and cash equivalents, marketable securities, escrows, receivables, accounts payable, accrued expenses and other assets and liabilities are reasonable estimates of their fair values because of the short maturities of these instruments.

We follow the authoritative guidance for fair value measurements when valuing our financial instruments for disclosure purposes. We determine the fair value of our unsecured senior notes and unsecured exchangeable senior notes using market prices. The inputs used in determining the fair value of our unsecured senior notes and unsecured exchangeable senior notes is categorized at a level 1 basis (as defined in the accounting standards for Fair Value Measurements and Disclosures) due to the fact that we use quoted market rates to value these instruments. However, the inputs used in determining the fair value could be categorized at a level 2 basis if trading volumes are low. We determine the fair value of our mortgage notes payable using discounted cash flow analyses by discounting the spread between the future contractual interest payments and hypothetical future interest payments on mortgage debt based on current market rates for similar securities. In determining the current market rates, we add our estimates of market spreads to the quoted yields on federal government treasury securities with similar maturity dates to our debt. The inputs used in determining the fair value of our mortgage notes payable and mezzanine notes payable are categorized at a level 3 basis (as defined in the accounting standards for Fair Value Measurements and Disclosures) due to the fact that we consider the rates used in the valuation techniques to be unobservable inputs.

Derivative Instruments and Hedging Activities

Derivative instruments and hedging activities require management to make judgments on the nature of its derivatives and their effectiveness as hedges. These judgments determine if the changes in fair value of the derivative instruments are reported in the Consolidated Statements of Operations as a component of net income or as a component of comprehensive income (loss) and as a component of equity on the Consolidated Balance Sheets. While management believes its judgments are reasonable, a change in a derivative’s effectiveness as a hedge could materially affect expenses, net income and equity. We account for the effective portion of changes in the fair value of a derivative in other comprehensive income (loss) and subsequently reclassify the effective portion to earnings over the term that the hedged transaction affects earnings. We account for the ineffective portion of changes in the fair value of a derivative directly in earnings.

 

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Recent Accounting Pronouncements

On April 10, 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity” (“ASU 2014-08”). ASU No. 2014-08 clarifies that discontinued operations presentation applies only to disposals representing a strategic shift that has (or will have) a major effect on an entity’s operations and financial results (e.g., a disposal of a major geographical area, a major line of business, a major equity method investment or other major parts of an entity). ASU 2014-08 is effective prospectively for reporting periods beginning after December 15, 2014. Early adoption is permitted, and we early adopted ASU 2014-08 during the first quarter of 2014. Our adoption of ASU 2014-08 resulted in the operating results and gain on sale of real estate from the operating property sold during the six months ended June 30, 2015 not being reflected as Discontinued Operations in our Consolidated Statements of Operations (See Note 3 to the Consolidated Financial Statements).

In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis” (ASU 2015-02”). ASU 2015-02 affects reporting entities that are required to evaluate whether they should consolidate certain legal entities. ASU 2015-02 modifies the evaluation of whether limited partnerships and similar legal entities are VIEs or voting interest entities, eliminates the presumption that a general partner should consolidate a limited partnership and affects the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships. ASU 2015-02 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. A reporting entity may apply the amendments in ASU 2015-02 using: (a) a modified retrospective approach by recording a cumulative-effect adjustment to equity as of the beginning of the fiscal year of adoption; or (b) by applying the amendments retrospectively. We are currently assessing the potential impact that the adoption of ASU 2015-02 will have on our consolidated financial statements.

In April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs(“ASU 2015-03”), which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs is not affected. ASU 2015-03 is effective for financial statements issued fiscal years beginning after December 15, 2015, and interim periods within those fiscal years and shall be applied on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. Early adoption is permitted for financial statements that have not been previously issued. We do not expect the adoption of ASU 2015-03 to have a material impact on our consolidated financial statements.

Results of Operations

The following discussion is based on our Consolidated Statements of Operations for the three months ended June 30, 2015 and 2014.

At June 30, 2015 and June 30, 2014, we owned or had interests in a portfolio of 170 and 180 properties, respectively (in each case, the “Total Property Portfolio”). As a result of changes within our Total Property Portfolio, the financial data presented below shows significant changes in revenue and expenses from period-to-period. Accordingly, we do not believe that our period-to-period financial data with respect to the Total Property Portfolio is necessarily meaningful. Therefore, the comparison of operating results for the three and six months ended June 30, 2015 and 2014 show separately the changes attributable to the properties that were owned by us and in-service throughout each period compared (the “Same Property Portfolio”) and the changes attributable to the properties included in the Placed In-Service, Acquired, Development or Redevelopment or Sold Portfolios.

In our analysis of operating results, particularly to make comparisons of net operating income between periods meaningful, it is important to provide information for properties that were in-service and owned by us

 

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throughout each period presented. We refer to properties acquired or placed in-service prior to the beginning of the earliest period presented and owned by us and in-service through the end of the latest period presented as our Same Property Portfolio. The Same Property Portfolio therefore excludes properties placed in-service, acquired or in development or redevelopment after the beginning of the earliest period presented or disposed of prior to the end of the latest period presented.

Net operating income, or “NOI,” is a non-GAAP financial measure equal to net income attributable to Boston Properties, Inc. common shareholders, the most directly comparable GAAP financial measure, plus income attributable to noncontrolling interests, depreciation and amortization, interest expense, transaction costs, general and administrative expense, less gains on sales of real estate, gains (losses) from investments in securities, income from unconsolidated joint ventures, interest and other income and development and management services revenue. We use NOI internally as a performance measure and believe NOI provides useful information to investors regarding our financial condition and results of operations because it reflects only those income and expense items that are incurred at the property level. Therefore, we believe NOI is a useful measure for evaluating the operating performance of our real estate assets.

Our management also uses NOI to evaluate regional property level performance and to make decisions about resource allocations. Further, we believe NOI is useful to investors as a performance measure because, when compared across periods, NOI reflects the impact on operations from trends in occupancy rates, rental rates, operating costs and acquisition and development activity on an unleveraged basis, providing perspectives not immediately apparent from net income attributable to Boston Properties, Inc. common shareholders. NOI excludes certain components from net income attributable to Boston Properties, Inc. common shareholders in order to provide results that are more closely related to a property’s results of operations. For example, interest expense is not necessarily linked to the operating performance of a real estate asset and is often incurred at the corporate level as opposed to the property level. In addition, depreciation and amortization, because of historical cost accounting and useful life estimates, may distort operating performance at the property level. NOI presented by us may not be comparable to NOI reported by other REITs that define NOI differently. We believe that in order to facilitate a clear understanding of our operating results, NOI should be examined in conjunction with net income attributable to Boston Properties, Inc. common shareholders as presented in our Consolidated Financial Statements. NOI should not be considered as an alternative to net income attributable to Boston Properties, Inc. common shareholders as an indication of our performance or to cash flows as a measure of liquidity or ability to make distributions. For a reconciliation of NOI to net income attributable to Boston Properties, Inc. commons shareholders, see Note 11 to the Consolidated Financial Statements.

Comparison of the six months ended June 30, 2015 to the six months ended June 30, 2014.

The table below shows selected operating information for the Same Property Portfolio and the Total Property Portfolio. The Same Property Portfolio consists of 146 properties totaling approximately 38.0 million net rentable square feet of space, excluding unconsolidated joint ventures. The Same Property Portfolio includes properties acquired or placed in-service on or prior to January 1, 2014 and owned and in service through June 30, 2015. The Total Property Portfolio includes the effects of the other properties either placed in-service, acquired or in development or redevelopment after January 1, 2014 or disposed of on or prior to June 30, 2015. This table includes a reconciliation from the Same Property Portfolio to the Total Property Portfolio by also providing information for the six months ended June 30, 2015 and 2014 with respect to the properties that were placed in-service, in development or redevelopment or sold. For the six months ended June 30, 2015 and 2014 we had no properties that were acquired.

 

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    Same Property Portfolio     Properties
Placed
In-Service
Portfolio
    Properties  in
Development
or
Redevelopment
Portfolio
    Properties Sold
Portfolio
    Total Property Portfolio  

(dollars in thousands)

  2015     2014     Increase/
(Decrease)
    %
Change
    2015     2014     2015     2014     2015     2014     2015     2014     Increase/
(Decrease)
    %
Change
 

Rental Revenue:

         

Rental Revenue

  $ 1,124,487      $ 1,091,573      $ 32,914        3.02   $ 46,604      $ 8,586      $ 661      $ 1,077      $ —        $ 16,894      $ 1,171,752      $ 1,118,130      $ 53,622        4.80

Termination Income

    21,604        2,096        19,508        930.73     —          —          —          —          —          —          21,604        2,096        19,508        930.73
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Rental Revenue

    1,146,091        1,093,669        52,422        4.79     46,604        8,586        661        1,077        —          16,894        1,193,356        1,120,226        73,130        6.53
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Real Estate Operating Expenses

    413,546        391,784        21,762        5.55     16,939        4,105        254        531        —          4,916        430,739        401,336        29,403        7.33
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Operating Income, excluding residential and hotel

    732,545        701,885        30,660        4.37     29,665        4,481        407        546        —          11,978        762,617        718,890        43,727        6.08
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Residential Net Operating Income(1)

    1,207        1,259        (52     (4.13 )%      3,171        (625     —          —          1,210        3,648        5,588        4,282        1,306        30.50

Hotel Net Operating Income(1)

    6,417        6,448        (31     (0.48 )%      —          —          —          —          —          —          6,417        6,448        (31     (0.48 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated Net Operating Income(1)

    740,169        709,592        30,577        4.31     32,836        3,856        407        546        1,210        15,626        774,622        729,620        45,002        6.17
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Revenue:

         

Development and management services

    —          —          —          —          —          —          —          —          —          —          10,190        11,722        (1,532     (13.07 )% 

Other Expenses:

         

General and administrative expense

    —          —          —          —          —          —          —          —          —          —          51,075        53,176        (2,101     (3.95 )% 

Transaction costs

    —          —          —          —          —          —          —          —          —          —          535        1,098        (563     (51.28 )% 

Depreciation and amortization

    302,219        297,747        4,472        1.50     18,921        4,200        806        285        121        6,666        322,067        308,898        13,169        4.26
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Other Expenses

    302,219        297,747        4,472        1.50     18,921        4,200        806        285        121        6,666        373,677        363,172        10,505        2.89
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating Income

    437,950        411,845        26,105        6.34     13,915        (344     (399     261        1,089        8,960        411,135        378,170        32,965        8.72

Other Income:

                           

Income from unconsolidated joint ventures

                      17,912        5,650        12,262        217.03

Interest and other income

                      2,700        3,420        (720     (21.05 )% 

Gains from investments in securities

                      369        948        (579     (61.08 )% 

Other Expenses:

                 

Interest expense

                      217,291        224,531        (7,240     (3.22 )% 
                     

 

 

   

 

 

   

 

 

   

 

 

 

Income Before Gains On Sales Of Real Estate

                      214,825        163,657        51,168        31.27

Gains on sales of real estate

                      95,084        —          95,084        100.00
                     

 

 

   

 

 

   

 

 

   

 

 

 

Net Income