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, 2006

 

¨ 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)

  (IRS Employer Id. Number)

111 Huntington Avenue

Boston, Massachusetts

  02199
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (617) 236-3300

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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  x

  Accelerated filer  ¨   Non-accelerated filer  ¨

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 $.01 per share  

114,296,793

(Class)   (Outstanding on August 4, 2006)

 



Table of Contents

BOSTON PROPERTIES, INC.

FORM 10-Q

for the quarter ended June 30, 2006

TABLE OF CONTENTS

 

         Page

PART I.

  FINANCIAL INFORMATION   

ITEM 1.

  Financial Statements.    1
 

a)      Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005

   1
 

b)      Consolidated Statements of Operations for the three and six months ended June 30, 2006 and 2005

   2
 

c)      Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2006 and 2005

   3
 

d)      Consolidated Statements of Cash Flows for the six months ended June 30, 2006 and 2005

   4
 

e)      Notes to the Consolidated Financial Statements

   6

ITEM 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations    25

ITEM 3.

  Quantitative and Qualitative Disclosures about Market Risk    62

ITEM 4.

  Controls and Procedures    63

PART II.

  OTHER INFORMATION   

ITEM 1.

  Legal Proceedings    63

ITEM 1A.

  Risk Factors    64

ITEM 2.

  Unregistered Sales of Equity Securities and Use of Proceeds    64

ITEM 3.

  Defaults Upon Senior Securities    64

ITEM 4.

  Submission of Matters to a Vote of Security Holders    64

ITEM 5.

  Other Information    65

ITEM 6.

  Exhibits    65

SIGNATURES

   66


Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1—Financial Statements.

BOSTON PROPERTIES, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except for share and par value amounts)

 

     June 30,
2006
   

December 31,

2005

 

ASSETS

    

Real estate, at cost

   $ 8,698,493     $ 8,724,954  

Construction in process

     78,926       177,576  

Land held for future development

     222,519       248,645  

Less: accumulated depreciation

     (1,314,472 )     (1,265,073 )
                

Total real estate

     7,685,466       7,886,102  

Cash and cash equivalents

     370,396       261,496  

Cash held in escrows

     894,244       25,618  

Tenant and other receivables (net of allowance for doubtful accounts of $2,556 and $2,519, respectively)

     35,814       52,668  

Accrued rental income (net of allowance of $1,008 and $2,638, respectively)

     298,306       302,356  

Deferred charges, net

     250,154       242,660  

Prepaid expenses and other assets

     79,174       41,261  

Investments in unconsolidated joint ventures

     96,962       90,207  
                

Total assets

   $ 9,710,516     $ 8,902,368  
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Liabilities:

    

Mortgage notes payable

   $ 2,912,135     $ 3,297,192  

Unsecured senior notes (net of discount of $3,734 and $3,938, respectively)

     1,471,266       1,471,062  

Unsecured exchangeable senior notes

     450,000       —    

Unsecured line of credit

     —         58,000  

Accounts payable and accrued expenses

     90,748       109,823  

Dividends and distributions payable

     95,839       107,643  

Accrued interest payable

     50,175       47,911  

Other liabilities

     246,042       154,123  
                

Total liabilities

     5,316,205       5,245,754  
                

Commitments and contingencies

     —         —    
                

Minority interests

     824,867       739,268  
                

Stockholders’ equity:

    

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

     —         —    

Preferred stock, $.01 par value, 50,000,000 shares authorized, none issued or outstanding

     —         —    

Common stock, $.01 par value, 250,000,000 shares authorized, 114,298,348 and 112,621,162 issued and 114,219,448 and 112,542,262 outstanding in 2006 and 2005, respectively

     1,142       1,125  

Additional paid-in capital

     2,831,119       2,745,719  

Earnings in excess of dividends

     720,322       182,105  

Treasury common stock at cost, 78,900 shares in 2006 and 2005

     (2,722 )     (2,722 )

Accumulated other comprehensive income (loss)

     19,583       (8,881 )
                

Total stockholders’ equity

     3,569,444       2,917,346  
                

Total liabilities and stockholders’ equity

   $ 9,710,516     $ 8,902,368  
                

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

 

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Table of Contents

BOSTON PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

    

Three months ended

June 30,

   

Six months ended

June 30,

 
     2006     2005     2006     2005  
     (in thousands, except for per share amounts)  

Revenue

        

Rental:

        

Base rent

   $ 277,155     $ 277,359     $ 553,553     $ 556,107  

Recoveries from tenants

     45,506       41,836       92,699       85,173  

Parking and other

     14,219       14,121       28,048       28,046  
                                

Total rental revenue

     336,880       333,316       674,300       669,326  

Hotel revenue

     19,674       17,566       32,017       29,662  

Development and management services

     5,230       4,137       9,606       8,673  

Interest and other

     8,565       2,916       10,530       4,547  
                                

Total revenue

     370,349       357,935       726,453       712,208  
                                

Expenses

        

Operating:

        

Rental

     110,232       106,455       222,846       214,939  

Hotel

     12,770       12,495       24,247       23,304  

General and administrative

     15,796       14,252       30,438       29,065  

Interest

     78,449       78,233       153,266       157,587  

Depreciation and amortization

     67,912       67,026       134,759       134,822  

Losses from early extinguishments of debt

     31,457       12,896       31,924       12,896  
                                

Total expenses

     316,616       291,357       597,480       572,613  
                                

Income before minority interest in property partnership, income from unconsolidated joint ventures, minority interest in Operating Partnership, gains on sales of real estate and discontinued operations

     53,733       66,578       128,973       139,595  

Minority interest in property partnership

     777       1,472       2,013       3,124  

Income from unconsolidated joint ventures

     1,677       847       2,967       2,182  
                                

Income before minority interest in Operating Partnership, gains on sales of real estate and discontinued operations

     56,187       68,897       133,953       144,901  

Minority interest in Operating Partnership

     (11,758 )     (14,596 )     (27,193 )     (30,282 )
                                

Income before gains on sales of real estate and discontinued operations

     44,429       54,301       106,760       114,619  

Gains on sales of real estate, net of minority interest

     581,302       102,073       585,844       103,281  
                                

Income before discontinued operations

     625,731       156,374       692,604       217,900  

Discontinued operations:

        

Income from discontinued operations, net of minority interest

     —         727       —         435  

Gain on sale of real estate from discontinued operations, net of minority interest

     —         8,389       —         8,389  
                                

Net income available to common shareholders

   $ 625,731     $ 165,490     $ 692,604     $ 226,724  
                                

Basic earnings per common share:

        

Income available to common shareholders before discontinued operations

   $ 5.33     $ 1.38     $ 5.95     $ 1.94  

Discontinued operations, net of minority interest

     —         0.08       —         0.08  
                                

Net income available to common shareholders

   $ 5.33     $ 1.46     $ 5.95     $ 2.02  
                                

Weighted average number of common shares outstanding

     113,994       110,764       113,255       110,477  
                                

Diluted earnings per common share:

        

Income available to common shareholders before discontinued operations

   $ 5.23     $ 1.35     $ 5.83     $ 1.90  

Discontinued operations, net of minority interest

     —         0.08       —         0.08  
                                

Net income available to common shareholders

   $ 5.23     $ 1.43     $ 5.83     $ 1.98  
                                

Weighted average number of common and common equivalent shares outstanding

     116,176       113,103       115,669       112,740  
                                

The accompanying notes are an integral part of these financial statements

 

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BOSTON PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF

COMPREHENSIVE INCOME

(Unaudited)

 

    

Three months ended

June 30,

  

Six months ended

June 30,

     2006    2005    2006    2005
     (in thousands)

Net income available to common shareholders

   $ 625,731    $ 165,490    $ 692,604    $ 226,724

Other comprehensive income:

           

Effective portion of interest rate contracts

     11,867      —        28,115      —  

Amortization of interest rate contracts

     175      175      349      349
                           

Other comprehensive income

     12,042      175      28,464      349
                           

Comprehensive income

   $ 637,773    $ 165,665    $ 721,068    $ 227,073
                           

 

 

The accompanying notes are an integral part of these financial statements

 

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BOSTON PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     For the six months ended
June 30,
 
     2006     2005  
     (in thousands)  

Cash flows from operating activities:

    

Net income available to common shareholders

   $ 692,604     $ 226,724  

Adjustments to reconcile net income available to common shareholders to net cash provided by operating activities:

    

Depreciation and amortization

     134,759       135,381  

Non-cash portion of interest expense

     3,019       2,547  

Non-cash compensation expense

     4,531       4,092  

Losses from early extinguishments of debt

     31,843       2,042  

Minority interest in property partnership

     (2,013 )     (3,124 )

Distributions in excess of earnings from unconsolidated joint ventures

     880       63  

Minority interest in Operating Partnership

     138,580       53,206  

Gains on sales of real estate

     (697,231 )     (134,509 )

Change in assets and liabilities:

    

Cash held in escrows

     3,437       (4,322 )

Tenant and other receivables, net

     14,187       (6,940 )

Accrued rental income, net

     (24,958 )     (40,359 )

Prepaid expenses and other assets

     (8,114 )     (6,007 )

Accounts payable and accrued expenses

     (4,832 )     1,552  

Accrued interest payable

     2,264       (2,926 )

Other liabilities

     (15,537 )     (5,001 )

Tenant leasing costs

     (16,709 )     (17,443 )
                

Total adjustments

     (435,894 )     (21,748 )
                

Net cash provided by operating activities

     256,710       204,976  
                

Cash flows from investing activities:

    

Acquisitions/additions to real estate

     (222,140 )     (154,574 )

Investments in marketable securities

     (282,764 )     (25,000 )

Net investments in unconsolidated joint ventures

     (6,867 )     (323 )

Net proceeds from the sale of real estate placed in escrow

     (872,063 )     —    

Net proceeds from the sales of real estate

     1,150,981       472,647  
                

Net cash provided by (used in) investing activities

     (232,853 )     292,750  
                

The accompanying notes are an integral part of these financial statements

 

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BOSTON PROPERTIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     For the six months ended
June 30,
 
     2006     2005  
     (in thousands)  

Cash flows from financing activities:

    

Borrowings on unsecured line of credit

     195,000       —    

Repayments of unsecured line of credit

     (253,000 )     —    

Proceeds from mortgage notes payable

     28,459       549,310  

Repayments of mortgage notes payable

     (162,038 )     (662,549 )

Proceeds from unsecured exchangeable senior notes

     450,000       —    

Proceeds from a real estate financing transaction

     —         45,375  

Dividends and distributions

     (201,436 )     (178,893 )

Net proceeds from the issuance of common securities

     280       264  

Proceeds from stock option exercises

     32,559       26,564  

Contributions (distributions) from/to minority interest holders, net

     11,274       (5,670 )

Redemption of minority interest

     (14,891 )     —    

Deferred financing costs

     (1,164 )     (4,289 )
                

Net cash provided by (used in) financing activities

     85,043       (229,888 )
                

Net increase in cash and cash equivalents

     108,900       267,838  

Cash and cash equivalents, beginning of period

     261,496       239,344  
                

Cash and cash equivalents, end of period

   $ 370,396     $ 507,182  
                

Supplemental disclosures:

    

Cash paid for interest

   $ 150,979     $ 159,125  
                

Interest capitalized

   $ 2,996     $ 1,559  
                

Non-cash investing and financing activities:

    

Additions to real estate included in accounts payable

   $ 18,043     $ 3,944  
                

Dividends and distributions declared but not paid

   $ 95,839     $ 95,597  
                

Conversions of Minority interests to Stockholders’ equity

   $ 13,840     $ 7,120  
                

Basis adjustment to real estate in connection with conversions of Minority interests to Stockholders’ equity

   $ 35,941     $ 10,921  
                

Marketable securities transferred in connection with the legal defeasance of mortgage note payable

   $ 282,764     $ —    
                

Mortgage note payable legally defeased

   $ 254,385     $ —    
                

Issuance of restricted securities to employees and directors

   $ 11,054     $ 12,751  
                

The accompanying notes are an integral part of these financial statements

 

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Table of Contents

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, 2006 owned an approximate 81.4% (80.5% at June 30, 2005) 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 in this report 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”).

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 must redeem such OP Unit for cash equal to the then value of a share of common stock of the Company (“Common Stock”). 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.

At June 30, 2006, there was one series of Preferred Units outstanding (i.e., Series Two Preferred Units). The Series Two Preferred Units bear a distribution that is set in accordance with an amendment to the partnership agreement of the Operating Partnership. Preferred Units may also be converted into OP Units at the election of the holder thereof or the Operating Partnership in accordance with the amendment to the partnership agreement (See also Note 9).

All references 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, 2006, the Company owned or had interests in a portfolio of 124 commercial real estate properties (121 and 122 properties at December 31, 2005 and June 30, 2005, respectively) (the “Properties”) aggregating approximately 42.1 million net rentable square feet (approximately 42.0 million and 41.2 million net rentable square feet at December 31, 2005 and June 30, 2005, respectively), including four properties under construction and one redevelopment/expansion project collectively totaling approximately 1.3 million net rentable square feet, and structured parking for approximately 31,837 vehicles containing approximately 9.8 million square feet. At June 30, 2006, the Properties consist of:

 

    120 office properties, including 102 Class A office properties (including four properties under construction) and 18 Office/Technical properties;

 

    two hotels; and

 

    two retail properties.

 

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Table of Contents

BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The Company owns or controls undeveloped land parcels totaling approximately 531.2 acres. In addition, the Company has a 25% interest in the Boston Properties Office Value-Added Fund, L.P. (the “Value-Added Fund”), which is a strategic partnership with two institutional investors through which the Company pursues the acquisition of value-added investments in assets within its existing markets. The Company’s investments through the Value-Added Fund are not included in its portfolio information or any other portfolio level statistics. At June 30, 2006, the Value-Added Fund had investments in an office complex in Herndon, Virginia and an office property in Chelmsford, Massachusetts.

The Company considers Class A office properties to be centrally located buildings that are professionally managed and maintained, that 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.

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., executes all significant business relationships. All majority-owned subsidiaries and affiliates over which the Company has financial and operating control and variable interest entities (“VIE”s) 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 presentation 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 on Form 10-K for its fiscal year ended December 31, 2005.

3. Real Estate Activity During the Six Months Ended June 30, 2006

Acquisitions

On April 13, 2006, the Company acquired a parcel of land located in Waltham, Massachusetts for a purchase price of $16.0 million.

On June 30, 2006, the Company acquired 303 Almaden Boulevard, a Class A office property with approximately 157,000 net rentable square feet located in San Jose, California, at a purchase price of approximately $45.2 million. The acquisition was financed with available cash.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Development

On January 17, 2006, the Company placed-in-service its Seven Cambridge Center development project located in Cambridge, Massachusetts. Seven Cambridge Center is a fully-leased, build-to-suit project with approximately 231,000 net rentable square feet of office, research laboratory and retail space. The Company has leased 100% of the space to the Massachusetts Institute of Technology for occupancy by its affiliate, the Eli and Edythe L. Broad Institute. On October 1, 2005, the Company had placed-in-service the West Garage phase of the project consisting of parking for approximately 800 cars.

On March 31, 2006, the Company commenced construction of South of Market, a Class A office project consisting of three buildings aggregating approximately 652,000 net rentable square feet located in Reston, Virginia.

On April 1, 2006, the Company placed-in-service 12290 Sunrise Valley, a 182,000 net rentable square foot Class A office property located in Reston, Virginia. The Company has leased 100% of the space.

Dispositions

On February 23, 2005, the Company sold a parcel of land at the Prudential Center located in Boston, Massachusetts for a net sale price of approximately $31.5 million and an additional obligation of the buyer to fund approximately $19.6 million of development-related costs at the Prudential Center for aggregate proceeds of $51.1 million. Due to the structure of the transaction and certain continuing involvement provisions related to the development of the property, this transaction did not initially qualify as a sale for financial reporting purposes and had been accounted for as a financing transaction. On January 3, 2006, the continuing involvement provisions expired and the Company recognized a gain on sale of approximately $4.8 million (net of minority interest share of approximately $0.9 million).

On June 6, 2006, the Company sold 280 Park Avenue, a 1,179,000 net rentable square foot Class A office property located in midtown Manhattan, New York, for approximately $1.2 billion. Net proceeds totaled approximately $875 million after legal defeasance of indebtedness secured by the property (consisting of approximately $254.4 million of principal indebtedness and approximately $28.2 million of related defeasance costs) and the payment of transfer taxes, brokers’ fees and other customary closing costs. The Company recognized a gain on sale of approximately $581.6 million (net of minority interest share of approximately $109.5 million). The net proceeds from the sale have been recorded in Cash Held in Escrows in the Company’s Consolidated Balance Sheets because the cash was held in escrow by a qualifying intermediary for the purpose of potentially accomplishing a like-kind exchange under Section 1031 of the Internal Revenue Code. Pursuant to the purchase and sale agreement, the Company entered into a master lease agreement with the buyer at closing. Under the master lease agreement, the Company has guaranteed that the buyer will receive at least a minimum amount of base rent from approximately 74,340 square feet of space during the ten-year period following the expiration of the current leases for this space. The current leases for this space are scheduled to expire at various times between June 2006 and October 2007. The aggregate amount of base rent guaranteed by the Company over the entire period from 2006 to 2017 is approximately $67.3 million. The Company’s guarantee obligations, which are in the form of base rent payments to the buyer, will be reduced by the amount of base rent payable, whether or not actually paid, under qualifying leases for this space that are obtained by the Company from prospective tenants. The Company will remain responsible for any free rent periods. The buyer will bear all customary leasing costs for this space, including tenant improvements and leasing commissions. The recognized gain on sale of the property has been reduced by approximately $67.3 million, representing the Company’s maximum obligation under the master lease, and has been deferred and recorded in Other Liabilities in the Company’s Consolidated Balance Sheets until such master lease obligation has been satisfied. As part of

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

the transaction, the buyer has engaged the Company as the property manager and leasing agent for 280 Park Avenue for a one-year term that renews automatically. Under the purchase and sale agreement, the Company has also agreed to provide to the buyer fixed monthly revenue support from the closing date until December 31, 2008. The aggregate amount of the revenue support payments will be approximately $22.5 million and has been recorded as a purchase price adjustment and included in Other Liabilities within the Company’s Consolidated Balance Sheets. Due to the Company’s continuing involvement through an agreement with the buyer to manage and lease the property for a fee after the sale and the financial obligations discussed above, this property has not been categorized as discontinued operations in the accompanying Consolidated Statements of Operations (See Note 11).

4. Investments in Unconsolidated Joint Ventures

The investments in unconsolidated joint ventures consist of the following at June 30, 2006:

 

Entity

   Properties   Nominal %
Ownership
 

Square 407 Limited Partnership

   Market Square North   50.0 %

The Metropolitan Square Associates LLC

   Metropolitan Square   51.0 % (1)

BP/CRF 265 Franklin Street Holdings LLC

   265 Franklin Street   35.0 %

BP/CRF 901 New York Avenue LLC

   901 New York Avenue   25.0 % (2)

Wisconsin Place Entities

   Wisconsin Place   23.9 % (3)(4)

Boston Properties Office Value-Added Fund, L.P.

   Worldgate Plaza and
300 Billerica Road
  25.0 % (2)

KEG Associates I, LLC

   505 9th Street   50.0 % (3)

New York Land Venture

   New York Land   50.0 % (3)

(1) This joint venture is unconsolidated and accounted for under the equity method due to participatory rights of the outside partner.
(2) The Company’s economic ownership can increase based on the achievement of certain return thresholds.
(3) The property is not in operation (i.e., under construction or undeveloped land).
(4) Represents the Company’s effective ownership interest. The Company has a 66.67%, 5% and 0% interest in the office, retail and residential joint venture entities, respectively, each of which owns a 33.33% interest in the entity developing and owning the land and infrastructure of the project.

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 at an agreed upon fair value. Under these provisions, the Company is not compelled to purchase the interest of its outside joint venture partners.

On March 13, 2006, a joint venture in which the Company has a 50% interest acquired a land parcel located in New York City for a purchase price of approximately $6.0 million. In addition, on May 8, 2006, the joint venture acquired additional land parcels located in New York City for an aggregate purchase price of approximately $15.3 million. On May 8, 2006, the joint venture obtained mortgage financing collateralized by the land parcels totaling approximately $23.6 million. The mortgage financing bears interest at a variable rate equal to LIBOR plus 2.25% per annum and matures in May 2008. The Company and its third-party joint venture partner have agreed to guarantee approximately $11.8 million of the mortgage loan.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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

 

    

June 30,

2006

  

December 31,

2005

     (in thousands)
ASSETS   

Real estate and development in process, net

   $ 767,165    $ 733,908

Other assets

     74,745      67,654
             

Total assets

   $ 841,910    $ 801,562
             
LIABILITIES AND MEMBERS’/PARTNERS’ EQUITY      

Mortgage and notes payable (1)

   $ 617,912    $ 587,727

Other liabilities

     19,859      18,717

Members’/Partners’ equity

     204,139      195,118
             

Total liabilities and members’/partners’ equity

   $ 841,910    $ 801,562
             

Company’s share of equity

   $ 94,274    $ 87,489

Basis differentials (2)

     2,688      2,718
             

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

   $ 96,962    $ 90,207
             

(1) The Company and its third-party joint venture partners in the Wisconsin Place Entities have guaranteed the seller financing totaling $15.5 million related to the acquisition of the land by the Land and Infrastructure Entity. The Company and its third-party joint venture partners in the New York land venture have each agreed to guarantee approximately $11.8 million of the mortgage loan. The fair value of the Company’s stand-ready obligations related to the issuance of these guarantees is immaterial.
(2) This amount represents the aggregate difference between the Company’s historical cost basis reflected and the basis reflected at the joint venture level, which is typically amortized over the life of the related asset. Basis differentials occur primarily 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.

The combined summarized statements of operations of the joint ventures are as follows:

 

     For the three months
ended June 30,
   For the six months ended
June 30,
     2006    2005    2006    2005
     (in thousands)    (in thousands)

Total revenue

   $ 26,588    $ 23,875    $ 51,804    $ 47,323

Expenses

           

Operating

     8,548      7,782      17,087      15,278

Interest

     9,035      8,024      17,603      15,937

Depreciation and amortization

     5,987      6,101      12,053      10,913
                           

Total expenses

     23,570      21,907      46,743      42,128
                           

Net income

   $ 3,018    $ 1,968    $ 5,061    $ 5,195
                           
                           

Company’s share of net income

   $ 1,677    $ 847    $ 2,967    $ 2,182
                           

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

5. Mortgage Notes Payable

On January 31, 2006, the Company repaid the mortgage loan collateralized by its 101 Carnegie Center property located in Princeton, New Jersey totaling approximately $6.6 million using available cash. There was no prepayment penalty associated with the repayment. The mortgage loan bore interest at a fixed rate of 7.66% per annum and was scheduled to mature on April 1, 2006.

On February 24, 2006, the Company repaid the construction financing collateralized by its Seven Cambridge Center property located in Cambridge, Massachusetts totaling approximately $112.5 million using approximately $7.5 million of available cash and $105.0 million drawn under the Company’s Unsecured Line of Credit. There was no prepayment penalty associated with the repayment. The Company recognized a loss from early extinguishment of debt totaling approximately $0.5 million consisting of the write-off of unamortized deferred financing costs. The construction financing bore interest at a variable rate equal to LIBOR plus 1.10% per annum and was scheduled to mature in April 2007.

On June 5, 2006, the Company repaid the mortgage loan collateralized by its 191 Spring Street property located in Lexington, Massachusetts totaling approximately $17.9 million using available cash. There was no prepayment penalty associated with the repayment. The mortgage loan bore interest at a fixed rate of 8.50% per annum and was scheduled to mature on September 1, 2006.

On June 6, 2006, in connection with the sale of 280 Park Avenue, the Company legally defeased the mortgage indebtedness collateralized by the property totaling approximately $254.4 million. The mortgage financing bore interest at a fixed rate equal to 7.64% per annum and was scheduled to mature in February 2011. The Company acquired U.S. Treasuries totaling approximately $282.6 million to substitute as collateral for the loan and which became the sole source of payment of the loan. The Company transferred the mortgage loan and U.S. Treasuries to a third-party successor entity and has been legally released as the primary obligor with respect to the loan. The defeasance was accounted for as an extinguishment of debt and the Company has recognized a loss from early extinguishment of debt totaling approximately $31.4 million consisting of the difference between the value of the U.S. Treasuries and the principal balance of the mortgage loan totaling approximately $28.2 million and the write-off of unamortized deferred financing costs totaling approximately $3.2 million.

During 2005, the Company entered into forward-starting interest rate swap contracts to lock the 10-year treasury rate and 10-year swap spread in contemplation of obtaining long-term fixed-rate financing to refinance existing debt that is expiring or freely prepayable prior to February 2007. Based on swap spreads at each trade date, the swaps fix the 10-year treasury rate for a financing in February 2007 at a weighted average of 4.34% per annum on notional amounts aggregating $500.0 million. The swaps go into effect in February 2007 and expire in February 2017. The Company entered into the interest rate swap contracts designated and qualifying as a cash flow hedges to reduce its exposure to the variability in future cash flows attributable to changes in the Treasury rate in contemplation of obtaining ten-year fixed-rate financing in early 2007. SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), as amended and interpreted, establishes accounting and reporting standards for derivative instruments. 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. At June 30, 2006, derivatives with a fair value of $34.2 million were included in Prepaid Expenses and Other Assets within the Company’s Consolidated Balance Sheets. For the six months ended June 30, 2006, the Company has recorded the changes in fair value of the swap contracts related to the effective portion of the

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

interest rate contracts totaling approximately $28.1 million in Accumulated Other Comprehensive Income (Loss) within the Company’s Consolidated Balance Sheets. The accumulated comprehensive income (loss) will be reclassified to interest expense over the term of the forecasted fixed-rate debt. The Company expects that within the next twelve months it will reclassify into earnings approximately $1.4 million of the amounts recorded within Accumulated Other Comprehensive Income (Loss) relating to the forward-starting interest rate swap contracts.

6. Unsecured Exchangeable Senior Notes

On April 6, 2006, the Company’s Operating Partnership closed an offering of $400 million in aggregate principal amount of its 3.75% exchangeable senior notes due 2036. On May 2, 2006, the Company’s Operating Partnership closed an additional $50 million aggregate principal amount of the notes as a result of the underwriter’s exercise of its over-allotment option. The notes will be exchangeable into the Company’s common stock at an initial exchange rate, subject to adjustment, of 8.9461 shares per $1,000 principal amount of notes (or an initial exchange price of approximately $111.78 per share of common stock) under the circumstances described in the prospectus supplement filed with the Securities and Exchange Commission on April 3, 2006. Noteholders may require the Operating Partnership to purchase the notes at par initially on May 18, 2013 and, after that date, the notes will be redeemable at par at the option of the Operating Partnership under the circumstances described in the prospectus supplement.

7. Unsecured Line of Credit

On May 19, 2005, the Company modified its $605.0 million unsecured revolving credit facility (the “Unsecured Line of Credit”) by extending the maturity date from January 17, 2006 to October 30, 2007, with a provision for a one-year extension at the option of the Company, subject to certain conditions, and by reducing the per annum variable interest rate on outstanding balances from Eurodollar plus 0.70% to Eurodollar plus 0.65% per annum. Under the Unsecured Line of Credit, a facility fee equal to 15 basis points per annum is payable in quarterly installments. The interest rate and facility fee are subject to adjustment in the event of a change in the Operating Partnership’s unsecured debt ratings. The Unsecured Line of Credit involves a syndicate of lenders. The Unsecured Line of Credit contains a competitive bid option that allows banks that are part of the lender consortium to bid to make loan advances to the Company at a reduced Eurodollar rate. The Company had an outstanding balance on the Unsecured Line of Credit of $225.0 million at June 30, 2006, which is collateralized by the Company’s 599 Lexington Avenue property and therefore is included in Mortgage Notes Payable in the Company’s Consolidated Balance Sheets.

The terms of the Unsecured Line of Credit require that the Company maintain a number of customary financial and other covenants on an ongoing basis, including: (1) a leverage ratio not to exceed 60%, however for a single period of not more than five consecutive quarters the leverage ratio can exceed 60% (but may not exceed 65%), (2) a secured debt leverage ratio not to exceed 55%, (3) a fixed charge coverage ratio of at least 1.40, (4) an unsecured leverage ratio not to exceed 60%, (5) a minimum net worth requirement, (6) an unsecured interest coverage ratio of at least 1.75 and (7) limitations on permitted investments, development, partially owned entities, business outside of commercial real estate and commercial non-office properties. At June 30, 2006, the Company was in compliance with each of these financial and other covenant requirements.

8. Commitments and Contingencies

General

In the normal course of business, the Company guarantees its performance of services or indemnifies third parties against its negligence.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The Company has letter of credit and performance obligations of approximately $22.8 million related to lender and development requirements.

The Company and its third-party joint venture partners have guaranteed the seller financing totaling $15.5 million related to the acquisition of the land by the WP Project Developer LLC, the Land and Infrastructure Entity of the Wisconsin Place joint venture entities. The Company and its third-party joint venture partners in the New York land venture have each agreed to guarantee approximately $11.8 million of the mortgage loan.

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. Under these provisions, the Company is not compelled to purchase the interest of its outside joint venture partners.

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, or TRIA, was enacted in November 2002 to require regulated insurers to make available coverage for certified acts of terrorism (as defined by the statute) through December 31, 2004, which date was extended to December 31, 2005 by the United States Department of Treasury on June 18, 2004 and which date was further extended to December 31, 2007 by the Terrorism Risk Insurance Extension Act of 2005 (the “TRIA Extension Act”). TRIA expires on December 31, 2007, and the Company cannot currently anticipate whether it will be extended. Effective as of March 1, 2006, the Company’s property insurance program per occurrence limits were decreased from $1 billion to $800 million, including coverage for both “certified” and “non-certified” acts of terrorism by TRIA. The amount of such insurance available in the market has decreased because of the natural disasters which occurred during 2005. The Company also carries nuclear, biological, chemical and radiological terrorism insurance coverage (“NBCR Coverage”) for “certified” acts of terrorism as defined by TRIA, which is provided by IXP, Inc. as a direct insurer. Effective as of March 1, 2006, the Company extended the NBCR Coverage to March 1, 2007, excluding the Company’s Value-Added Fund properties. Effective as of March 1, 2006, the per occurrence limit for NBCR Coverage was decreased from $1 billion to $800 million. Under TRIA, after the payment of the required deductible and coinsurance the NBCR Coverage is backstopped by the Federal Government if the aggregate industry insured losses resulting from a certified act of terrorism exceed a “program trigger.” Under the TRIA Extension Act (a) the program trigger is $5 million through March 31, 2006, $50 million from April 1, 2006 through December 31, 2006 and $100 million from January 1, 2007 through December 31, 2007 and (b) the coinsurance is 10% through December 31, 2006 and 15% through December 31, 2007. The Company may elect to terminate the NBCR Coverage when the program trigger increases on January 1, 2007, 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 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 are 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 with a $120 million per occurrence limit and a $120 million aggregate limit, $20 million of which is provided by IXP, Inc., as a direct insurer. The amount of the Company’s earthquake insurance coverage may not be sufficient to cover losses from earthquakes. As a result of increased costs of coverage and limited availability, the amount of third-party earthquake insurance that the Company may be able to purchase on commercially reasonable terms may be reduced. In addition, the Company may discontinue earthquake insurance on some or all of its properties in the future if the premiums exceed the Company’s estimation of the value of the coverage.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

In January 2002, the Company formed a wholly-owned taxable REIT subsidiary, IXP, Inc., or IXP, to act as a captive insurance company and be one of the elements of the Company’s overall insurance program. IXP 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 for “certified acts of terrorism” under TRIA. 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. 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 IXP’s 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.

The Company continues to monitor the state of the insurance market in general, and the scope and costs of coverage for acts of terrorism 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 or the presence of mold at the Company’s properties, 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.

9. Minority Interests

Minority interests relate to the interest in the Operating Partnership not owned by the Company and interests in property partnerships not wholly-owned by the Company. As of June 30, 2006, the minority interest in the Operating Partnership consisted of 21,147,685 OP Units, 513,835 LTIP Units and 3,360,199 Series Two Preferred Units (or 4,409,710 OP Units on an as converted basis) held by parties other than the Company.

The minority 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 $12.3 million and $18.0 million at June 30, 2006 and December 31, 2005, respectively, are included in Minority Interests on the accompanying Consolidated Balance Sheets.

On May 31, 2006, the Company redeemed the outside members’ equity interests in the limited liability company that owns Citigroup Center for an aggregate redemption price of $100 million, with $50 million paid at closing and $25 million to be paid on each of the first and second anniversaries of the closing or, if earlier, in connection with a sale of Citigroup Center. In addition, the parties terminated the existing tax protection agreement. The redemption was accounted for using the purchase method in accordance with Financial Accounting Standards Board’s (“FASB”) Statements of Financial Accounting Standards (“SFAS”) No. 141 “Business Combinations” (“SFAS No. 141”). The difference between the aggregate book value of the outside members’ equity interests totaling approximately $14.9 million and the purchase price increased the recorded value of the property’s net assets. The unpaid redemption price has been recorded at its fair value totaling approximately $45.6 million in Other Liabilities in the Company’s Consolidated Balance Sheets.

The Preferred Units at June 30, 2006 consist solely of 3,360,199 Series Two Preferred Units, which bear a preferred distribution equal to the greater of (1) the distribution which would have been paid in respect of the

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Series Two Preferred Unit had such Series Two Preferred Unit been converted into an OP Unit (including both regular and special distributions) or (2) an increasing rate, ranging from 5.00% to 7.00% per annum (7.00% for the three months ended June 30, 2006 and 2005) on a liquidation preference of $50.00 per unit, and are convertible into OP Units at a rate of $38.10 per Preferred Unit (1.312336 OP Units for each Preferred Unit). Distributions to holders of Preferred Units are recognized on a straight-line basis that approximates the effective interest method.

During the six months ended June 30, 2006, 341,136 Series Two Preferred Units of the Operating Partnership were converted by the holders into 447,685 OP Units.

During the six months ended June 30, 2006, 677,723 OP Units were presented by the holders for redemption and were redeemed by the Company in exchange for an equal number of shares of Common Stock. The aggregate book value of the OP Units that were redeemed, as measured for each OP Unit on the date of its redemption, was approximately $13.8 million. The difference between the aggregate book value and the purchase price of these OP Units was approximately $35.9 million, which increased the recorded value of the Company’s net assets.

On January 30, 2006, the Operating Partnership paid a distribution on the OP Units and LTIP Units in the amount of $0.68 per unit to holders of record as of the close of business on December 30, 2005. On April 28, 2006, the Operating Partnership paid a distribution on the OP Units and LTIP Units in the amount of $0.68 per unit to holders of record as of the close of business on March 31, 2006.

On February 15, 2006, the Operating Partnership paid a distribution on its outstanding Series Two Preferred Units of $4.17323 per unit, which amount includes the impact of the special cash distribution on the OP Units and LTIP Units declared by Boston Properties, Inc., as general partner of the Operating Partnership, in July 2005 and paid on October 31, 2005. On May 15, 2006, the Operating Partnership paid a distribution on its outstanding Series Two Preferred Units of $0.89239 per unit.

On June 19, 2006, Boston Properties, Inc., as general partner of the Operating Partnership, declared a distribution on the OP Units and LTIP Units in the amount of $0.68 per unit payable on July 31, 2006 to holders of record as of the close of business on June 30, 2006.

10. Stockholders’ Equity

As of June 30, 2006, the Company had 114,219,448 shares of Common Stock outstanding.

During the six months ended June 30, 2006, the Company issued 677,723 shares of its Common Stock in connection with the redemption of an equal number of OP Units.

During the six months ended June 30, 2006, the Company issued 990,902 shares of its Common Stock upon the exercise by employees of options to purchase Common Stock.

On January 30, 2006, the Company paid a dividend in the amount of $0.68 per share of Common Stock to shareholders of record as of the close of business on December 30, 2005. On April 28, 2006, the Company paid a dividend in the amount of $0.68 per share of Common Stock to shareholders of record as of the close of business on March 31, 2006.

On June 19, 2006, the Company’s Board of Directors declared a dividend in the amount of $0.68 per share of Common Stock payable on July 31, 2006 to shareholders of record as of the close of business on June 30, 2006.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

11. Discontinued Operations

Effective January 1, 2002, the Company adopted the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 requires that long-lived assets that are to be disposed of by sale be measured at the lesser of (1) book value or (2) fair value less cost to sell. In addition, it requires that one accounting model be used for long-lived assets to be disposed of by sale and broadens the presentation of discontinued operations to include more disposal transactions.

During the six months ended June 30, 2006, the Company sold 280 Park Avenue, a Class A office property totaling approximately 1,179,000 net rentable square feet located in midtown Manhattan. During the year ended December 31, 2005, the Company sold the following operating properties:

 

    Old Federal Reserve, a Class A office property totaling approximately 150,000 net rentable square feet located in San Francisco, California;

 

    100 East Pratt Street, a Class A office property totaling approximately 639,000 net rentable square feet located in Baltimore, Maryland;

 

    Riverfront Plaza, a Class A office property totaling approximately 910,000 net rentable square feet located in Richmond, Virginia;

 

    Residence Inn by Marriott®, a 221-room extended-stay hotel property located in Cambridge, Massachusetts;

 

    40-46 Harvard Street, an industrial property totaling approximately 152,000 net rentable square feet located in Westwood, Massachusetts; and

 

    Embarcadero Center West Tower, a Class A office property totaling approximately 475,000 net rentable square feet located in San Francisco, California.

Due to the Company’s continuing involvement in the management, for a fee, of 280 Park Avenue through an agreement with the buyer and other financial obligations to the buyer as discussed in Note 3, 280 Park Avenue has not been categorized as discontinued operations for the three and six months ended June 30, 2006 and 2005 in the accompanying Consolidated Statements of Operations. Due to the Company’s continuing involvement in the management, for a fee, of the 100 East Pratt Street, Riverfront Plaza and Embarcadero Center West Tower properties through agreements with the buyers, these properties are not categorized as discontinued operations for the three and six months ended June 30, 2005 in the accompanying Consolidated Statements of Operations. The Company has presented the other properties listed above as discontinued operations in its Consolidated Statements of Operations for the three and six months ended June 30, 2006 and 2005, as applicable.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

There were no properties categorized as discontinued operations for the three and six months ended June 30, 2006. The following table summarizes income from discontinued operations (net of minority interest) and the related realized gains on sales of real estate from discontinued operations (net of minority interest) for the three and six months ended June 30, 2005 (in thousands):

 

     For the three months
ended June 30,
    

For the six months

ended June 30,

 
     2006    2005      2006    2005  

Total revenue

   $ —      $ 2,739      $ —      $ 4,658  

Operating expenses

     —        1,675        —        3,579  

Depreciation and amortization

     —        193        —        559  

Minority interest in Operating Partnership

     —        144        —        85  
                               

Income from discontinued operations (net of minority interest)

   $ —      $ 727      $ —      $ 435  
                               

Realized gains on sales of real estate

   $ —      $ 10,141      $ —      $ 10,141  

Minority interest in Operating Partnership

     —        (1,752 )      —        (1,752 )
                               

Realized gains on sales of real estate (net of minority interest)

   $ —      $ 8,389      $ —      $ 8,389  
                               

The Company’s application of SFAS No. 144 results in the presentation of the net operating results of these qualifying properties sold during 2005 as income from discontinued operations. The application of SFAS No. 144 does not have an impact on net income available to common shareholders. SFAS No. 144 only impacts the presentation of these properties within the Consolidated Statements of Operations.

12. Earnings Per Share

Earnings per share (“EPS”) has been computed pursuant to the provisions of SFAS No. 128. The following table provides a reconciliation of both the net income and the number of common shares used in the computation of basic EPS, which is calculated by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period. During 2004, the Company adopted EITF 03-6 “Participating Securities and the Two-Class Method under FASB 128” (“EITF 03-6”), which provides further guidance on the definition of participating securities. Pursuant to EITF 03-6, the Operating Partnership’s Series Two Preferred Units, which are reflected as Minority Interests in the Company’s Consolidated Balance Sheets, are considered participating securities and are included in the computation of basic and diluted earnings per share of the Company if the effect of applying the if-converted method is dilutive. The terms of the Series Two Preferred Units enable the holders to obtain OP Units of the Operating Partnership, as well as Common Stock of the Company. Accordingly, for the reporting periods in which the Operating Partnership’s net income is in excess of distributions paid on the OP Units, LTIP Units and Series Two Preferred Units, such income is allocated to the OP Units, LTIP Units and Series Two Preferred Units in proportion to their respective interests and the impact is included in the Company’s consolidated basic and diluted earnings per share computation due to its holding of the Operating Partnership’s securities. For the three months ended June 30, 2006 and 2005, approximately $17.7 million and $3.7 million, respectively, were allocated to the Series Two Preferred Units in excess of distributions paid during the reporting period and are included in the Company’s computation of basic and diluted earnings per share. For the six months ended June 30, 2006 and 2005, approximately $18.3 million and $3.3 million, respectively, were allocated to the Series Two Preferred Units in excess of distributions paid during the reporting period and are included in the Company’s computation of basic and diluted earnings per share. Other potentially dilutive common shares, including 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.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

     For the three months ended June 30, 2006  
     Income
(Numerator)
    Shares
(Denominator)
   Per Share
Amount
 
     (in thousands, except for per share
amounts)
 

Basic Earnings:

       

Income available to common shareholders before allocation of undistributed earnings of Series Two Preferred Units

   $ 625,731     113,994    $ 5.49  

Allocation of undistributed earnings of Series Two Preferred Units

     (17,652 )   —        (0.16 )
                     

Net income available to common shareholders

     608,079     113,994      5.33  

Effect of Dilutive Securities:

       

Stock Based Compensation

     —       2,182      (0.10 )

Diluted Earnings:

       
                     

Net income

   $ 608,079     116,176    $ 5.23  
                     

 

     For the three months ended June 30, 2005  
     Income
(Numerator)
    Shares
(Denominator)
   Per Share
Amount
 
     (in thousands, except for per share
amounts)
 

Basic Earnings:

       

Income available to common shareholders before discontinued operations and allocation of undistributed earnings of Series Two Preferred Units

   $ 156,374     110,764    $ 1.41  

Discontinued operations, net of minority interest

     9,116     —        0.08  

Allocation of undistributed earnings of Series Two Preferred Units

     (3,700 )   —        (0.03 )
                     

Net income available to common shareholders

     161,790     110,764      1.46  

Effect of Dilutive Securities:

       

Stock Based Compensation

     —       2,339      (0.03 )

Diluted Earnings:

       
                     

Net income

   $ 161,790     113,103    $ 1.43  
                     
     For the six months ended June 30, 2006  
     Income
(Numerator)
    Shares
(Denominator)
   Per Share
Amount
 
     (in thousands, except for per share
amounts)
 

Basic Earnings:

       

Income available to common shareholders before allocation of undistributed earnings of Series Two Preferred Units

   $ 692,604     113,255    $ 6.11  

Allocation of undistributed earnings of Series Two Preferred Units

     (18,254 )   —        (0.16 )
                     

Net income available to common shareholders

     674,350     113,255      5.95  

Effect of Dilutive Securities:

       

Stock Based Compensation

     —       2,414      (0.12 )

Diluted Earnings:

       
                     

Net income

   $ 674,350     115,669    $ 5.83  
                     

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

     For the six months ended June 30, 2005  
     Income
(Numerator)
    Shares
(Denominator)
   Per
Share
Amount
 
     (in thousands, except for per share
amounts)
 

Basic Earnings:

       

Income available to common shareholders before discontinued operations and allocation of undistributed earnings of Series Two Preferred Units

   $ 217,900     110,477    $ 1.97  

Discontinued operations, net of minority interest

     8,824     —        0.08  

Allocation of undistributed earnings of Series Two Preferred Units

     (3,305 )   —        (0.03 )
                     

Net income available to common shareholders

     223,419     110,477      2.02  

Effect of Dilutive Securities:

       

Stock Based Compensation

     —       2,263      (0.04 )

Diluted Earnings:

       
                     

Net income

   $ 223,419     112,740    $ 1.98  
                     

13. Stock Option and Incentive Plan

During the six months ended June 30, 2006, the Company issued 9,182 shares of restricted stock and 140,561 LTIP Units under the stock option and incentive plan. The shares of restricted stock were valued at approximately $0.8 million ($89.03 per share weighted-average). The LTIP Units were valued at approximately $10.5 million ($75.03 per unit fair value) using an option pricing model in accordance with the provisions of SFAS No. 123R. The per unit fair value of each LTIP Unit granted was estimated on the date of grant using the following assumptions; an expected life of 6.5 years, a risk-free interest rate of 4.97% and an expected price volatility of 17.84%. 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 not included in Unearned Compensation within Stockholders’ Equity because they are securities issued by the Operating Partnership and have been included in Minority Interests in the Consolidated Balance Sheets. Employees vest in restricted stock and LTIP Units over a five-year term. Restricted stock and LTIP Units are measured at fair value on the date of grant based on the number of shares or units granted, as adjusted for forfeitures and the 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. Dividends paid on both vested and unvested shares of restricted stock and LTIP Units are charged directly to Earnings in Excess of Dividends in the Consolidated Balance Sheets. Stock-based compensation expense associated with restricted stock and LTIP Units was approximately $1.8 million and $1.6 million for the three months ended June 30, 2006 and 2005, respectively, and $4.1 million and $3.7 million for the six months ended June 30, 2006 and 2005, respectively.

14. 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 Greater Boston, Greater Washington, D.C., Midtown Manhattan, Greater San Francisco and New Jersey. Segments by property type include: Class A Office, Office/Technical and Hotels.

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, general and administrative expenses, interest expense,

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

depreciation and amortization expense, minority interest in property partnership, income from unconsolidated joint ventures, minority interest in Operating Partnership, gains on sales of real estate (net of minority interest), discontinued operations (net of minority interest) and losses from early extinguishments of debt are not included in Net Operating Income as the 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.

Information by geographic area and property type:

Three months ended June 30, 2006 (dollars in thousands):

 

     Greater
Boston
    Greater
Washington, D.C.
    Midtown
Manhattan
   

Greater

San Francisco

    New Jersey     Total  

Rental Revenue:

            

Class A

   $ 77,783     $ 55,435     $ 132,329     $ 44,958     $ 15,789     $ 326,294  

Office/Technical

     6,787       3,799       —         —         —         10,586  

Hotels

     19,674       —         —         —         —         19,674  
                                                

Total

     104,244       59,234       132,329       44,958       15,789       356,554  
                                                

% of Total

     29.24 %     16.61 %     37.11 %     12.61 %     4.43 %     100.00 %

Operating Expenses:

            

Class A

     29,118       14,527       40,269       17,608       6,739       108,261  

Office/Technical

     1,210       761       —         —         —         1,971  

Hotels

     12,770       —         —         —         —         12,770  
                                                

Total

     43,098       15,288       40,269       17,608       6,739       123,002  
                                                

% of Total

     35.04 %     12.43 %     32.74 %     14.31 %     5.48 %     100.00 %
                                                

Net Operating Income

   $ 61,146     $ 43,946     $ 92,060     $ 27,350     $ 9,050     $ 233,552  
                                                

% of Total

     26.18 %     18.82 %     39.42 %     11.71 %     3.87 %     100.00 %

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Three months ended June 30, 2005 (dollars in thousands):

 

     Greater
Boston
    Greater
Washington, D.C.
    Midtown
Manhattan
   

Greater

San Francisco

    New Jersey     Total  

Rental Revenue:

            

Class A

   $ 72,679     $ 56,395     $ 131,552     $ 50,393     $ 16,381     $ 327,400  

Office/Technical

     2,194       3,722       —         —         —         5,916  

Hotels

     17,566       —         —         —         —         17,566  
                                                

Total

     92,439       60,117       131,552       50,393       16,381       350,882  
                                                

% of Total

     26.34 %     17.14 %     37.49 %     14.36 %     4.67 %     100.00 %

Operating Expenses:

            

Class A

     26,296       14,506       39,257       18,336       6,870       105,265  

Office/Technical

     452       738       —         —         —         1,190  

Hotels

     12,495       —         —         —         —         12,495  
                                                

Total

     39,243       15,244       39,257       18,336       6,870       118,950  
                                                

% of Total

     32.99 %     12.82 %     33.00 %     15.41 %     5.78 %     100.00 %
                                                

Net Operating Income

   $ 53,196     $ 44,873     $ 92,295     $ 32,057     $ 9,511     $ 231,932  
                                                

% of Total

     22.94 %     19.35 %     39.79 %     13.82 %     4.10 %     100.00 %

Six months ended June 30, 2006 (dollars in thousands):

 

     Greater
Boston
    Greater
Washington, D.C.
    Midtown
Manhattan
   

Greater

San Francisco

    New Jersey     Total  

Rental Revenue:

            

Class A

   $ 152,842     $ 108,769     $ 267,734     $ 91,495     $ 32,573     $ 653,413  

Office/Technical

     13,281       7,606       —         —         —         20,887  

Hotels

     32,017       —         —         —         —         32,017  
                                                

Total

     198,140       116,375       267,734       91,495       32,573       706,317  
                                                

% of Total

     28.05 %     16.48 %     37.91 %     12.95 %     4.61 %     100.00 %

Operating Expenses:

            

Class A

     58,571       28,960       83,011       34,154       14,002       218,698  

Office/Technical

     2,633       1,515       —         —         —         4,148  

Hotels

     24,247       —         —         —         —         24,247  
                                                

Total

     85,451       30,475       83,011       34,154       14,002       247,093  
                                                

% of Total

     34.58 %     12.33 %     33.60 %     13.82 %     5.67 %     100.00 %
                                                

Net Operating Income

   $ 112,689     $ 85,900     $ 184,723     $ 57,341     $ 18,571     $ 459,224  
                                                

% of Total

     24.54 %     18.71 %     40.22 %     12.49 %     4.04 %     100.00 %

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Six months ended June 30, 2005 (dollars in thousands):

 

     Greater
Boston
    Greater
Washington, D.C.
    Midtown
Manhattan
   

Greater

San Francisco

    New Jersey     Total  

Rental Revenue:

            

Class A

   $ 147,104     $ 119,741     $ 258,165     $ 99,616     $ 32,934     $ 657,560  

Office/Technical

     4,358       7,408       —         —         —         11,766  

Hotels

     29,662       —         —         —         —         29,662  
                                                

Total

     181,124       127,149       258,165       99,616       32,934       698,988  
                                                

% of Total

     25.91 %     18.19 %     36.94 %     14.25 %     4.71 %     100.00 %

Operating Expenses:

            

Class A

     52,924       31,794       78,251       35,713       13,730       212,412  

Office/Technical

     988       1,539       —         —         —         2,527  

Hotels

     23,304       —         —         —         —         23,304  
                                                

Total

     77,216       33,333       78,251       35,713       13,730       238,243  
                                                

% of Total

     32.41 %     14.00 %     32.84 %     14.99 %     5.76 %     100.00 %
                                                

Net Operating Income

   $ 103,908     $ 93,816     $ 179,914     $ 63,903     $ 19,204     $ 460,745  
                                                

% of Total

     22.55 %     20.36 %     39.05 %     13.87 %     4.17 %     100.00 %

The following is a reconciliation of net operating income to net income available to common shareholders:

 

    

Three months

ended June 30,

   

Six months

ended June 30,

 
     2006     2005     2006     2005  
     (in thousands)     (in thousands)  

Net operating income

   $ 233,552     $ 231,932     $ 459,224     $ 460,745  

Add:

        

Development and management services income

     5,230       4,137       9,606       8,673  

Interest and other income

     8,565       2,916       10,530       4,547  

Minority interest in property partnership

     777       1,472       2,013       3,124  

Income from unconsolidated joint ventures

     1,677       847       2,967       2,182  

Gains on sales of real estate, net of minority interest

     581,302       102,073       585,844       103,281  

Income from discontinued operations, net of minority interest

     —         727       —         435  

Gains on sales of real estate from discontinued operations, net of minority interest

     —         8,389       —         8,389  

Less:

        

General and administrative expense

     (15,796 )     (14,252 )     (30,438 )     (29,065 )

Interest expense

     (78,449 )     (78,233 )     (153,266 )     (157,587 )

Depreciation and amortization expense

     (67,912 )     (67,026 )     (134,759 )     (134,822 )

Losses from early extinguishments of debt

     (31,457 )     (12,896 )     (31,924 )     (12,896 )

Minority interest in Operating Partnership

     (11,758 )     (14,596 )     (27,193 )     (30,282 )
                                

Net income available to common shareholders

   $ 625,731     $ 165,490     $ 692,604     $ 226,724  
                                

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

15. Newly Issued Accounting Standards

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments—an Amendment of FASB Statements No. 133 and 140” (“SFAS No. 155”). The purpose of SFAS No. 155 is to simplify the accounting for certain hybrid financial instruments by permitting fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company does not expect the adoption of SFAS No. 155 to have a material impact on the Company’s cash flows, results of operations, financial position or liquidity.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets—an Amendment of FASB Statement No. 140” (“SFAS No. 156”). SFAS No. 156 requires recognition of a servicing asset or a servicing liability each time an entity undertakes an obligation to service a financial asset by entering into a servicing contract. SFAS No. 156 also requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value and subsequently measured at fair value at each reporting date. SFAS No. 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company does not expect the adoption of SFAS No. 156 to have a material impact on the Company’s cash flows, results of operations, financial position or liquidity.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109” (“FIN No. 48”). FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on description, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating and assessing the impact of this interpretation.

16. Subsequent Events

On July 19, 2006, the Company executed a contract to acquire 3200 Zanker Road, an approximately 544,000 net rentable square foot Class A office complex located in San Jose, California, at a purchase price of approximately $126.0 million. The acquisition is subject to the satisfaction of customary closing conditions and there can be no assurance that the acquisition will be consummated on the terms currently contemplated or at all.

On August 1, 2006, the Company repaid the construction financing and permanent financing totaling approximately $34.0 million and $49.7 million, respectively, collateralized by the Capital Gallery property in Washington, D.C. The construction financing was provided by the same lender as the permanent financing. Capital Gallery had previously consisted of a Class A office property totaling approximately 397,000 net rentable square feet. The purpose of the construction financing was to fund a portion of the cost of an expansion project at the property. The expansion project entailed removing a three-story low-rise section of the property comprised of 100,000 net rentable square feet from in-service status and redeveloping it into a ten-story office building. Upon completion, the total complex size will approximate 610,000 net rentable square feet. The construction financing bore interest at a variable rate equal to LIBOR plus 1.65% per annum and was scheduled to mature in February 2008. The permanent financing bore interest at a fixed rate equal to 8.24% per annum and was scheduled to mature on August 15, 2006. The agreement with the lender provided an extension provision for the existing mortgage loan to coincide with the February 2008 maturity date of the construction financing.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

On August 1, 2006, 1,621,132 Series Two Preferred Units of the Operating Partnership were converted by the holders thereof into 2,127,471 OP Units. The OP Units were subsequently presented by the holders for redemption and were redeemed by the Company in exchange for an equal number of shares of Common Stock.

On August 3, 2006, the Company amended and restated its $605.0 million Unsecured Line of Credit as amended and restated, the “August 2006 Unsecured Line of Credit,” by extending the maturity date from October 30, 2007 to August 3, 2010, with a provision for a one-year extension at the option of the Company, subject to certain conditions, and by reducing the per annum variable interest rate on outstanding balances from Eurodollar plus 0.65% to Eurodollar plus 0.55% per annum. Under the August 2006 Unsecured Line of Credit, a facility fee equal to 15 basis points per annum is payable in quarterly installments. The interest rate and facility fee are subject to adjustment in the event of a change in the Operating Partnership’s unsecured debt ratings. The August 2006 Unsecured Line of Credit involves a syndicate of lenders. The August 2006 Unsecured Line of Credit contains a competitive bid option that allows banks that are part of the lender consortium to bid to make loan advances to the Company at a reduced Eurodollar rate.

 

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BOSTON PROPERTIES, INC.

 

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

As used herein, the terms “we,” “us,” “our” or 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.

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. This Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. We caution investors that any forward-looking statements presented in this report, or which management may make orally or in writing from time to time, are based on beliefs and assumptions made by, and information currently available to, 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:

 

    general risks affecting the real estate industry (including, without limitation, the inability to enter into or renew leases, 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 successfully;

 

    risks and uncertainties affecting property development and construction (including, without limitation, construction delays, cost overruns, inability to obtain necessary permits and public opposition to such activities);

 

    risks associated with the availability and terms of financing and the use of debt to fund acquisitions and developments, including the risk associated with interest rates impacting 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;

 

    risks associated with the impact on our insurance program if TRIA, which expires on December 31, 2007, is not extended or is extended on different terms;

 

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

 

    potential liability for uninsured losses and environmental contamination;

 

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

 

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BOSTON PROPERTIES, INC.

 

    possible adverse changes in tax and environmental laws;

 

    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 Annual Reports 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. 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 five markets—Boston, midtown Manhattan, Washington, D.C., San Francisco and Princeton, N.J. We generate revenue and cash primarily by leasing our 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, the costs of tenant improvements, current and anticipated operating costs and real estate taxes, our current and anticipated vacancy, current and anticipated future demand for office space generally and general economic factors. We also generate cash through the sale of assets, which may be either non-core assets that have limited growth potential or core assets that command premiums from real estate investors.

The office markets in which we operate continued to show dramatic improvement into the second quarter of 2006. We continue to experience strong rental growth in midtown Manhattan, San Francisco, Washington, D.C. and the Boston suburbs. We continue to see improvement in market leasing conditions, highlighted by the accelerating growth of rents in midtown Manhattan. We expect this trend to continue, but its impact on our rental revenues will be felt gradually given the modest amount of 2006 lease expirations. Moreover, some of the leases that expire in 2006 reflect the high rents achieved in the late 1990s and early 2000s, and therefore we will experience some roll down in near-term rents despite the positive overall trends.

We remain in a period of sustained job growth with little projection of shadow space or direct vacancy in our markets. High-quality space alternatives of any significant size are quickly disappearing. Rents and lease transaction economics are improving and in most instances, though not all, we have been able to increase rents in response to improving demand. Our second quarter lease executions continued at a strong pace, totaling just over 1.1 million square feet in 84 new leases and/or amendments. This activity was spread evenly throughout our portfolio.

We continue to believe that the best utilization of our management skills is in the continued success of our development strategies. Given current market conditions, we generally believe that the returns we can generate from developments will be significantly greater than those we can expect to realize from acquisitions. As a result, we will continue to focus significant energy and capital on our current and future development pipeline. We are also considering alternative uses (i.e., non-office) for some of our land holdings and may participate in or

 

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undertake alternative development projects. We currently own land totaling approximately 7.2 million developable square feet in our portfolio with another 2.4 million developable square feet in land purchase options.

On June 6, 2006, we completed the sale of 280 Park Avenue, a Class A office property located in midtown Manhattan, for approximately $1.2 billion. We did not identify any replacement properties for 280 Park Avenue under the like-kind exchange provisions of Section 1031 of the Internal Revenue Code and, therefore, our aggregate distributions for the 2006 tax year will include, in addition to our regular quarterly distributions, at least that portion of the sale proceeds necessary for us to avoid paying corporate level tax on the estimated taxable gain of $750 million. Under applicable tax rules, distributions for the 2006 tax year must be paid by January 30, 2007.

We believe the sale of 280 Park Avenue is evidence of a trend that sees allocators of capital continuing to place premiums on high-quality, well-located office buildings resulting in lower capitalization rates and higher prices per square foot. As an owner of these types of assets, we are pleased with higher valuations, and we intend to continue to explore the selective sale of some of our assets (including large core assets) to realize some of this value. Unfortunately, the same market conditions that are leading to record valuations for Class A office buildings and that make significant asset sales attractive to us are also continuing to make it more difficult for us to acquire assets at what we believe to be attractive rates of return. However, we have acquired and intend to pursue the acquisition of assets at attractive initial rates of return, below replacement cost or where the existing leases demonstrate potential for long-term returns consistent with our underwriting philosophy.

The highlights of the three months ended June 30, 2006 included the following:

 

    On April 1, 2006, we placed-in-service 12290 Sunrise Valley, a 182,000 net rentable square foot Class A office property located in Reston, Virginia. We have leased 100% of the space.

 

    On April 6, 2006, our Operating Partnership closed an offering of $400 million in aggregate principal amount of its 3.75% exchangeable senior notes due 2036. On May 2, 2006, our Operating Partnership closed an additional $50 million aggregate principal amount of the notes as a result of the underwriter’s exercise of its over-allotment option. The notes will be exchangeable into our common stock at an initial exchange rate, subject to adjustment, of 8.9461 shares per $1,000 principal amount of notes (or an initial exchange price of approximately $111.78 per share of common stock) under the circumstances described in the prospectus supplement filed with the Securities and Exchange Commission on April 3, 2006. Noteholders may require the Operating Partnership to purchase the notes at par initially on May 18, 2013 and, after that date, the notes will be redeemable at par at the option of the Operating Partnership under the circumstances described in the prospectus supplement.

 

    On April 13, 2006, we acquired a parcel of land located in Waltham, Massachusetts for a purchase price of $16.0 million.

 

    On May 31, 2006, we redeemed the outside members’ equity interests in the limited liability company that owns Citigroup Center for an aggregate redemption price of $100 million, with $50 million paid at closing and $25 million to be paid on each of the first and second anniversaries of the closing or, if earlier, in connection with a sale of Citigroup Center. In addition, the parties terminated the existing tax protection agreement.

 

    On June 5, 2006, we repaid the mortgage loan collateralized by our 191 Spring Street property located in Lexington, Massachusetts totaling approximately $17.9 million using available cash. There was no prepayment penalty associated with the repayment. The mortgage loan bore interest at a fixed rate of 8.50% per annum and was scheduled to mature on September 1, 2006.

 

   

On June 6, 2006, we completed the sale of 280 Park Avenue, a Class A office property of approximately 1,179,000 net rentable square feet located in midtown Manhattan, for approximately $1.2 billion in cash. Net cash proceeds were approximately $875 million, after legal defeasance of indebtedness secured by the property (consisting of approximately $254.4 million of principal indebtedness and approximately

 

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$28.2 million of related defeasance costs) and the payment of transfer taxes, brokers’ fees and other customary closing costs. As part of the transaction, we have been engaged by the buyer as the property manager and leasing agent for 280 Park Avenue for a one-year term that renews automatically.

 

    On June 30, 2006, we acquired 303 Almaden Boulevard, a Class A office property with approximately 157,000 net rentable square feet located in San Jose, California, at a purchase price of approximately $45.2 million. The acquisition was financed with available cash.

Transactions completed subsequent to June 30, 2006:

 

    On July 19, 2006, we executed a contract to acquire 3200 Zanker Road, an approximately 544,000 net rentable square foot Class A office complex located in San Jose, California, at a purchase price of approximately $126.0 million. The acquisition is subject to the satisfaction of customary closing conditions and there can be no assurances that the acquisition will be consummated on the terms currently contemplated or at all.

 

    On August 1, 2006, we repaid the construction financing and permanent financing totaling approximately $34.0 million and $49.7 million, respectively, collateralized by our Capital Gallery property in Washington, D.C. The construction financing was provided by the same lender as the permanent financing.

 

    On August 3, 2006, we modified our $605.0 million Unsecured Line of Credit by extending the maturity date from October 30, 2007 to August 3, 2010, with a provision for a one-year extension at our option, subject to certain conditions, and by reducing the per annum variable interest rate on outstanding balances from Eurodollar plus 0.65% to Eurodollar plus 0.55% per annum.

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, we assess the fair value of acquired tangible and intangible assets, including land, buildings, tenant improvements, “above-” and “below-market” leases, origination costs, acquired in-place leases, other identified intangible assets and assumed liabilities in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” and allocate the purchase price to the acquired assets and assumed liabilities, including land at appraised value and buildings at replacement cost. We assess and consider fair value based on estimated cash flow projections that utilize appropriate discount and/or capitalization rates, 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. 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

 

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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. 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.

Real estate is stated at depreciated cost. The cost of buildings and improvements includes the purchase price of property, legal fees and other acquisition 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.

Management reviews its long-lived assets used in operations for impairment 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 impairment is 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 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” as defined by SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets,” (“SFAS No. 144”) 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 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 impairment has occurred, the affected assets must be reduced to their fair value. No such impairment losses have been recognized to date.

SFAS No. 144 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 the property sale within one year is considered probable. Following the classification of a property as “held for sale,” no further depreciation is recorded on the assets.

A variety of costs are incurred in the acquisition, development and leasing of properties. After 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 is substantially complete and capitalization must cease involves a degree of judgement. Our capitalization policy on development properties is guided by SFAS No. 34 “Capitalization of Interest Cost” and SFAS No. 67 “Accounting for Costs and the Initial Rental Operations of Real Estate Projects.” The costs of land and buildings under development include specifically identifiable costs. The capitalized costs include pre-construction costs essential 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 consider a construction project as substantially completed and held available for occupancy

 

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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 and (2) occupied or held available for occupancy, and we capitalize only those costs associated with the portion under construction.

Investments in Unconsolidated Joint Ventures

Except for ownership interests in variable interest entities, we account for our investments in joint ventures under the equity method of accounting because we exercise significant influence over, but do not control, these entities. These investments are recorded initially at cost, as Investments in Unconsolidated Joint Ventures, and subsequently adjusted for equity in earnings and cash contributions and distributions. Any difference between the carrying amount of these investments on our 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 is reflected within the Consolidated Balance Sheets, and our share of net 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. For ownership interests in variable interest entities, we consolidate those in which we are the primary beneficiary.

Revenue Recognition

Base rental revenue is reported on a straight-line basis over the terms of our respective leases. In accordance with SFAS No. 141, we recognize rental revenue of acquired in-place “above-” and “below-market” leases at their fair values over the terms 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.

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;

 

    debt to market capitalization; 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) low risk tenants;

 

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

 

    require a security deposit; and/or

 

    reduce upfront tenant improvement investments; or
  (3) the tenant’s credit is below our acceptable parameters.

We maintain a rigorous process of monitoring 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.

 

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Tenant receivables are assigned a credit rating of 1-4 with a rating of 1 representing the highest possible rating with no allowance recorded and a rating of 4 representing the lowest credit rating, recording 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 collectibility 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 was approximately 7.7 years as of June 30, 2006. 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 continual 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 the expenses are incurred. Tenant reimbursements are recognized and presented in accordance with Emerging Issues Task Force, or EITF, Issue 99-19 “Reporting Revenue Gross as a Principal versus Net as an Agent,” or Issue 99-19. Issue 99-19 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.

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

We receive management and development fees from third parties. 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 on a straight-line basis or percentage of completion depending on the risk associated with each project. Profit on development fees earned from joint venture projects is 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 of SFAS No. 66, “Accounting for Sales of Real Estate.” The specific timing of the sale is measured against various criteria in SFAS No. 66 related to the terms of the transactions and any continuing involvement in the form of management or financial assistance associated with the properties. If the sales criteria are not met, we defer gain recognition and account for the continued operations of the property by applying the finance, 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. In accordance with SFAS No. 141, we allocate the acquisition cost of real estate to land, building, tenant improvements, acquired “above-” and “below-market” leases, origination costs and acquired in-place leases based on an assessment of their fair value 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.

 

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Fair Value of Financial Instruments

For purposes of disclosure, we calculate the fair value of our mortgage notes payable and unsecured senior notes. We discount the spread between the future contractual interest payments and future interest payments on our mortgage debt and unsecured notes based on a current market rate. In determining the current market rate, we add our estimate of a market spread to the quoted yields on federal government treasury securities with similar maturity dates to our own debt. Because our valuations of our financial instruments are based on these types of estimates, the fair value of our financial instruments may change if our estimates do not prove to be accurate.

Results of Operations

The following discussion is based on our Consolidated Financial Statements for the three and six months ended June 30, 2006 and 2005.

At June 30, 2006 and June 30, 2005, we owned or had interests in a portfolio of 124 and 122 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 are necessarily meaningful. Therefore, the comparison of operating results for the three and six months ended June 30, 2006 and 2005 show separately the changes attributable to the properties that were owned by us throughout each period compared (the “Same Property Portfolio”) and the changes attributable to the Total Property Portfolio.

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 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 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 repositioned 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 available to common shareholders, the most directly comparable GAAP financial measure, plus minority interest in Operating Partnership, losses from early extinguishment of debt, depreciation and amortization, interest expense, general and administrative expense, income from discontinued operations (net of minority interest), less gains on sales of real estate (net of minority interest), income from unconsolidated joint ventures, minority interest in property partnership, 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 perspective not immediately apparent from net income. NOI excludes certain components from net income 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 as presented in our

 

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consolidated financial statements. NOI should not be considered as an alternative to net income as an indication of our performance or to cash flows as a measure of liquidity or ability to make distributions.

Comparison of the six months ended June 30, 2006 to the six months ended June 30, 2005.

The table below shows selected operating information for the Same Property Portfolio and the Total Property Portfolio. The Same Property Portfolio consists of the 115 properties totaling approximately 29.9 million net rentable square feet of space (excluding approximately 9.1 million square feet of structured parking for approximately 29,835 vehicles). The Same Property Portfolio includes two hotel properties, properties acquired or placed in-service on or prior to January 1, 2005 and owned through June 30, 2006. The Total Property Portfolio includes the effects of the other properties either placed in-service, acquired or repositioned after January 1, 2005 or disposed of on or prior to June 30, 2006. 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, 2006 and 2005 with respect to the properties which were acquired, placed in-service, repositioned or sold.

In September 2004, we commenced the redevelopment of our Capital Gallery property in Washington, D.C. Capital Gallery is a Class A office property currently totaling approximately 397,000 net rentable square feet. The project entails removing a three-story low-rise section of the property, which is comprised of 100,000 net rentable square feet, from in-service status and developing it into a ten-story office building resulting in a total complex size of approximately 620,000 net rentable square feet. In April 2006, tenants began to take initial occupancy. This property is included in Properties Repositioned for the six months ended June 30, 2006 and June 30, 2005.

 

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     Same Property Portfolio     Properties Sold    Properties
Acquired
  

Properties Placed

In-Service

   Properties
Repositioned
   Total Property Portfolio  
     2006    2005   

Increase/

(Decrease)

    % Change     2006    2005    2006     2005    2006    2005    2006    2005    2006     2005    

Increase/

(Decrease)

    % Change  
     (dollars in thousands)  

Rental Revenue:

                                         

Rental Revenue

   $ 617,528    $ 597,456    $ 20,072     3.36 %   $ 32,408    $ 59,945    $ 3,437     $ —      $ 10,390    $ —      $ 8,325    $ 6,570    $ 672,088     $ 663,971     $ 8,117     1.22 %

Termination Income

     2,212      2,957      (745 )   (25.19 %)     —        2,398      —         —        —        —        —        —        2,212       5,355       (3,143 )   (58.69 %)
                                                                                                                   

Total Rental Revenue

     619,740      600,413      19,327     3.22 %     32,408      62,343      3,437       —        10,390      —        8,325      6,570      674,300       669,326       4,974     0.74 %
                                                                                                                   

Operating Expenses

     203,123      188,467      14,656     7.78 %     14,080      24,833      1,768       —        1,685      —        2,190      1,639      222,846       214,939       7,907     3.68 %
                                                                                                                   
Net Operating Income, excluding hotels      416,617      411,946      4,671     1.13 %     18,328      37,510      1,669       —        8,705      —        6,135      4,931      451,454       454,387       (2,933 )   (0.65 %)
                                                                                                                   
Hotel Net Operating Income (1)      7,770      6,358      1,412     22.21 %     —        —        —         —        —        —        —        —        7,770       6,358       1,412     22.21 %
                                                                                                                   
Consolidated Net Operating Income (1)      424,387      418,304      6,083     1.45 %     18,328      37,510      1,669       —        8,705      —        6,135      4,931      459,224       460,745       (1,521 )   (0.33 %)
                                                                                                                   

Other Revenue:

                                         

Development and Management Services

     —        —        —       —         —        —        —         —        —        —        —        —        9,606       8,673       933     10.76 %

Interest and Other

     —        —        —       —         —        —        —         —        —        —        —        —        10,530       4,547       5,983     131.58 %
                                                                                                                   

Total Other Revenue

     —        —        —       —         —        —        —         —        —        —        —        —        20,136       13,220       6,916     52.31 %

Other Expenses:

                                         

General and administrative expense

     —        —        —       —         —        —        —         —        —        —        —        —        30,438       29,065       1,373     4.72 %

Interest

     —        —        —       —         —        —        —         —        —        —        —        —        153,266       157,587       (4,321 )   (2.74 %)
Depreciation and amortization      125,116      123,525      1,591     1.29 %     3,501      10,407      1,665       —        3,342      —        1,135      890      134,759       134,822       (63 )   (0.05 %)
Loss from early extinguishments of debt      —        —        —       —         —        —        —         —        —        —        —        —        31,924       12,896       19,028     147.55 %
                                                                                                                   

Total Other Expenses

     125,116      123,525      1,591     1.29 %     3,501      10,407      1,665       —        3,342      —        1,135      890      350,387       334,370       16,017     4.79 %
                                                                                                                   
Income before minority interests    $ 299,271    $ 294,779      4,492     1.52 %   $ 14,827    $ 27,103    $ 4     $ —      $ 5,363    $ —      $ 5,000    $ 4,041    $ 128,973     $ 139,595       (10,622 )   (7.61 %)
Income from unconsolidated joint ventures    $ 1,470    $ 1,441    $ 29     2.01 %   $ —      $ 17    ($ 179 )   $ —      $ 1,676    $ 724    $ —      $ —        2,967       2,182       785     35.98 %
Income from discontinued operations, net of minority interest    $ —      $ —      $ —       —       $ —  $    $ 435    $ —       $ —      $ —      $ —      $ —      $ —        —         435       (435 )   (100.0 %)

Minority interest in property partnership

     2,013       3,124       (1,111 )   (35.56 %)

Minority interest in Operating Partnership

     (27,193 )     (30,282 )     3,089     10.20 %

Gains on sales of real estate, net of minority interest

     585,844       103,281       482,563     467.23 %

Gain on sale of real estate from discontinued operations, net of minority interest

     —         8,389       (8,389 )   (100.0 %)
                                                               

Net Income available to common shareholders

   $ 692,604     $ 226,724     $ 465,880     205.48 %
                                                               

(1) For a detailed discussion of NOI, including the reasons management believes NOI is useful to investors, see page 32.

 

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Rental Revenue

The increase of approximately $8.1 million in the Total Property Portfolio is comprised of increases and decreases within the five categories that comprise our Total Property Portfolio. Rental revenue from the Same Property Portfolio increased approximately $20.1 million, Properties Sold decreased approximately $27.5 million, Properties Acquired increased approximately $3.4 million, Properties Placed In-Service increased approximately $10.4 million and Properties Repositioned increased approximately $1.8 million for the six months ended June 30, 2006 compared to the six months ended June 30, 2005.

Rental revenue from the Same Property Portfolio increased approximately $20.1 million for the six months ended June 30, 2006 compared to 2005. Included in rental revenue is an overall increase in base rental revenue of approximately $27.0 million, offset by a decrease of approximately $18.2 million in straight line rents, primarily due to the reduction of free rent at Times Square Tower during the prior year. Approximately $10.6 million of the increase from the Same Property Portfolio was due to an increase in recoveries from tenants and approximately $0.7 million of the increase from the Same Property Portfolio was due to an increase in parking and other income. With relatively little roll-over in the remainder of 2006 and much of the related rent commencement deferred into 2007 for much of our currently vacant space, we do not expect more than a modest increase in the Same Property Portfolio rental revenue during the remainder of 2006.

The increase in rental revenue from Properties Placed In-Service relates to placing in-service our Seven Cambridge Center development project in the first quarter of 2006 and 12290 Sunrise Valley in the second quarter of 2006. Rental revenue from Properties Placed In-Service increased approximately $10.4 million, as detailed below:

 

        Rental Revenue for the six months ended June 30

Property

 

Date Placed In-Service

      2006           2005           Change    
        (in thousands)

Seven Cambridge Center

  First Quarter, 2006   $ 9,083   $ —     $ 9,083

12290 Sunrise Valley

  Second Quarter, 2006     1,307     —       1,307
                   

Total

    $ 10,390   $ —     $ 10,390
                   

The acquisition of Prospect Place on December 30, 2005 and 303 Almaden Boulevard on June 30, 2006 increased revenue from Properties Acquired by approximately $3.4 million for the six months ended June 30, 2006.

The aggregate increase in rental revenue was offset by the sales of 280 Park Avenue in June of 2006 and Embarcadero Center West Tower, Riverfront Plaza and 100 East Pratt Street during 2005. These properties have not been classified as discontinued operations due to our continuing involvement as the property manager for each property. Rental Revenue from Properties Sold decreased by approximately $27.5 million, as detailed below:

 

         Rental Revenue for the six months ended June 30  

Property

  

Date Sold

      2006           2005           Change      
         (in thousands)  

280 Park Avenue

   June 6, 2006   $ 32,408   $ 34,965   ($ 2,557 )

Riverfront Plaza

   May 16, 2005     —       8,726     (8,726 )

100 East Pratt Street

   May 12, 2005     —       8,434     (8,434 )

Embarcadero Center West Tower

   December 14, 2005     —       7,820     (7,820 )
                      

Total

     $ 32,408   $ 59,945   ($ 27,537 )
                      

 

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Rental revenue from Properties Repositioned for the six months ended June 30, 2006 increased approximately $1.8 million over the six months ended June 30, 2005. In April 2006 tenants began to take occupancy at our redevelopment project at Capital Gallery. We anticipate placing the project in-service during the third quarter of 2006 with initial occupancy of approximately 83%.

Termination Income

Termination income for the six months ended June 30, 2006 was related to ten tenants across the Total Property Portfolio that terminated their leases, and we recognized termination income totaling approximately $2.2 million. This compared to termination income of $5.4 million for the six months ended June 30, 2005 related to twelve tenants. We currently anticipate realizing approximately $1.0 million in termination income in each of the third and fourth quarters of 2006.

Operating Expenses

The $7.9 million increase in property operating expenses (real estate taxes, utilities, insurance, repairs and maintenance, cleaning and other property-related expenses) in the Total Property Portfolio is mainly comprised of increases and decreases within five categories that comprise our Total Property Portfolio. Operating expenses for the Same Property Portfolio increased approximately $14.7 million, Properties Sold decreased approximately $10.8 million, Properties Acquired increased approximately $1.8 million, Properties Placed In-Service increased approximately $1.7 million and Properties Repositioned increased approximately $0.5 million.

Operating expenses from the Same Property Portfolio increased approximately $14.7 million for the six months ended June 30, 2006 compared to 2005. Included in Same Property Portfolio operating expenses is an increase in utility expenses of approximately $6.1 million, an increase of approximately 18% over the prior year to date utility expense. In addition, real estate taxes increased approximately $4.3 million due to increased real estate tax assessments, with more than half of this increase specifically attributed to properties located in New York City. The remaining $4.3 million increase in the Same Property Portfolio operating expenses is related to an increase in repairs and maintenance.

The increase in operating expenses from Properties Placed In-Service relates to placing in-service our Seven Cambridge Center development project in the first quarter of 2006 and 12290 Sunrise Valley in the second quarter of 2006. Operating expenses from Properties Placed In-Service increased approximately $1.7 million, as detailed below:

 

        Operating Expenses for the six months ended June 30

Property

 

Date Placed In-Service

      2006           2005           Change    
        (in thousands)

Seven Cambridge Center

  First Quarter, 2006   $ 1,567   $ —     $ 1,567

12290 Sunrise Valley

  Second Quarter, 2006     118     —       118
                   

Total

    $ 1,685   $ —     $ 1,685
                   

A decrease of approximately $10.8 million in the Total Property Portfolio operating expenses was due to the sales of 280 Park Avenue in June of 2006 and Embarcadero Center West Tower, 100 East Pratt Street and Riverfront Plaza in 2005, as detailed below.

 

         Operating Expenses for the six months ended June 30  

Property

  

Date Sold

      2006               Change      
         (in thousands)  

280 Park Avenue

   June 6, 2006   $ 14,080   $ 15,683   ($ 1,603 )

100 East Pratt Street

   May 12, 2005     —       2,971     (2,971 )

Riverfront Plaza

   May 16, 2005     —       2,839     (2,839 )

Embarcadero Center West Tower

   December 14, 2005     —       3,339     (3,339 )
                      

Total

     $ 14,080   $ 24,832   ($ 10,752 )
                      

 

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Our redevelopment project at Capital Gallery opened in April 2006 as tenants began to take occupancy. Operating expenses from Properties Repositioned for the six months ended June 30, 2006 increased approximately $0.5 million over the six months ended June 30, 2005.

We continue to review and monitor the impact of rising insurance costs and energy costs, as well as other factors, on our operating budgets for fiscal year 2006. Because some operating expenses are not recoverable from tenants, an increase in operating expenses due to one or more of the foregoing factors could have an adverse effect on our results of operations.

Hotel Net Operating Income

Net operating income for the hotel properties increased approximately $1.4 million, a 22.2% increase for the six months ended June 30, 2006 as compared to 2005. For the six months ended June 30, 2005 the operations of the Residence Inn by Marriott® has been included as part of discontinued operations due to its sale on November 4, 2005. Revenue from the hotels continued to improve in the second quarter, primarily as a result of citywide conventions. We expect the hotels to contribute between $12 million and $13 million of net operating income for the remainder of the year ending December 31, 2006.

The following reflects our occupancy and rate information for our hotel properties for the six months ended June 30, 2006 and 2005:

 

     2006     2005     Percentage
Change
 

Occupancy

     75.3 %     75.6 %   (0.4 %)

Average daily rate

   $ 207.07     $ 186.43     11.1 %

Revenue per available room, REVPAR

   $ 160.31     $ 141.50     13.3 %

Development and Management Services

Development and Management Services income increased approximately $1.0 million for the six months ended June 30, 2006 compared to 2005. Development income decreased slightly due to the completion of third-party development projects at 901 New York Avenue in 2005 and the National Institute of Health in Washington, D.C. Management Service income has increased approximately $1.3 million due to maintaining management contracts following the sales of 100 East Pratt Street, Riverfront Plaza and Embarcadero Center West Tower as well as the sale of 280 Park Avenue on June 6, 2006. We expect our third-party management and development fee income for the calendar year 2006 to be between $15 million and $16 million, which includes the income from our continued management of 280 Park Avenue.

Interest and Other Income

Interest and other income increased by approximately $6.0 million for the six months ended June 30, 2006 compared to 2005 as a result of higher overall interest rates as well as the timing of our cash balances for the six months ended June 30, 2006 compared to June 30, 2005. During the second quarter we raised $450 million through our Operating Partnership’s unsecured exchangeable senior notes. On June 6, 2006, we completed the sale of 280 Park Avenue for net cash proceeds of approximately $875 million. We did not identify any replacement properties for 280 Park Avenue under the like-kind exchange provisions of Section 1031 of the Internal Revenue Code and, therefore, our aggregate distributions for the 2006 tax year will include, in addition to our regular quarterly distributions, at least that portion of the sale proceeds necessary for us to avoid paying corporate level tax on the estimated taxable gain. We continue to look at additional asset sales as a way to monetize the strong valuations in the market. We expect interest income to be between $37 million and $38 million for 2006 given the additional cash balances we are currently carrying.

 

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Other Expenses

General and Administrative

General and administrative expenses increased approximately $1.4 million for the six months ended June 30, 2006 compared to 2005. An overall increase of approximately $2.2 million was attributed to bonuses and salaries for the six months ended June 30, 2006 compared to 2005. These increases were offset by a decrease of approximately $0.5 million attributable to accounting- and legal-related expenses, as well as other overall decreases of approximately $0.3 million. We anticipate our general and administrative expenses to be approximately $60.0 million for the year 2006.

Commencing in 2003, we issued restricted stock and/or LTIP Units, as opposed to granting stock options and restricted stock, under the 1997 Stock Option and Incentive Plan as our primary vehicle for employee equity compensation. An LTIP Unit is generally the economic equivalent of a share of our restricted stock. Employees generally vest in restricted stock and LTIP Units over a five-year term (for awards granted prior to 2003, vesting is in equal annual installments; for those granted in 2003 and later, vesting is over a five-year term with annual vesting of 0%, 0%, 25%, 35% and 40%). Restricted stock and LTIP Units are valued based on observable market prices for similar instruments. Such value is recognized as an expense ratably over the corresponding employee service period. LTIP Units that were issued in January 2005 and all subsequent LTIP Unit awards will be valued using an option pricing model in accordance with the provisions of SFAS No. 123R. To the extent restricted stock or LTIP Units are forfeited prior to vesting, the corresponding previously recognized expense is reversed as an offset to “stock-based compensation.” Stock-based compensation expense associated with $6.1 million of equity-based compensation that was granted in January 2003 and $9.7 million in January 2004 will generally be expensed ratably as such restricted stock and LTIP Units vests over a five-year vesting period. Stock-based compensation associated with approximately $11.4 million of restricted stock and LTIP Units granted in January 2005 and approximately $11.3 million of restricted stock and LTIP Units granted in April 2006 will also be incurred ratably as such restricted stock and LTIP Units vest. To the extent we continue to grant restricted stock and/or LTIP Unit awards, our expense will continue to increase significantly until 2008 even if there are no future increases in the aggregate value of restricted equity granted each year. This is because we expense the value of the restricted stock and LTIP Unit awards ratably over the five-year vesting period and a full run-rate will not be achieved until 2008.

Interest Expense

Interest expense for the Total Property Portfolio decreased approximately $4.3 million for the six months ended June 30, 2006 compared to 2005. The majority of the decreases are due to (1) the repayment of outstanding mortgage debt in connection with the sales of 280 Park Avenue in June 2006, Riverfront Plaza and 100 East Pratt Street in the second quarter of 2005, and Embarcadero Center West Tower in October 2005, which collectively decreased interest expense by $9.1 million, (2) the impact of refinancing our fixed rate debt collateralized by 599 Lexington Avenue using borrowings under our unsecured line at a lower interest rate, which decreased interest expense approximately $1.4 million, and (3) the repayment of our mortgage loans collateralized by 191 Spring Street and 601 and 651 Gateway Boulevard, which decreased interest expense approximately $1.6 million. These decreases were offset by (1) increases of approximately $4.9 million at Times Square Tower due to increasing interest rates (5.70% on June 30, 2006 and 3.78% on June 30, 2005) as well as the increased principal balance due to the refinancing of the mortgage loan in June 2005 and (2) an increase of approximately $4.2 million related to interest incurred on the $450 million unsecured exchangeable senior notes at 3.75% per annum interest rate. We expect interest expense for the year ended December 31, 2006 to be somewhere between $297 million and $300 million, taking into account the expected repayment of debt with the proceeds from our unsecured exchangeable senior notes, increases in the LIBOR rate and the increase in interest expense from the cessation of interest capitalization related to placing new developments in service.

 

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At June 30, 2006, our variable rate debt consisted of our construction loans on our Times Square Tower and Capital Gallery Expansion, as well as our borrowings under our unsecured line of credit. On August 1, 2006, we repaid the mortgage loan collateralized by our Capital Gallery Expansion project. The following summarizes our outstanding debt as of June 30, 2006 compared with June 30, 2005:

 

     June 30,  
     2006     2005  
     (dollars in thousands)  

Debt Summary:

    

Balance

    

Fixed rate

   $ 4,101,345     $ 4,376,618  

Variable rate

     732,056       522,139  
                

Total

   $ 4,833,401     $ 4,898,757  
                

Percent of total debt:

    

Fixed rate

     84.85 %     89.34 %

Variable rate

     15.15 %     10.66 %
                

Total

     100.00 %     100.00 %
                

Weighted average interest rate at end of period:

    

Fixed rate

     5.90 %     6.65 %

Variable rate

     5.70 %     3.85 %
                

Total

     5.87 %     6.36 %
                

Depreciation and Amortization

Depreciation and amortization expense for the Total Property Portfolio decreased approximately $0.1 million for the six months ended June 30, 2006 compared to 2005. The majority of the change to depreciation was due to the sales of 280 Park Avenue, in June of 2006, Embarcadero Center West Tower, 100 East Pratt Street and Riverfront Plaza in 2005, which resulted in a decrease of approximately $6.9 million. This decrease was offset partially by increased depreciation of $3.3 million due to the placing in-service our Seven Cambridge Center development project in the first quarter of 2006 and 12290 Sunrise Valley in the second quarter of 2006, approximately $1.7 million related to the acquisition of Prospect Place on December 30, 2005 and approximately $0.2 million related to the initial lease occupancy at Capital Gallery. Depreciation and amortization in the Same Property Portfolio increased approximately $1.6 million for the six months ended June 30, 2006 compared to 2005.

Capitalized Costs

Costs directly related to the development of rental properties are not included in our operating results. These costs are capitalized and included in real estate assets on our Consolidated Balance Sheets and amortized over their useful lives. Capitalized development costs include interest, wages, property taxes, insurance and other project costs incurred during the period of development. Capitalized wages for the six months ended June 30, 2006 and 2005 were $2.9 million and $3.1 million, respectively. These costs are not included in the general and administrative expenses discussed above. Interest capitalized for the six months ended June 30, 2006 and 2005 was $3.0 million and $1.6 million, respectively. These costs are not included in the interest expense referenced above. As we continue to expand our development pipeline, we anticipate capitalized costs to increase.

Losses from early extinguishments of debt

For the six months ended June 30, 2006, we repaid the construction financing collateralized by our Seven Cambridge Center property and, in connection with the sale of 280 Park Avenue, we legally defeased the

 

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mortgage indebtedness collateralized by 280 Park Avenue totaling approximately $254.4 million. In connection with the defeasance of mortgage indebtedness at 280 Park Avenue we recognized a loss from early extinguishment of debt totaling approximately $31.4 million consisting of the difference between the value of the U.S. Treasuries and the principal balance of the mortgage loan totaling approximately $28.2 million and the write-off of unamortized deferred financing costs totaling approximately $3.2 million. The construction financing at Seven Cambridge Center totaling approximately $112.5 million was repaid using approximately $7.5 million of available cash and $105.0 million drawn under our Unsecured Line of Credit. There was no prepayment penalty associated with the repayment for Seven Cambridge Center. We recognized losses from early extinguishments of debt totaling approximately $0.5 million consisting of the write-off of unamortized deferred financing costs.

In connection with the sales of 100 East Pratt Street and Riverfront Plaza in May 2005, we repaid the mortgage loans collateralized by the properties totaling approximately $188 million. During the six months ended June 30, 2005, we recognized a loss from early extinguishment of debt totaling approximately $11.0 million, consisting of prepayment fees of approximately $10.8 million and the write-off of unamortized deferred financing costs of approximately $0.2 million. We also recognized a $1.9 million loss from early extinguishment of debt which relates to the refinancing of our Times Square Tower mortgage loan as well the modification on our Unsecured Line of Credit.

Income from Unconsolidated Joint Ventures

During the first quarter of 2005, we placed in-service 901 New York Avenue, a 539,000 net rentable square foot Class A office property located in Washington, D.C., in which we have a 25% ownership interest. The addition of this property increased income from joint ventures by approximately $0.7 million for the six months ended June 30, 2006.

Income from discontinued operations, net of minority interest

For the six months ended June 30, 2006 there were no properties included in discontinued operations. Properties included in discontinued operations for the six months ended June 30, 2005 consisted of Old Federal Reserve, 40-46 Harvard Street and Residence Inn by Marriott®.

Gains on sales of real estate, net of minority interest

On June 6, 2006, we sold 280 Park Avenue, a 1,179,000 net rentable square foot Class A office property located in midtown Manhattan, New York, for approximately $1.2 billion. Net proceeds totaled approximately $875 million after legal defeasance of indebtedness secured by the property (consisting of approximately $254.4 million of principal indebtedness and approximately $28.2 million of related defeasance costs) and the payment of transfer taxes, brokers’ fees and other customary closing costs. We recognized a gain on sale of approximately $581.6 million (net of minority interest share of approximately $109.5 million).

In January 2006 we recognized a gain on the sale of a parcel of land at the Prudential Center located in Boston, Massachusetts which had been accounted for previously as a financing transaction. During January 2006, the transaction qualified as a sale for financial reporting purposes.

Gains on sales of real estate for the six months ended June 30, 2005 in the Total Property Portfolio primarily relate to the sales of Riverfront Plaza and 100 East Street which are not included in discontinued operations due to our continuing involvement in the management, for a fee, of these properties after the sales. In addition, the sale of Decoverly Four and Five, consisting of two undeveloped land parcels located in Rockville, Maryland are included in gains on sales of real estate and other assets for the six months ended June 30, 2005.

 

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Minority interest in property partnership

Minority interest in property partnership consists of the outside equity interests in the venture that owns Citigroup Center. This venture is consolidated with our financial results because we exercise control over the entity. Due to the redemption of the minority interest holder at Citigroup Center, minority interest in property partnership will no longer reflect an allocation to the minority interest holder.

Minority interest in Operating Partnership

Minority interest in Operating Partnership decreased $2.8 million for the three months ended June 30, 2006 compared to 2005 mainly attributed to a reduction in the minority interest in our Operating Partnership’s income allocation related to underlying changes in allocable income, offset by changes in the partnership’s ownership interests.

Comparison of the three months ended June 30, 2006 to the three months ended June 30, 2005.

The table below shows selected operating information for the Same Property Portfolio and the Total Property Portfolio. The Same Property Portfolio consists of the 115 properties totaling approximately 29.9 million net rentable square feet of space (excluding approximately 9.1 million square feet of structured parking for approximately 29,835 vehicles). The Same Property Portfolio includes two hotel properties, properties acquired or placed in-service on or prior to April 1, 2005 and owned through June 30, 2006. The Total Property Portfolio includes the effects of the other properties either placed in-service, acquired or repositioned after April 1, 2005 or disposed of on or prior to June 30, 2006. This table includes a reconciliation from the Same Property Portfolio to the Total Property Portfolio by also providing information for the three months ended June 30, 2006 and 2005 with respect to the properties which were acquired, placed in-service, repositioned or sold.

In September 2004, we commenced the redevelopment of our Capital Gallery property in Washington, D.C. Capital Gallery is a Class A office property currently totaling approximately 397,000 net rentable square feet. The project entails removing a three-story low-rise section of the property, which is comprised of 100,000 net rentable square feet, from in-service status and developing it into a ten-story office building resulting in a total complex size of approximately 620,000 net rentable square feet. In April 2006, tenants began to take initial occupancy. This property is included in Properties Repositioned for the six months ended June 30, 2006 and June 30, 2005.

 

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    Same Property Portfolio     Properties Sold   Properties
Acquired
 

Properties Placed

In-Service

  Properties
Repositioned
  Total Property Portfolio  
    2006   2005  

Increase/

(Decrease)

    %
Change
    2006   2005   2006     2005   2006   2005   2006   2005   2006     2005    

Increase/

(Decrease)

    %
Change
 
    (dollars in thousands)  

Rental Revenue:

                               

Rental Revenue

  $ 309,085   $ 298,992   $ 10,093     3.38 %   $ 13,502   $ 27,089   $ 1,745     $ —     $ 6,064   $ —     $ 5,084   $ 3,257   $ 335,480     $ 329,338     $ 6,142     1.86 %

Termination Income

    1,400     1,580     (180 )   (11.39 %)     —       2,398     —         —       —       —       —       —       1,400       3,978       (2,578 )   (64.81 %)
                                                                                                         

Total Rental Revenue

    310,485     300,572     9,913     3.30 %     13,502     29,487     1,745       —       6,064     —       5,084     3,257     336,880       333,316       3,564     1.07 %
                                                                                                         

Operating Expenses

    101,643     94,038     7,605     8.09 %     5,669     11,565     868       —       807     —       1,245     852     110,232       106,455       3,777     3.55 %
                                                                                                         

Net Operating Income, excluding hotels

    208,842     206,534     2,308     1.12 %     7,833     17,922     877       —       5,257     —       3,839     2,405     226,648       226,861       (213 )   (0.10 %)
                                                                                                         

Hotel Net Operating Income (1)

    6,904     5,071     1,833     36.15 %     —       —       —         —       —       —       —       —       6,904       5,071       1,833     36.15 %
                                                                                                         

Consolidated Net Operating Income (1)

    215,746     211,605     4,141     1.96 %     7,833     17,922     877       —       5,257     —       3,839     2,405     233,552       231,932       1,620     0.7 %
                                                                                                         

Other Revenue:

                               

Development and Management Services

    —       —       —       —         —       —       —         —       —       —       —       —       5,230       4,137       1,093     26.42 %

Interest and Other

    —       —       —       —         —       —       —         —       —       —       —       —       8,565       2,916       5,649     193.72 %
                                                                                                         

Total Other Revenue

    —       —       —       —         —       —       —         —       —       —       —       —       13,795       7,053       6,742     95.59 %

Other Expenses:

                               

General and administrative expense

    —       —       —       —         —       —       —         —       —       —       —       —       15,796       14,252       1,544     10.83 %

Interest

    —       —       —       —         —       —       —         —       —       —       —       —       78,449       78,233       216     0.28 %

Depreciation and amortization

    63,763     62,034     1,729     2.79 %     714     4,545     743       —       1,980     —       712     447     67,912       67,026       886     1.32 %

Loss from early extinguishments of debt

    —       —       —       —         —       —       —         —       —       —       —       —       31,457       12,896       18,561     143.93 %
                                                                                                         

Total Other Expenses

    63,763     62,034     1,729     2.79 %     714     4,545     743       —       1,980     —       712     447     193,614       172,407       21,207     12.30 %
                                                                                                         

Income before minority interests

  $ 151,983   $ 149,571   $ 2,412     1.61 %   $ 7,119   $ 13,377   $ 134     $ —     $ 3,277   $ —     $ 3,127   $ 1,958   $ 53,733     $ 66,578     ($ 12,845 )   (19.29 %)

Income from unconsolidated joint ventures

  $ 1,079   $ 246   $ 833     338.62 %   $ —     $ 9   ($ 178 )   $ —     $ 776   $ 592   $ —     $ —       1,677       847       830     97.99 %

Income from discontinued operations, net of minority interest

  $ —     $ —     $ —       —       $ —     $ 727   $ —       $ —     $ —     $ —     $ —     $ —       —         727       (727 )   (100.0 %)

Minority interest in property partnership

                  777       1,472       (695 )   (47.21 %)

Minority interest in Operating Partnership

                  (11,758 )     (14,596 )     2,838     19.44 %

Gains on sales of real estate, net of minority interest

                  581,302       102,073       479,229     469.50 %

Gain on sale of real estate from discontinued operations, net of minority interest

                  —         8,389       (8,389 )   (100.0 %)
                                                     

Net Income available to common shareholders

                $ 625,731     $ 165,490     $ 460,241     278.11 %
                                                     

(1) For a detailed discussion of NOI, including the reasons management believes NOI is useful to investors, see page 32.

 

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Rental Revenue

The increase of approximately $6.1 million in the Total Property Portfolio is comprised of increases and decreases within the five categories that comprise our Total Property Portfolio. Rental revenue from the Same Property Portfolio increased approximately $10.1 million, Properties Sold decreased approximately $13.6 million, Properties Acquired increased approximately $1.7 million, Properties Placed In-Service increased approximately $6.1 million, Properties Repositioned increased approximately $1.8 million.

Rental revenue from the Same Property Portfolio increased approximately $10.1 million for the three months ended June 30, 2006 compared to 2005. Included in rental revenue is an overall increase in base rental revenue of approximately $13.7 million. Approximately $5.2 million of the increase from the Same Property Portfolio was due to an increase in recoveries from tenants. These increases were offset by a decrease of approximately $8.8 million related to straight line rents, primarily due to the reduction of free rent at Times Square Tower during the prior year. With relatively little roll-over in the remainder of 2006 and much of the related rent commencement deferred into 2007 for much of our currently vacant space, we do not expect more than a modest increase in the Same Property Portfolio rental revenue during the remainder of 2006.

The increase in rental revenue from Properties Placed In-Service relates to placing in-service our Seven Cambridge Center development project in the first quarter of 2006 and 12290 Sunrise Valley in the second quarter of 2006. Rental revenue from Properties Placed In-Service increased approximately $6.1 million, as detailed below:

 

         Rental Revenue for the three months ended June 30

Property

 

Date Placed In-Service

       2006            2005            Change    
         (in thousands)

Seven Cambridge Center

  First Quarter, 2006    $ 4,757    $ —      $ 4,757

12290 Sunrise Valley

  Second Quarter, 2006      1,307      —        1,307
                      

Total

     $ 6,064    $ —      $ 6,064
                      

The acquisition of Prospect Place on December 30, 2005 and 303 Almaden Boulevard on June 30, 2006 increased revenue from Properties Acquired by approximately $1.7 million for the three months ended June 30, 2006.

The aggregate increase in rental revenue was offset by the sales of 280 Park Avenue in June 2006 and Embarcadero Center West Tower, Riverfront Plaza and 100 East Pratt Street during 2005. These properties have not been classified as discontinued operations due to our continuing involvement as the property manager for each property. Rental Revenue from Properties Sold decreased by approximately $13.6 million, as detailed below:

 

   

Date Sold

  Rental Revenue for the three months ended June 30  

Property

        2006           2005           Change      
        (in thousands)  

280 Park Avenue

  June 6, 2006   $ 13,502   $ 17,927   ($ 4,425 )

Riverfront Plaza

  May 16, 2005     —       2,788     (2,788 )

100 East Pratt Street

  May 12, 2005     —       2,501     (2,501 )

Embarcadero Center West Tower

  December 14, 2005     —       3,873     (3,873 )
                     

Total

    $ 13,502   $ 27,089   ($ 13,587 )
                     

 

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Rental revenue from Properties Repositioned for the three months ended June 30, 2006 increased approximately $1.8 million over the three months ended June 30, 2005. In April 2006 tenants began to take occupancy at our redevelopment project at Capital Gallery. We anticipate placing the project in-service during the third quarter of 2006 with initial occupancy of approximately 83%.

Termination Income

Termination income for the three months ended June 30, 2006 was related to seven tenants across the Total Property Portfolio that terminated their leases, and we recognized termination income totaling approximately $1.4 million. This compared to termination income of $4.0 million for the three months ended June 30, 2005 related to seven tenants. We currently anticipate realizing approximately $1.0 million in termination income in each of the third and fourth quarters of 2006.

Operating Expenses

The $3.8 million increase in property operating expenses (real estate taxes, utilities, insurance, repairs and maintenance, cleaning and other property-related expenses) in the Total Property Portfolio is mainly comprised of increases and decreases within five categories that comprise our Total Property Portfolio. Operating expenses for the Same Property Portfolio increased approximately $7.6 million, Properties Acquired increased approximately $0.9 million, Properties Placed In-Service increased approximately $0.8 million, Properties Repositioned increased approximately $0.3 million and Properties Sold decreased approximately $5.9 million.

Operating expenses from the Same Property Portfolio increased approximately $7.6 million for the three months ended June 30, 2006 compared to 2005. Included in Same Property Portfolio operating expenses is an increase in utility expenses of approximately $2.8 million, an increase of approximately 17% over the prior year second quarter utility expense. In addition, real estate taxes increased approximately $2.2 million due to increased real estate tax assessments, with approximately half of this increase specifically attributed to properties located in New York City. The remaining $2.6 million increase in the Same Property Portfolio operating expenses is related to an increase in repairs and maintenance.

The increase in operating expenses from Properties Placed In-Service relates to placing in-service our Seven Cambridge Center development project in the first quarter of 2006 and 12290 Sunrise Valley in the second quarter of 2006. Operating expenses from Properties Placed In-Service increased approximately $0.8 million, as detailed below:

 

    

Date Placed In-Service

   Operating Expenses for the three months ended June 30

Property

          2006            2005            Change    
          (in thousands)

Seven Cambridge Center

   First Quarter, 2006    $ 689    $ —      $ 689

12290 Sunrise Valley

   Second Quarter, 2006      118      —        118
                       

Total

      $ 807    $ —      $ 807
                       

A decrease of approximately $5.9 million in the Total Property Portfolio operating expenses was due to the sales of 280 Park Avenue in June 2006 and Embarcadero Center West Tower, 100 East Pratt Street and Riverfront Plaza in 2005, as detailed below.

 

    

Date Sold

   Operating Expenses for the three months ended June 30  

Property

          2006            2005            Change      
          (in thousands)  

280 Park Avenue

   June 6, 2006    $ 5,669    $ 8,035    ($ 2,366 )

100 East Pratt Street

   May 12, 2005      —        886      (886 )

Riverfront Plaza

   May 16, 2005      —        906      (906 )

Embarcadero Center West Tower

   December 14, 2005      —        1,738      (1,738 )
                         

Total

      $ 5,669    $ 11,565    ($ 5,896 )
                         

 

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Our redevelopment project at Capital Gallery opened in April 2006 as tenants began to take occupancy. Operating expenses from Properties Repositioned for the three months ended June 30, 2006 increased approximately $0.3 million over the three months ended June 30, 2005.

We continue to review and monitor the impact of rising insurance costs and energy costs, as well as other factors, on our operating budgets for fiscal year 2006. Because some operating expenses are not recoverable from tenants, an increase in operating expenses due to one or more of the foregoing factors could have an adverse effect on our results of operations.

Hotel Net Operating Income

Net operating income for the hotel properties increased approximately $1.8 million, a 36.2% increase for the three months ended June 30, 2006 as compared to 2005. For the three months ended June 30, 2005 the operations of the Residence Inn by Marriott® has been included as part of discontinued operations due to its sale on November 4, 2005. Revenue from the hotels continued to improve in the second quarter, primarily as a result of citywide conventions. We expect the hotels to contribute between $12 million and $13 million of net operating income for the remainder of the year ending December 31, 2006.

The following reflects our occupancy and rate information for our hotel properties for the three months ended June 30, 2006 and 2005:

 

     2006     2005     Percentage
Change
 

Occupancy

     83.4 %     82.2 %   1.5 %

Average daily rate

   $ 241.69     $ 211.19     14.4 %

Revenue per available room, REVPAR

   $ 203.42     $ 174.26     16.7 %

Development and Management Services

Development and Management Service income increased approximately $1.1 million for the three months ended June 30, 2006 compared to 2005. Management Service income has increased approximately $1.0 million due to maintaining management contracts following the sales of 100 East Pratt Street, Riverfront Plaza and Embarcadero Center West Tower as well as the sale of 280 Park Avenue on June 6, 2006. We expect our third-party management and development fee income for the calendar year 2006 to be between $15 million and $16 million, which includes the impact of our continued management of 280 Park Avenue.

Interest and Other Income

Interest and other income increased approximately 5.6 million for the three months ended June 30, 2006 compared to 2005 as a result of higher overall interest rates as well as the timing of our cash balances for the six months ended June 30, 2006 compared to June 30, 2005. During the second quarter we raised $450 million through our Operating Partnership’s unsecured exchangeable senior notes. On June 6, 2006, we completed the sale of 280 Park Avenue for net cash proceeds of approximately $875 million. We did not identify any replacement properties for 280 Park Avenue under the like-kind exchange provisions of Section 1031 of the Internal Revenue Code and, therefore, our aggregate distributions for the 2006 tax year will include, in addition to our regular quarterly distributions, at least that portion of the sale proceeds necessary for us to avoid paying corporate level tax on the estimated taxable gain, estimated to be $750 million. We continue to look at additional asset sales as a way to monetize the strong valuations in the market. We expect interest income to be between $37 million and $38 million for 2006 given the additional cash balances we are currently carrying.

 

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Other Expenses

General and Administrative

General and administrative expenses increased approximately $1.5 million for the three months ended June 30, 2006 compared to 2005. The majority of this increase was attributed to bonuses and salaries for the three months ended June 30, 2006 compared to 2005.

Commencing in 2003, we issued restricted stock and/or LTIP Units, as opposed to granting stock options and restricted stock, under the 1997 Stock Option and Incentive Plan as our primary vehicle for employee equity compensation. An LTIP Unit is generally the economic equivalent of a share of our restricted stock. Employees generally vest in restricted stock and LTIP Units over a five-year term (for awards granted prior to 2003, vesting is in equal annual installments; for those granted in 2003 and later, vesting is over a five-year term with annual vesting of 0%, 0%, 25%, 35% and 40%). Restricted stock and LTIP Units are valued based on observable market prices for similar instruments. Such value is recognized as an expense ratably over the corresponding employee service period. LTIP Units that were issued in January 2005 and any future LTIP Unit awards will be valued using an option pricing model in accordance with the provisions of SFAS No. 123R. To the extent restricted stock or LTIP Units are forfeited prior to vesting, the corresponding previously recognized expense is reversed as an offset to “stock-based compensation.” Stock-based compensation expense associated with $6.1 million of equity-based compensation that was granted in January 2003 and $9.7 million in January 2004 will generally be expensed ratably as such restricted stock and LTIP Units vests over a five-year vesting period. Stock-based compensation associated with approximately $11.4 million of restricted stock and LTIP Units granted in January 2005 and approximately $11.3 million of restricted stock and LTIP Units granted in April 2006 will also be incurred ratably as such restricted stock and LTIP Units vest. To the extent we continue to grant restricted stock and/or LTIP Unit awards, our expense will continue to increase significantly until 2008 even if there are no future increases in the aggregate value of restricted equity granted each year. This is because we expense the value of the restricted stock and LTIP Unit awards ratably over the five-year vesting period and a full run-rate will not be achieved until 2008.

Interest Expense

Interest expense for the Total Property Portfolio increased slightly for the three months ended June 30, 2006 compared to 2005. The fluctuation is due to (1) the repayment of outstanding mortgage debt in connection with the sales of 280 Park Avenue in June 2006, Riverfront Plaza and 100 East Pratt Street in the second quarter of 2005, and Embarcadero Center West Tower in October 2005, which collectively decreased interest expense by $4.4 million, (2) the impact of refinancing our fixed rate debt collateralized by 599 Lexington Avenue using borrowings under our unsecured line at a lower interest rate, which decreased interest expense approximately $0.8 million, and (3) the repayment of our mortgage loans collateralized by 191 Spring Street and 601 and 651 Gateway Boulevard, which decreased interest expense approximately $1.0 million. These decreases were offset by (1) increases of approximately $2.7 million at Times Square Tower due to increasing interest rates (5.70% on June 30, 2006 and 3.78% on June 30, 2005) as well as the increased principal balance due to the refinancing of the mortgage loan in June 2005 and (2) an increase of approximately $4.1 million related to interest incurred on the $450 million unsecured exchangeable senior notes at 3.75% per annum interest rate.

 

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BOSTON PROPERTIES, INC.

 

At June 30, 2006, our variable rate debt consisted of our construction loans on our Times Square Tower and Capital Gallery Expansion, as well as our borrowings under our unsecured line of credit. On August 1, 2006, we repaid the mortgage loan collateralized by our Capital Gallery Expansion project. The following summarizes our outstanding debt as of June 30, 2006 compared with June 30, 2005:

 

     June 30,  
     2006     2005  
     (dollars in thousands)  

Debt Summary:

    

Balance

    

Fixed rate

   $ 4,101,345     $ 4,376,618  

Variable rate

     732,056       522,139  
                

Total

   $ 4,833,401     $ 4,898,757  
                

Percent of total debt:

    

Fixed rate

     84.85 %     89.34 %

Variable rate

     15.15 %     10.66 %
                

Total

     100.00 %     100.00 %
                

Weighted average interest rate at end of period:

    

Fixed rate

     5.90 %     6.65 %

Variable rate

     5.70 %     3.85 %
                

Total

     5.87 %     6.36 %
                

Depreciation and Amortization

Depreciation and amortization expense for the Total Property Portfolio increased slightly for the three months ended June 30, 2006 compared to 2005. The majority of the change in depreciation was due to the sales of 280 Park Avenue in June 2006 and Embarcadero Center West Tower, 100 East Pratt Street and Riverfront Plaza in 2005, which resulted in a decrease of approximately $3.8 million. This decrease was offset partially by increased depreciation of $2.0 million due to the placing in-service our Seven Cambridge Center development project in the first quarter of 2006, an increase of approximately $1.7 million related to the Same Property Portfolio and approximately $0.8 million related to the acquisition of Prospect Place on December 30, 2005.

Capitalized Costs

Costs directly related to the development of rental properties are not included in our operating results. These costs are capitalized and included in real estate assets on our Consolidated Balance Sheets and amortized over their useful lives. Capitalized development costs include interest, wages, property taxes, insurance and other project costs incurred during the period of development. Capitalized wages for the three months ended June 30, 2006 and 2005 were $1.5 million and $1.4 million, respectively. These costs are not included in the general and administrative expenses discussed above. Interest capitalized for the three months ended June 30, 2006 and 2005 was $1.3 million and $0.9 million, respectively. These costs are not included in the interest expense referenced above. As we continue to expand our development pipeline, we anticipate capitalized costs to increase.

Losses from early extinguishments of debt

In connection with the defeasance of mortgage indebtedness at 280 Park Avenue we recognized a loss from early extinguishment of debt totaling approximately $31.4 million consisting of the difference between the value of the U.S. Treasuries and the principal balance of the mortgage loan totaling approximately $28.2 million and the write-off of unamortized deferred financing costs totaling approximately $3.2 million.

 

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BOSTON PROPERTIES, INC.

 

In connection with the sales of 100 East Pratt Street and Riverfront Plaza in May 2005, we repaid the mortgage loans collateralized by the properties totaling approximately $188 million. During the three months ended June 30, 2005, we recognized a loss from early extinguishment of debt totaling approximately $11.0 million, consisting of prepayment fees of approximately $10.8 million and the write-off of unamortized deferred financing costs of approximately $0.2 million. We also recognized a $1.9 million loss from early extinguishment of debt which relates to the refinancing of our Times Square Tower mortgage loan as well the modification on our Unsecured Line of Credit.

Income from Unconsolidated Joint Ventures

During the first quarter of 2005, we placed in-service 901 New York Avenue, a 539,000 net rentable square foot Class A office property located in Washington, D.C., in which we have a 25% ownership interest. The addition of this property increased income from joint ventures by approximately $0.8 million for the three months ended June 30, 2006. This was partially offset by our 265 Franklin Street venture, the occupancy of which has decreased from 75.2% as of June 30, 2005 to 72.1% as of June 30, 2006.

Income from discontinued operations, net of minority interest

For the three months ended June 30, 2006 there were no properties included in discontinued operations. Properties included in discontinued operations for the three months ended June 30, 2005 consisted of Old Federal Reserve, 40-46 Harvard Street and Residence Inn by Marriott®.

Gains on sales of real estate, net of minority interest

On June 6, 2006, we sold 280 Park Avenue, a 1,179,000 net rentable square foot Class A office property located in midtown Manhattan, New York, for approximately $1.2 billion. Net proceeds totaled approximately $875 million after legal defeasance of indebtedness secured by the property (consisting of approximately $254.4 million of principal indebtedness and approximately $28.2 million of related defeasance costs) and the payment of transfer taxes, brokers’ fees and other customary closing costs. We recognized a gain on sale of approximately $581.6 million (net of minority interest share of approximately $109.5 million).

Gains on sales of real estate for the three months ended June 30, 2005 in the Total Property Portfolio primarily relate to the sales of Riverfront Plaza and 100 East Street which are not included in discontinued operations due to our continuing involvement in the management, for a fee, of these properties after the sales.

Minority interest in property partnership

Minority interest in property partnership consists of the outside equity interests in the venture that owns Citigroup Center. This venture is consolidated with our financial results because we exercise control over the entity. Due to the redemption of the minority interest holder at Citigroup Center, minority interest in property partnership will no longer reflect an allocation to the minority interest holder.

Minority interest in Operating Partnership

Minority interest in Operating Partnership decreased $2.8 million for the three months ended June 30, 2006 compared to 2005 mainly attributed to a reduction in the minority interest in our Operating Partnership’s income allocation related to underlying changes in allocable income, offset by changes in the partnership’s ownership interests.

 

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Liquidity and Capital Resources

General

Our principal liquidity needs for the next twelve months are to:

 

    fund normal recurring expenses;

 

    meet debt service requirements including the repayment or refinancing of $140.7 million of indebtedness that matures on or prior to August 1, 2007, $6.6 million of which is due in 2006 and the remainder in the first quarter of 2007;

 

    fund capital expenditures, including tenant improvements and leasing costs;

 

    fund current development costs not covered under existing construction loans;

 

    fund potential property acquisitions; and

 

    make the minimum distribution required to maintain our REIT qualification under the Internal Revenue Code of 1986, as amended.

We did not identify any replacement properties for 280 Park Avenue under the like-kind exchange provisions of Section 1031 of the Internal Revenue Code and, therefore, our aggregate distributions for the 2006 tax year will include, in addition to our regular quarterly distributions, at least that portion of the sale proceeds necessary for us to avoid paying corporate level tax on the estimated taxable gain, estimated to be $750 million. Under applicable tax rules, distributions for the 2006 tax year must be paid by January 30, 2007.

We believe that these needs will be satisfied using cash on hand, cash flows generated by operations and provided by financing activities, as well as cash generated from asset sales. Base rental revenue, recovery income from tenants, other income from operations, available cash balances, draws on our unsecured line of credit and refinancing of maturing indebtedness are our principal sources of capital used to pay operating expenses, debt service, recurring capital expenditures and the minimum distribution required to maintain our REIT qualification. We seek to increase income from our existing properties by maintaining quality standards for our properties that promote high occupancy rates and permit increases in rental rates while reducing tenant turnover and controlling operating expenses. Our sources of revenue also include third-party fees generated by our office real estate management, leasing, development and construction businesses. Consequently, we believe our revenue, together with proceeds from financing activities, will continue to provide the necessary funds for our short-term liquidity needs. However, material changes in these factors may adversely affect our net cash flows. Such changes, in turn, could adversely affect our ability to fund distributions, debt service payments and tenant improvements. In addition, a material adverse change in our cash provided by operations may affect our ability to comply with the financial performance covenants under our unsecured line of credit and unsecured senior notes.

Our principal liquidity needs for periods beyond twelve months are for the costs of developments, possible property acquisitions, scheduled debt maturities, major renovations, expansions and other non-recurring capital improvements. We expect to satisfy these needs using one or more of the following:

 

    construction loans;

 

    long-term secured and unsecured indebtedness;

 

    income from operations;

 

    income from joint ventures;

 

    sales of real estate;

 

    issuances of our equity securities and/or additional preferred or common units of partnership interest in BPLP; and

 

    our unsecured revolving line of credit or other short-term bridge facilities.

 

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We draw on multiple financing sources to fund our long-term capital needs. Our unsecured line of credit is utilized primarily as a bridge facility to fund acquisition opportunities, to refinance outstanding indebtedness and to meet short-term development and working capital needs. We generally fund our development projects with construction loans that may be partially guaranteed by our Operating Partnership until project completion or lease-up thresholds are achieved.

Cash Flow Summary

The following summary discussion of our cash flows is based on the consolidated statements of cash flows and is not meant to be an all-inclusive discussion of the changes in our cash flows for the periods presented below.

Cash and cash equivalents were $370.4 million and $507.2 million at June 30, 2006 and 2005, respectively, representing a decrease of $136.8 million. As of June 30, 2006, approximately $872 million of cash proceeds were held in escrow by a qualifying intermediary for the purpose of potentially accomplishing a like-kind exchange of 280 Park Avenue under Section 1031 of the Internal Revenue Code and were therefore not included in cash and cash equivalents. No qualifying replacement properties were identified by the statutory deadline of July 21, 2006 and the cash was subsequently released from escrow back to us with no restrictions as to its use.

The decrease in cash and cash equivalents was a result of the following increases and decreases in cash flows:

 

     Six months ended June 30,  
     2006     2005    

Increase

(Decrease)

 
     (in thousands)  

Net cash provided by operating activities

   $ 256,710     $ 204,976     $ 51,734  

Net cash (used in) provided by investing activities

   ($ 232,853 )   $ 292,750     ($ 525,603 )

Net cash (used in) provided by financing activities

   $ 85,043     ($ 229,888 )   $ 314,931  

Our principal source of cash flow is related to the operation of our office properties. The average term of our tenant leases is approximately 7.7 years with occupancy rates historically in the range of 92% to 98%. Our properties provide a relatively consistent stream of cash flow that provides us with resources to pay operating expenses, debt service and fund quarterly dividend and distribution payment requirements. In addition, over the past year, we have raised capital through the sale of some of our properties and raised proceeds from secured borrowings.

Cash provided by investing activities to fund acquisitions, development and recurring and nonrecurring capital expenditures. We selectively invest in new projects that enable us to take advantage of our development, leasing, financing and property management skills and invest in existing buildings that meet our investment criteria. Cash used in investing activities for the six months ended June 30, 2006 consisted of the following:

 

    

Six months

ended June 30,

2006

 
     (in thousands)  

Net proceeds from the sale of real estate

   $ 1,150,981  

Net proceeds from the sale of real estate placed in escrow

     (872,063 )

Investments in marketable securities

     (282,764 )

Acquisitions/additions to real estate

     (206,873 )

Recurring capital expenditures

     (8,507 )

Net investments in unconsolidated joint ventures

     (6,867 )

Hotel improvements, equipment upgrades and replacements

     (6,251 )

Planned non-recurring capital expenditures associated with acquisition properties

     (509 )
        

Net cash used in investing activities

   ($ 232,853 )
        

 

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Cash provided by financing activities for the six months ended June 30, 2006 totaled approximately $85.0 million. This consisted primarily of the proceeds from our exchangeable unsecured senior notes offering of $450 million offset by the repayment of our Seven Cambridge Center construction loan, our 101 Carnegie Center mortgage loan and our 191 Spring Street loan as well as the payments of dividends and distributions to shareholders and the unitholders of our Operating Partnership. Future debt payments are discussed below under the heading “Debt Financing.”

Capitalization

At June 30, 2006, our total consolidated debt was approximately $4.8 billion. The weighted-average annual interest rate on our consolidated indebtedness was 5.87% and the weighted-average maturity was approximately 4.9 years.

Debt to total market capitalization ratio, defined as total consolidated debt as a percentage of the market value of our outstanding equity securities plus our total consolidated debt, is a measure of leverage commonly used by analysts in the REIT sector. Our total market capitalization was approximately $17.5 billion at June 30, 2006. Total market capitalization was calculated using the June 30, 2006 closing stock price of $90.40 per common share and the following: (1) 114,219,417 shares of our common stock, (2) 21,147,685 outstanding common units of partnership interest in Boston Properties Limited Partnership (excluding common units held by Boston Properties, Inc.), (3) an aggregate of 4,409,710 common units issuable upon conversion of all outstanding Series Two Preferred Units of partnership int