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 September 30, 2007

 

¨ 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)

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

(Address of Principal Executive Offices) (Zip Code)

(617) 236-3300

(Registrant’s telephone number, including area code)

 


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

Indicate by check mark whether the registrant 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   119,265,452
(Class)   (Outstanding on November 2, 2007)

 



Table of Contents

BOSTON PROPERTIES, INC.

FORM 10-Q

for the quarter ended September 30, 2007

TABLE OF CONTENTS

 

          Page

PART I. FINANCIAL INFORMATION

  

ITEM 1.

  

Financial Statements (unaudited)

  
  

a) Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006

   1
  

b) Consolidated Statements of Operations for the three and nine months ended September 30, 2007 and 2006

   2
  

c) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2007 and 2006

   3
  

d) Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006

   4
  

e) Notes to the Consolidated Financial Statements

   6

ITEM 2.

  

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

   28

ITEM 3.

  

Quantitative and Qualitative Disclosures about Market Risk

   71

ITEM 4.

  

Controls and Procedures

   72

PART II. OTHER INFORMATION

  

ITEM 1.

  

Legal Proceedings

   73

ITEM 1A.

  

Risk Factors

   73

ITEM 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   73

ITEM 3.

  

Defaults Upon Senior Securities

   73

ITEM 4.

  

Submission of Matters to a Vote of Security Holders

   73

ITEM 5.

  

Other Information

   73

ITEM 6.

  

Exhibits

   74

SIGNATURES

   75


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)

 

     September 30,
2007
    December 31,
2006
 
ASSETS     

Real estate, at cost

   $ 8,961,830     $ 8,819,934  

Real estate held for sale, net

     —         433,492  

Construction in process

     629,138       115,629  

Land held for future development

     212,801       183,403  

Less: accumulated depreciation

     (1,488,077 )     (1,392,055 )
                

Total real estate

     8,315,692       8,160,403  

Cash and cash equivalents

     1,894,198       725,788  

Cash held in escrows

     17,835       25,784  

Tenant and other receivables (net of allowance for doubtful accounts of $2,199 and $2,682, respectively)

     43,199       57,052  

Accrued rental income (net of allowance of $504 and $783, respectively)

     299,082       327,337  

Deferred charges, net

     257,469       274,079  

Prepaid expenses and other assets

     55,658       40,868  

Investments in unconsolidated joint ventures

     102,488       83,711  
                

Total assets

   $ 10,985,621     $ 9,695,022  
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Liabilities:

    

Mortgage notes payable

   $ 2,644,393     $ 2,679,462  

Unsecured senior notes (net of discount of $3,199 and $3,525, respectively)

     1,471,801       1,471,475  

Unsecured exchangeable senior notes (net of discount of $19,426 and $0, respectively)

     1,293,074       450,000  

Unsecured line of credit

     —         —    

Accounts payable and accrued expenses

     133,714       102,934  

Dividends and distributions payable

     96,152       857,892  

Accrued interest payable

     46,671       47,441  

Other liabilities

     198,314       239,084  
                

Total liabilities

     5,884,119       5,848,288  
                

Commitments and contingencies

     —         —    
                

Minority interests

     753,620       623,508  
                

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, 119,332,112 and 117,582,442 issued and 119,253,212 and 117,503,542 outstanding in 2007 and 2006, respectively

     1,193       1,175  

Additional paid-in capital

     3,289,760       3,119,941  

Earnings in excess of dividends

     1,065,993       108,155  

Treasury common stock at cost, 78,900 shares in 2007 and 2006

     (2,722 )     (2,722 )

Accumulated other comprehensive loss

     (6,342 )     (3,323 )
                

Total stockholders’ equity

     4,347,882       3,223,226  
                

Total liabilities and stockholders’ equity

   $ 10,985,621     $ 9,695,022  
                

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
September 30,
    Nine months ended
September 30,
 
    2007     2006     2007     2006  
    (in thousands, except for per share amounts)  

Revenue

       

Rental:

       

Base rent

  $ 270,513     $ 272,146     $ 813,929     $ 823,984  

Recoveries from tenants

    45,621       45,896       140,125       138,224  

Parking and other

    16,328       13,967       48,137       41,869  
                               

Total rental revenue

    332,462       332,009       1,002,191       1,004,077  

Hotel revenue

    8,646       8,319       24,690       21,598  

Development and management services

    5,318       4,558       15,175       14,159  

Interest and other

    25,081       14,611       68,274       25,124  
                               

Total revenue

    371,507       359,497       1,110,330       1,064,958  
                               

Expenses

       

Real estate operating:

       

Rental

    114,140       111,176       341,339       333,016  

Hotel

    6,275       6,339       18,706       16,860  

General and administrative

    20,189       12,739       53,288       43,177  

Interest

    69,929       73,571       217,598       226,837  

Depreciation and amortization

    71,616       70,558       216,715       203,640  

Losses from early extinguishments of debt

    2,695       208       3,417       32,132  
                               

Total expenses

    284,844       274,591       851,063       855,662  
                               

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

    86,663       84,906       259,267       209,296  

Minority interest in property partnership

    —         —         —         2,013  

Income from unconsolidated joint ventures

    1,390       20,200       19,623       23,167  
                               

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

    88,053       105,106       278,890       234,476  

Minority interest in Operating Partnership

    (14,178 )     (18,404 )     (42,455 )     (44,911 )
                               

Income before gains on sales of real estate and discontinued operations

    73,875       86,702       236,435       189,565  

Gains on sales of real estate, net of minority interest

    168,495       17,889       788,855       604,200  
                               

Income before discontinued operations

    242,370       104,591       1,025,290       793,765  

Discontinued operations:

       

Income from discontinued operations, net of minority interest

    —         3,371       1,283       7,228  

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

    —         —         173,899       —    
                               

Net income available to common shareholders

  $ 242,370     $ 107,962     $ 1,200,472     $ 800,993  
                               

Basic earnings per common share:

       

Income available to common shareholders before discontinued operations

  $ 2.02     $ 0.90     $ 8.53     $ 6.82  

Discontinued operations, net of minority interest

    —         0.03       1.48       0.06  
                               

Net income available to common shareholders

  $ 2.02     $ 0.93     $ 10.01     $ 6.88  
                               

Weighted average number of common shares outstanding

    119,010       115,432       118,715       113,989  
                               

Diluted earnings per common share:

       

Income available to common shareholders before discontinued operations

  $ 1.99     $ 0.88     $ 8.39     $ 6.68  

Discontinued operations, net of minority interest

    —         0.03       1.45       0.06  
                               

Net income available to common shareholders

  $ 1.99     $ 0.91     $ 9.84     $ 6.74  
                               

Weighted average number of common and common equivalent shares outstanding

    120,655       117,728       120,760       116,365  
                               

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
September 30,
    Nine months ended
September 30,
     2007     2006     2007     2006
     (in thousands)

Net income available to common shareholders

   $ 242,370     $ 107,962     $ 1,200,472     $ 800,993

Other comprehensive income (loss):

        

Effective portion of interest rate contracts

     (2,906 )     (20,564 )     (2,906 )     7,551

Amortization of interest rate contracts

     (98 )     174       (113 )     523
                              

Other comprehensive income (loss)

     (3,004 )     (20,390 )     (3,019 )     8,074
                              

Comprehensive income

   $ 239,366     $ 87,572     $ 1,197,453     $ 809,067
                              

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 nine months ended
September 30,
 
     2007     2006  
     (in thousands)  

Cash flows from operating activities:

    

Net income available to common shareholders

   $ 1,200,472     $ 800,993  

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

    

Depreciation and amortization

     217,323       206,307  

Non-cash portion of interest expense

     7,057       5,231  

Non-cash compensation expense

     9,318       6,481  

Losses from early extinguishments of debt

     838       31,877  

Minority interest in property partnership

     —         (2,013 )

Earnings in excess of distributions from unconsolidated joint ventures

     (13,462 )     (16,741 )

Minority interest in Operating Partnership

     214,330       160,492  

Gains on sales of real estate

     (1,134,408 )     (718,431 )

Change in assets and liabilities:

    

Cash held in escrows

     5,119       4,182  

Tenant and other receivables, net

     13,853       7,873  

Accrued rental income, net

     (30,298 )     (37,212 )

Prepaid expenses and other assets

     (14,200 )     (24,155 )

Accounts payable and accrued expenses

     6,892       (986 )

Accrued interest payable

     (770 )     (2,208 )

Other liabilities

     (8,345 )     (11,214 )

Tenant leasing costs

     (20,596 )     (27,439 )
                

Total adjustments

     (747,349 )     (417,956 )
                

Net cash provided by operating activities

     453,123       383,037  
                

Cash flows from investing activities:

    

Acquisitions/additions to real estate

     (714,101 )     (379,923 )

Investments in marketable securities

     —         (282,764 )

Net investments in unconsolidated joint ventures

     (5,315 )     24,231  

Net proceeds from the sale of real estate placed in escrow

     —         (872,063 )

Net proceeds from the sale of real estate released from escrow

     —         872,063  

Net proceeds from the sales of real estate

     1,773,125       1,130,132  
                

Net cash provided by investing activities

     1,053,709       491,676  
                

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 nine months ended
September 30,
 
     2007     2006  
     (in thousands)  

Cash flows from financing activities:

    

Borrowings on unsecured line of credit

     260,000       195,000  

Repayments of unsecured line of credit

     (260,000 )     (253,000 )

Proceeds from mortgage notes payable

     1,020,216       30,396  

Repayments of mortgage notes payable

     (1,122,135 )     (264,157 )

Proceeds from unsecured exchangeable senior notes

     840,363       450,000  

Proceeds from real estate financing transaction

     1,610       22,462  

Payments on real estate financing transactions

     (8,156 )     (3,665 )

Dividends and distributions

     (1,047,131 )     (296,035 )

Net proceeds from equity transactions

     14,521       38,079  

Contributions from minority interest holders, net

     3,297       11,274  

Redemption of minority interest

     (35,625 )     (14,891 )

Deferred financing costs

     (5,382 )     (2,646 )
                

Net cash used in financing activities

     (338,422 )     (87,183 )
                

Net increase in cash and cash equivalents

     1,168,410       787,530  

Cash and cash equivalents, beginning of period

     725,788       261,496  
                

Cash and cash equivalents, end of period

   $ 1,894,198     $ 1,049,026  
                

Supplemental disclosures:

    

Cash paid for interest

   $ 231,938     $ 228,370  
                

Interest capitalized

   $ 20,627     $ 4,556  
                

Non-cash investing and financing activities:

    

Additions to real estate included in accounts payable

   $ 12,922     $ 15,919  
                

Dividends and distributions declared but not paid

   $ 96,152     $ 95,607  
                

Conversions of Minority interests to Stockholders’ equity

   $ 30,102     $ 80,090  
                

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

   $ 111,865     $ 181,842  
                

Mortgage notes payable assumed in connection with the acquisition of real estate

   $ 65,224     $ —    
                

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

   $ —       $ 282,764  
                

Mortgage note payable legally defeased

   $ —       $ 254,385  
                

Financing incurred in connection with the acquisition of real estate

   $ —       $ 45,559  
                

Issuance of restricted securities to employees and directors

   $ 17,658     $ 11,054  
                

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 September 30, 2007 owned an approximate 84.2% (83.0% at September 30, 2006) general and limited partnership interest in the Operating Partnership. Partnership interests in the Operating Partnership are denominated as “common units of partnership interest” (also referred to as “OP Units”), “long term incentive units of partnership interest” (also referred to as “LTIP Units”) or “preferred units of partnership interest” (also referred to as “Preferred Units”).

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 (See Note 13).

At September 30, 2007, 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 herein to the Company refer to Boston Properties, Inc. and its consolidated subsidiaries, including the Operating Partnership, collectively, unless the context otherwise requires.

Properties

At September 30, 2007, the Company owned or had interests in a portfolio of 138 commercial real estate properties (131 and 128 properties at December 31, 2006 and September 30, 2006, respectively) (the “Properties”) aggregating approximately 44.1 million net rentable square feet (approximately 43.4 million and 42.5 million net rentable square feet at December 31, 2006 and September 30, 2006, respectively), including 13 properties under construction totaling approximately 3.9 million net rentable square feet, and structured parking for approximately 32,113 vehicles containing approximately 9.9 million square feet. At September 30, 2007, the Properties consist of:

 

   

134 office properties, including 113 Class A office properties (including 13 properties under construction) and 21 Office/Technical properties;

 

   

one hotel; and

 

   

three retail properties.

The Company owns or controls undeveloped land parcels totaling approximately 542.2 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 has pursued

 

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Table of Contents

BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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 September 30, 2007, the Value-Added Fund had investments in an office property in Chelmsford, Massachusetts and an office complex in San Carlos, California.

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 statement of the financial statements for these interim periods have been included. The results of operations for the interim periods are not necessarily indicative of the results to be obtained for other interim periods or for the full fiscal year. The year end consolidated balance sheet data was derived from audited financial statements, but does not include all disclosure required by accounting principles generally accepted in the United States of America. These financial statements should be read in conjunction with the Company’s financial statements and notes thereto contained in the Company’s Annual Report in the Company’s Form 10-K for its fiscal year ended December 31, 2006, as revised on Form 8-K filed on July 25, 2007.

3. Real Estate Activity During the Nine Months Ended September 30, 2007

Acquisitions

In January 2007, the Company acquired 6601 and 6605 Springfield Center Drive, consisting of two office/technical properties aggregating approximately 97,000 net rentable square feet located in Springfield, Virginia for an aggregate purchase price of approximately $16.5 million. On April 11, 2007, the Company acquired an adjacent parcel of land for a purchase price of approximately $25.6 million. The acquisitions were financed with available cash.

In January and February 2007, the Company acquired parcels of land located at 250 West 55th Street in New York City, through a majority-owned venture, for an aggregate purchase price of approximately $228.8 million. The acquisitions were financed with a $160.0 million mortgage loan, which bore interest at a variable

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

rate equal to LIBOR plus 0.40% per annum and was scheduled to mature in January 2009, and member capital contributions. The loan was collateralized by mortgages totaling approximately $13.6 million. On February 26, 2007, the Company entered into an agreement to redeem the outside members’ equity interest in the limited liability company that owns 250 West 55th Street for an aggregate redemption price of approximately $23.4 million (See Note 9). On May 9, 2007, the Company used available cash to repay the mortgage loan.

On January 29, 2007, the Company acquired 103 Fourth Avenue, an approximately 62,000 net rentable square foot office/technical property located in Waltham, Massachusetts, for a purchase price of approximately $14.3 million. The acquisition was financed with available cash.

On March 30, 2007, the Company acquired Kingstowne Towne Center, a mixed-use property located in Alexandria, Virginia, at a purchase price of approximately $134.0 million. This property is comprised of two Class A office properties totaling approximately 307,000 net rentable square feet and a retail/movie theater complex totaling approximately 88,000 net rentable square feet. The acquisition was financed with the assumption of mortgage indebtedness totaling $65.3 million (see Note 5) and available cash.

On March 30, 2007, the Company acquired Russia Wharf, a land parcel located in Boston, Massachusetts, for a purchase price of approximately $105.5 million. The acquisition was financed with available cash.

On July 24, 2007, the Company acquired 701 Carnegie Center, a land parcel located in Princeton, New Jersey for a purchase price of approximately $3.1 million with the title transferring pending subdivision approval. The purchase price was financed with available cash.

On September 27, 2007, the Company executed a contract to acquire North First Business Park located in San Jose, California, at a purchase price of approximately $71.5 million. This property is comprised of eight office/technical properties aggregating approximately 367,000 net rentable square feet located on approximately 24 acres of land. 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.

Development

During the nine months ended September 30, 2007, the Company commenced the following development projects:

 

   

the Offices at Wisconsin Place, a Class A office project with approximately 290,000 net rentable square feet located in Chevy Chase, Maryland (through a joint venture in which the Company owns a 66.7% interest);

 

   

701 Carnegie Center, a Class A office project with approximately 120,000 net rentable square feet located in Princeton, New Jersey;

 

   

South of Market, a Class A office project with approximately 225,000 net rentable square feet located in Reston, Virginia;

 

 

 

250 West 55th Street, a Class A office project with approximately 1,000,000 net rentable square feet located in New York City; and

 

   

Russia Wharf, a mixed-use project with approximately 580,000 net rentable square feet of Class A office space and approximately 235,000 square feet of residential space for rent or for sale located in Boston, Massachusetts.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Dispositions

On February 15, 2007, the Company sold the long-term leasehold interest in 5 Times Square in New York City and related credits, for approximately $1.28 billion in cash. 5 Times Square is a fully-leased Class A office tower that contains approximately 1,101,779 net rentable square feet. Net cash proceeds totaled approximately $1.23 billion, resulting in a gain on sale of approximately $605.2 million (net of minority interest share of approximately $108.4 million). In conjunction with the sale, the Company has agreed to provide to the buyer monthly revenue support from the closing date until December 31, 2008. The aggregate amount of the revenue support payments was approximately $1.6 million and has been recorded as a purchase price adjustment and included in Other Liabilities within the Company’s Consolidated Balance Sheets. As of September 30, 2007, the remaining revenue support obligation totaled approximately $0.2 million. As part of the transaction, the buyer has agreed to engage the Company as the property manager for 5 Times Square for a five-year term. Either party will have the right to terminate this relationship at any time after four years upon giving the other party six months advance notice. If not terminated, the agreement will automatically renew for successive one-year terms unless terminated by either party upon ninety (90) days advance notice. The Company will recognize management fees on a fair value basis over the term of the agreement. As a result, the recognized gain on sale of the property has been reduced by approximately $4.7 million, representing the difference between the management fees to be received by the Company and the fair value of the management fees. Such amount has been deferred and recorded in Other Liabilities in the Company’s Consolidated Balance Sheets and will be recognized as management services revenue over the term of the management agreement. Due to the Company’s continuing involvement through an agreement with the buyer to manage 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).

On March 23, 2007, the Company sold the Long Wharf Marriott, a 402-room hotel located in Boston, Massachusetts, for approximately $231.0 million. Net cash proceeds totaled approximately $225.6 million, resulting in a gain on sale of approximately $162.3 million (net of minority interest share of approximately $28.6 million). This property has been categorized as discontinued operations in the accompanying Consolidated Statements of Operations (See Note 11). The sale of this property was completed as part of a “like-kind exchange” under Section 1031 of the Internal Revenue Code.

On April 5, 2007, the Company sold Newport Office Park, an approximately 172,000 net rentable square foot Class A office property located in Quincy, Massachusetts, for approximately $37.0 million. Net cash proceeds totaled approximately $33.7 million, resulting in a gain on sale of approximately $11.5 million (net of minority interest share of approximately $2.1 million). This property has been categorized as discontinued operations in the accompanying Consolidated Statements of Operations (See Note 11).

On April 12, 2007, the Company entered into an agreement for the sale of a parcel of land located in Washington, D.C. for approximately $33.7 million. In addition, the Company entered into a development management agreement with the buyer to develop a Class A office property on the parcel totaling approximately 165,000 net rentable square feet. The sale is subject to the satisfaction of customary closing conditions and there can be no assurance that the sale will be consummated on the terms currently contemplated or at all.

On August 7, 2007, the Company sold Democracy Center in Bethesda, Maryland, for approximately $280.5 million. Democracy Center is a Class A office complex that contains an aggregate of approximately 685,000 net rentable square feet. Net cash proceeds totaled approximately $184.5 million, after the repayment of the mortgage indebtedness of approximately $94.6 million and closing costs of approximately $1.4 million, resulting in a gain on sale of approximately $168.3 million (net of minority interest share of approximately $29.9 million). Due to the Company’s continuing involvement through an agreement with the buyer to manage the property for a fee after the sale, this property has not been categorized as discontinued operations in the accompanying Consolidated Statements of Operations (See Note 11).

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

During the nine months ended September 30, 2007, the Company signed a new qualifying lease for approximately 22,000 net rentable square feet of its remaining 47,659 net rentable square foot master lease obligation related to the 2006 sale of 280 Park Avenue resulting in the recognition of approximately $15.4 million (net of minority interest share of approximately $2.6 million) as additional gain on sale of real estate. The Company had deferred approximately $67.3 million of the gain on sale of 280 Park Avenue, which amount represented the maximum obligation under the master lease. As of September 30, 2007, the remaining master lease obligation totaled approximately $26.5 million.

4. Investments in Unconsolidated Joint Ventures

The investments in unconsolidated joint ventures consist of the following at September 30, 2007:

 

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 901 New York Avenue LLC    901 New York Avenue    25.0 %(2)
KEG Associates I, LLC    505 9th Street    50.0 %(3)
Wisconsin Place Entities    Wisconsin Place    23.9 %(3)(4)
Eighth Avenue and 46th Street Entities    Eighth Avenue and 46th Street    50.0 %(3)
Boston Properties Office Value-Added Fund, L.P.   

300 Billerica Road and

One & Two Circle Star Way

   25.0 %(2)
Annapolis Junction NFM, LLC    Annapolis Junction    50.0 %(3)

(1) This joint venture is 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) These properties are not in operation (i.e., under construction or assembled 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, which each own 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 29, 2007, the Wisconsin Place joint venture entity that owns and is developing the retail component of the project (the “Retail Entity”) (a joint venture entity in which the Company owns a 5% interest) obtained construction financing totaling $66.0 million collateralized by the retail property. Wisconsin Place is a mixed-use development project consisting of office, retail and residential properties located in Chevy Chase, Maryland. The construction financing bears interest at a variable rate equal to LIBOR plus 1.375% per annum and matures on March 29, 2010 with two, one-year extension options. On March 29, 2007, the Wisconsin Place joint venture entity that owns and is developing the land and infrastructure components of the project (the “Land and Infrastructure Entity”) (a joint venture entity in which the Company owns an effective interest of approximately 23.89%) executed an amendment to its construction loan agreement. The construction financing consisted of a $96.5 million commitment, bearing interest at a per annum variable rate equal to LIBOR plus 1.50% and maturing on March 11, 2009. The outstanding balance on the construction loan was approximately $53.6 million on the $96.5 million commitment. The amended agreement provides for a reduction in the loan commitment amount to $69.1 million. The reduction relates to the repayment of the retail portion of the outstanding balance totaling approximately $15.9 million and an additional reduction in the borrowing capacity of approximately $11.5 million with a corresponding release of collateral in conjunction with the retail entity obtaining new construction financing.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

On June 1, 2007, the Company’s Value-Added Fund sold Worldgate Plaza located in Herndon, Virginia for approximately $109.0 million. Worldgate Plaza is an office complex consisting of approximately 322,000 net rentable square feet. Net cash proceeds totaled approximately $50.5 million, of which the Company’s share was approximately $20.3 million, after the repayment of the mortgage indebtedness of $57.0 million and closing costs of approximately $1.5 million, resulting in a gain on sale of approximately $32.8 million. The Company’s share of the gain on sale was approximately $15.5 million, which amount reflects the achievement of certain return thresholds as provided for in the joint venture agreement. The Company’s share of the gain on sale has been included in Income from Unconsolidated Joint Ventures in the accompanying Consolidated Statements of Operations. In connection with the repayment of the mortgage indebtedness on the property, the joint venture recognized a loss from early extinguishment of debt totaling approximately $0.1 million, consisting of the write-off of unamortized deferred financing costs. The mortgage loan bore interest at a variable rate equal to LIBOR plus 0.89% per annum and was scheduled to mature on December 1, 2007.

On June 22, 2007, a joint venture in which the Company has a 50% interest entered into agreements to complete the assemblage for its development site at Eighth Avenue and 46th Street in New York, New York consisting of an approximately 840,000 net rentable square foot Class A office property.

On July 16, 2007, the Company entered into a joint venture with an unrelated third party to develop Annapolis Junction, a Class A office complex aggregating approximately 425,000 net rentable square feet located in Anne Arundel County, Maryland. The joint venture partner contributed the land for a 50% interest in the joint venture and the Company will contribute cash of approximately $14.9 million for its 50% interest. The joint venture has commenced construction on an approximately 117,600 net rentable square foot Class A office property on the site. On September 13, 2007, the joint venture entity obtained construction financing totaling $45.5 million. The construction financing bears interest at a variable rate equal to LIBOR plus 1.20% per annum and matures in September 2010, with two, one-year extension options.

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

 

     September 30,
2007
   December 31,
2006
     (in thousands)
ASSETS      

Real estate and development in process, net

   $ 789,485    $ 760,139

Other assets

     100,745      87,759
             

Total assets

   $ 890,230    $ 847,898
             
LIABILITIES AND MEMBERS’/PARTNERS’ EQUITY      

Mortgage and notes payable(1)

   $ 627,494    $ 630,254

Other liabilities

     20,355      36,991

Members’/Partners’ equity

     242,381      180,653
             

Total liabilities and members’/partners’ equity

   $ 890,230    $ 847,898
             

Company’s share of equity

   $ 99,875    $ 81,053

Basis differentials(2)

     2,613      2,658
             

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

   $ 102,488    $ 83,711
             

(1) The Company and its third-party joint venture partners in the Wisconsin Place Entities have guaranteed the seller financing totaling $7.5 million related to the acquisition of the land by the Land and Infrastructure Entity. The fair value of the Company’s stand-ready obligations related to the issuance of these guarantees is immaterial.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

(2) This amount represents the aggregate difference between the Company’s historical cost basis and the basis reflected at the joint venture level, which is typically amortized over the life of the related 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
September 30,
   For the nine months ended
September 30,
           2007                2006                2007                2006      
     (in thousands)    (in thousands)

Total revenue

   $ 22,796    $ 25,846    $ 71,802    $ 77,650

Expenses

           

Operating

     8,176      7,699      25,700      24,786

Interest

     7,423      8,856      23,945      26,459

Depreciation and amortization

     5,215      5,937      16,039      17,990

Loss from early extinguishment of debt

     —        205      146      205
                           

Total expenses

     20,814      22,697      65,830      69,440
                           

Income before gain on sale of real estate

     1,982      3,149      5,972      8,210

Gain on sale of real estate

     —        51,395      32,777      51,395
                           

Net income

   $ 1,982    $ 54,544    $ 38,749    $ 59,605
                           

Company’s share of net income

   $ 1,390    $ 20,200    $ 19,623    $ 23,167
                           

5. Mortgage Notes Payable

On January 9, 2007, in connection with the acquisition of land parcels located at or adjacent to 250 West 55th Street in New York City, the Company obtained financing totaling $160.0 million. The loan was collateralized by mortgages totaling approximately $13.6 million. The mortgage loan bore interest at a variable rate equal to LIBOR plus 0.40% per annum and was scheduled to mature on January 9, 2009 with two, six-month extension options. On May 9, 2007, the Company used available cash to repay the mortgage loan.

On February 12, 2007, the Company refinanced its mortgage loan collateralized by 599 Lexington Avenue located in New York City. The new mortgage financing totaling $750.0 million bears interest at a fixed interest rate of 5.57% per annum and matures on March 1, 2017. On December 19, 2006, the Company had terminated its forward-starting interest rate swap contracts and received approximately $10.9 million, which amount will reduce the Company’s interest expense over the ten-year term of the financing, resulting in an effective interest rate of 5.38% per annum for the financing. The net proceeds of the new loan were used to refinance the $225.0 million mortgage loan on 599 Lexington Avenue and the $475.0 million mortgage loan on Times Square Tower. In connection with the refinancing, the lien of the Times Square Tower mortgage was spread to 599 Lexington Avenue and released from Times Square Tower so that Times Square Tower is no longer encumbered by any mortgage debt. The Times Square Tower mortgage loan bore interest at a variable rate equal to LIBOR plus 0.50% per annum and was scheduled to mature on July 9, 2008. There was no prepayment penalty associated with the repayment. The Company recognized a loss from early extinguishment of debt totaling approximately $0.7 million consisting of the write-off of unamortized deferred financing costs.

In connection with the acquisition of Kingstowne Towne Center in Alexandria, Virginia on March 30, 2007, the Company assumed two mortgage loans collateralized by the properties aggregating approximately $65.3 million. Pursuant to the provisions of Financial Accounting Standards Board’s (“FASB”) Statement of Financial

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Accounting Standards (“SFAS”) No. 141 “Business Combinations” (“SFAS No. 141”), the assumed mortgage loans of approximately $44.9 million and $20.4 million, which bear contractual interest at fixed rates of 5.99% and 5.96% and mature on January 1, 2016 and May 5, 2013, respectively, were recorded at their fair values of approximately $46.2 million and $20.8 million, respectively, using an effective interest rate of 5.50% per annum.

On May 17, 2007, the Company obtained mortgage financing totaling $25.0 million collateralized by its Montvale Center property located in Gaithersburg, Maryland. Montvale Center is a Class A office property consisting of approximately 123,000 net rentable square feet. The mortgage financing requires interest-only payments at a fixed rate equal to 5.93% per annum until maturity and matures on June 6, 2012.

On August 6, 2007, the Company used available cash to repay the mortgage loan collateralized by its Embarcadero Center Four property located in San Francisco, California totaling approximately $131.2 million. There was no prepayment penalty associated with the repayment. The mortgage loan bore interest at a fixed rate of 6.79% per annum and was scheduled to mature on February 1, 2008.

In conjunction with the sale of Democracy Center in Bethesda, Maryland on August 7, 2007, the Company repaid the mortgage financing collateralized by the property totaling approximately $94.6 million. The Company paid a prepayment fee of approximately $2.6 million associated with the repayment. The Company recognized a loss from early extinguishment of debt totaling approximately $2.7 million consisting of the prepayment fee and the write-off of unamortized deferred financing costs. The mortgage loan bore interest at a fixed rate equal to 7.05% per annum and was scheduled to mature on April 1, 2009.

On July 27, 2007, the Company commenced an interest rate hedging program for its expected financing activity in 2008. The Company has since entered into nine treasury locks based on a weighted-average 10-year treasury rate of 4.74% per annum on notional amounts aggregating $325.0 million. The treasury locks mature on April 1, 2008. In addition, the Company has entered into four forward-starting interest rate swap contracts to lock the 10-year LIBOR swap rate on notional amounts aggregating $125.0 million at a weighted-average forward-starting 10-year swap rate of 5.21% per annum. The 10-year treasury rate is a component of the 10-year swap rate and the swap contracts effectively fixed the 10-year treasury rate at a weighted-average interest rate of 4.53% per annum. The swap contracts go into effect on July 31, 2008 and expire on July 31, 2018. The contracts have effectively fixed the 10-year treasury rate at a weighted average interest rate of 4.68% per annum on notional amounts aggregating $450.0 million. The Company entered into the treasury locks and interest rate swap contracts designated and qualifying as cash flow hedges to reduce its exposure to the variability in future cash flows attributable to changes in the hedged rate in contemplation of obtaining ten-year fixed-rate financings in 2008. 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 treasury locks and forward-starting interest rate swap contracts were included in the assessment of hedge effectiveness. On September 27, 2007, the Company entered into an interest rate swap to fix the one-month LIBOR index rate at 4.57% per annum on a notional amount of $96.7 million. The interest rate swap goes into effect on October 22, 2007 and expires on October 29, 2008. The Company has recorded the changes in fair value of the treasury lock and swap contracts related to the effective portion totaling approximately $2.9 million in Accumulated Other Comprehensive Loss within the Company’s Consolidated Balance Sheets. The Company expects that within the next twelve months it will reclassify into earnings approximately $0.2 million of the amounts recorded within Accumulated Other Comprehensive Loss relating to the treasury locks and forward-starting interest rate swap contracts.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

6. Unsecured Exchangeable Senior Notes

On February 6, 2007, the Company’s Operating Partnership completed an offering of $862.5 million in aggregate principal amount (including $112.5 million as a result of the exercise by the initial purchasers of their over-allotment option) of its 2.875% exchangeable senior notes due 2037. The notes were priced at 97.433333% of their face amount, resulting in an effective interest rate of approximately 3.438% per annum and net proceeds to the Company of approximately $840.0 million. The notes mature on February 15, 2037, unless earlier repurchased, exchanged or redeemed.

Upon the occurrence of specified events, holders of the notes may exchange their notes prior to the close of business on the scheduled trading day immediately preceding February 20, 2012 into cash and, at the Operating Partnership’s option, shares of the Company’s common stock at an initial exchange rate of 6.6090 shares per $1,000 principal amount of notes (or an initial exchange price of approximately $151.31 per share of the Company’s common stock). On and after February 20, 2012, the notes will be exchangeable at any time prior to the close of business on the scheduled trading day immediately preceding the maturity date at the option of the holder at the applicable exchange rate. The initial exchange rate is subject to adjustment in certain circumstances.

Prior to February 20, 2012, the Operating Partnership may not redeem the notes except to preserve the Company’s status as a REIT. On or after February 20, 2012, the Operating Partnership may redeem all or a portion of the notes for cash at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest. Note holders may require the Operating Partnership to repurchase all or a portion of the notes on February 15 of 2012, 2017, 2022, 2027 and 2032 at a purchase price equal to 100% of the principal amount plus accrued and unpaid interest up to, but excluding, the repurchase date. The Operating Partnership will pay cash for all notes so repurchased.

If the Company undergoes a “fundamental change,” note holders will have the option to require the Operating Partnership to purchase all or any portion of the notes at a purchase price equal to 100% of the principal amount of the notes to be purchased plus any accrued and unpaid interest to, but excluding, the fundamental change purchase date. The Operating Partnership will pay cash for all notes so purchased. In addition, if a fundamental change occurs prior to February 20, 2012, the Operating Partnership will increase the exchange rate for a holder who elects to exchange its notes in connection with such a fundamental change under certain circumstances. The notes are senior unsecured obligations of the Operating Partnership and will rank equally in right of payment to all existing and future senior unsecured indebtedness and senior to any future subordinated indebtedness of the Operating Partnership. The notes will effectively rank junior in right of payment to all existing and future secured indebtedness of the Operating Partnership. The notes will be structurally subordinated to all liabilities of the subsidiaries of the Operating Partnership.

In connection with the closing, the Company and the Operating Partnership entered into a Registration Rights Agreement (the “Registration Rights Agreement”) with the initial purchasers, under which the Company and the Operating Partnership agreed, for the benefit of the holders of the notes, to file with the Securities and Exchange Commission and maintain a shelf registration statement providing for the sale by the holders of the notes and the Company’s common stock, if any, issuable upon exchange of the notes. The Company and the Operating Partnership will be required to pay liquidated damages in the form of specified additional interest to the holders of the notes if they fail to comply with these obligations; provided that the Operating Partnership will not be required to pay liquidated damages with respect to any note after it has been exchanged for any of the Company’s common stock. On March 13, 2007, the Company and the Operating Partnership filed with the SEC a registration statement covering the resale of the notes and shares of common stock issuable upon exchange of the notes. The registration statement was declared effective by the SEC on April 20, 2007.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

7. Unsecured Line of Credit

On August 3, 2006, the Company modified its $605.0 million unsecured revolving credit facility (the “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. The Unsecured Line of Credit is a recourse obligation of the Company’s Operating Partnership. 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. Effective March 22, 2007, the per annum variable interest rate was reduced to Eurodollar plus 0.475% and the facility fee was reduced to 12.5 basis points per annum as a result of an increase in the Operating Partnership’s unsecured debt rating. 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 negotiated LIBOR-based rate. The Company had an outstanding balance on the Unsecured Line of Credit of $225.0 million at December 31, 2006, which was collateralized by the Company’s 599 Lexington Avenue property and therefore was included in Mortgage Notes Payable in the Company’s Consolidated Balance Sheets. On February 12, 2007, the Company repaid the $225.0 million draw that was collateralized by the Company’s 599 Lexington Avenue. As of September 30, 2007, there were no outstanding borrowings under the Unsecured Line of Credit

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, the leverage ratio may increase to no greater than 65% provided that it is reduced back to 60% within 180 days, (2) a secured debt leverage ratio not to exceed 55%, (3) a fixed charge coverage ratio of at least 1.40, (4) an unsecured debt leverage ratio not to exceed 60%, however, the unsecured debt leverage ratio may increase to no greater than 65% provided that it is reduced back to 60% within 180 days, (5) a minimum net worth requirement, (6) an unsecured debt 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 September 30, 2007, 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.

The Company has letter of credit and performance obligations of approximately $28.4 million related to lender and development requirements.

The Company and its third-party joint venture partners have guaranteed the seller financing totaling $7.5 million related to the acquisition of land by WP Project Developer LLC, the Land and Infrastructure Entity of the Wisconsin Place joint venture entities.

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.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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, 2007, the Company’s property insurance program per occurrence limits were increased from $800 million to $900 million, including (i) coverage for “certified” acts of terrorism by TRIA of $900 million per occurrence and (ii) coverage for “non-certified” acts of terrorism by TRIA of $500 million per occurrence, and an additional $400 million of coverage for “non-certified” acts of terrorism by TRIA on a per occurrence and annual aggregate basis. 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, LLC as a direct insurer. Effective as of March 1, 2007, the Company extended the NBCR Coverage to March 1, 2008, excluding the Company’s Value-Added Fund properties. Effective as of March 1, 2007, the per occurrence limit for NBCR Coverage was increased from $800 million to $900 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 $100 million from January 1, 2007 through December 31, 2007 and (b) the coinsurance is 15% from January 1, 2007 through December 31, 2007. The Company may elect to terminate the NBCR Coverage if there is a change in its portfolio or for any other reason. In the event TRIA is not extended beyond December 31, 2007 (i) the NBCR coverage provided by IXP will terminate and (ii) the Company will have some gaps in its coverage for acts of terrorism that would have constituted both “certified” and “non-certified” acts of terrorism had TRIA not expired and the Company may obtain the right to replace a portion of such coverage. 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 annual aggregate limit, $20 million of which is provided by IXP, LLC, as a direct insurer. The amount of the Company’s earthquake insurance coverage may not be sufficient to cover losses from earthquakes. 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.

In January 2002, the Company formed a wholly-owned taxable REIT subsidiary, IXP, Inc., to act as a captive insurance company and be one of the elements of the Company’s overall insurance program. On September 27, 2006, IXP, Inc. was merged into IXP, LLC, a wholly owned subsidiary, and all insurance policies issued by IXP, Inc. were cancelled and reissued by IXP, LLC. The term “IXP” refers to IXP, Inc. for the period prior to September 27, 2006 and to IXP, LLC for the period on and subsequent to September 27, 2006. 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

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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 September 30, 2007, the minority interest in the Operating Partnership consisted of 20,285,974 OP Units, 676,192 LTIP Units and 1,113,044 Series Two Preferred Units (or 1,460,688 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 $5.1 million at September 30, 2007, are included in Minority Interests on the accompanying Consolidated Balance Sheets.

On February 26, 2007, the Company entered into an agreement to redeem the outside members’ equity interest in the limited liability company that owns 250 West 55th Street for an aggregate redemption price of approximately $23.4 million. The Company paid $17.0 million on February 26, 2007, with $3.0 million payable on February 26, 2008 and the balance of approximately $3.4 million payable in monthly installments from March 1, 2007 through August 1, 2009. The redemption was accounted for using the purchase method in accordance with SFAS No. 141 “Business Combinations” (“SFAS No. 141”). The difference between the aggregate book value of the outside members’ equity interest totaling approximately $10.6 million and the purchase price increased the recorded value of the property’s net assets.

On May 31, 2007 and June 15, 2007, the Company paid an aggregate of $25.0 million in connection with the agreement entered into in May 2006 to redeem the outside members’ equity interests in the limited liability company that owns Citigroup Center. The remaining unpaid redemption price, which is to be paid on May 31, 2008, is reflected at its fair value in Other Liabilities in the Company’s Consolidated Balance Sheets and totaled $24.0 million at September 30, 2007.

During the nine months ended September 30, 2007, 606,186 Series Two Preferred Units of the Operating Partnership were converted by the holders into 795,520 OP Units. In addition, the Company paid the accrued preferred distributions due to the holders of Preferred Units that were converted.

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

During the nine months ended September 30, 2007, 1,327,468 OP Units (including 794,768 OP Units issued upon conversion of the Series Two Preferred Units discussed above) 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 $30.1 million. The difference between the aggregate book value and the purchase price of these OP Units was approximately $111.9 million, which increased the recorded value of the Company’s net assets.

The Preferred Units at September 30, 2007 consist solely of 1,113,044 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 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 nine months ended September 30, 2007 and 2006) 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.

On January 30, 2007, 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 29, 2006. In addition, the Operating Partnership paid a special cash distribution on the OP Units and LTIP Units in the amount of $5.40 per unit to holders of record as of the close of business on December 29, 2006. On April 30, 2007, 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 30, 2007. On July 31, 2007, 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 June 29, 2007.

Holders of Series Two Preferred Units participated in the $5.40 per unit special cash distribution on an as-converted basis in connection with their regular May 2007 distribution payment as provided for in the Operating Partnership’s partnership agreement. At December 31, 2006, the Company had accrued approximately $12.2 million related to the $5.40 per unit special cash distribution payable to holders of the Series Two Preferred Units. During the nine months ended September 30, 2007, the Company recognized an adjustment of approximately $3.1 million to the special cash distribution accrual and allocation of earnings to the Series Two Preferred Units, as a result of conversions of Series Two Preferred Units, which amount has been reflected in Minority Interest in Operating Partnership within the Consolidated Statements of Operations.

On February 15, 2007, the Operating Partnership paid a distribution on its outstanding Series Two Preferred Units of $0.89239 per unit. On May 15, 2007, the Operating Partnership paid a distribution on its outstanding Series Two Preferred Units of $7.979 per unit, which amount included 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, on December 15, 2006 and paid on January 30, 2007. On August 15, 2007, the Operating Partnership paid a distribution on its outstanding Series Two Preferred Units of $0.89239 per unit.

On September 17, 2007, 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 October 31, 2007 to holders of record as of the close of business on September 28, 2007.

The Series Two Preferred Units may be converted into OP Units at the election of the holder thereof at any time. 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

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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. In lieu of a cash redemption, the Company may elect to acquire such OP Unit for one share of Common Stock. The value of the OP Units (not owned by the Company and including LTIP Units assuming that all conditions have been met for the conversion thereof) and Series Two Preferred Units had such units been redeemed at September 30, 2007 was approximately $2,178.0 million and $151.8 million, respectively, based on the closing price of the Company’s common stock of $103.90 per share on September 28, 2007.

10. Stockholders’ Equity

As of September 30, 2007, the Company had 119,253,212 shares of Common Stock outstanding.

During the nine months ended September 30, 2007, the Company issued 1,327,468 shares of its Common Stock in connection with the redemption of an equal number of OP Units.

During the nine months ended September 30, 2007, the Company issued 425,283 shares of its Common Stock upon the exercise of options to purchase Common Stock by certain employees.

On January 30, 2007, 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 29, 2006. In addition, the Company paid a special cash dividend of $5.40 per share of Common Stock to shareholders of record as of the close of business on December 29, 2006. On April 30, 2007, 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 30, 2007. On July 31, 2007, 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 June 29, 2007.

On September 17, 2007, the Company’s Board of Directors declared a dividend in the amount of $0.68 per share of Common Stock payable on October 31, 2007 to shareholders of record as of the close of business on September 28, 2007.

11. Discontinued Operations

The Company applies 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 nine months ended September 30, 2007, the Company sold the following operating properties:

 

   

5 Times Square, a Class A office tower that contains approximately 1,101,779 net rentable square feet located in New York City;

 

   

The Long Wharf Marriott, a 402-room hotel located in Boston, Massachusetts;

 

   

Newport Office Park, a Class A office property that contains approximately 172,000 net rentable square feet located in Quincy, Massachusetts; and

 

   

Democracy Center, a Class A office complex that contains an aggregate of approximately 685,000 net rentable square feet located in Bethesda, Maryland.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

During the year ended December 31, 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.

Due to the Company’s continuing involvement in the management, for a fee, of Democracy Center, 280 Park Avenue and 5 Times Square through agreements with the buyers and other financial obligations to the buyers, Democracy Center, 280 Park Avenue and 5 Times Square have not been categorized as discontinued operations in the accompanying Consolidated Statements of Operations. As a result, the gains on sales related to Democracy Center, 5 Times Square and 280 Park Avenue have been reflected under the caption “Gains on sales of real estate, net of minority interest,” in the 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 nine months ended September 30, 2007 and 2006, as applicable.

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 nine months ended September 30, 2007 and 2006 (in thousands):

 

     For the three months ended
September 30,
   For the nine months ended
September 30,
            2007                  2006                  2007                   2006       

Total revenue

   $ —      $ 12,963    $ 9,222     $ 33,955

Operating expenses

     —        7,978      7,110       22,710

Depreciation and amortization

     —        990      608       2,667

Minority interest in Operating Partnership

     —        624      221       1,350
                            

Income from discontinued operations (net of minority interest)

   $ —      $ 3,371    $ 1,283     $ 7,228
                            

Realized gains on sales of real estate

   $ —      $ —      $ 204,623     $ —  

Minority interest in Operating Partnership

     —        —        (30,724 )     —  
                            

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

   $ —      $ —      $ 173,899     $ —  
                            

The Company’s application of SFAS No. 144 results in the presentation of the net operating results of these qualifying properties sold or held for sale during 2007 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

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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 September 30, 2007 and 2006, approximately $2.0 million and $0.7 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 nine months ended September 30, 2007 and 2006, approximately $12.3 million and $17.0 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 stock options, restricted stock and other securities of the Operating Partnership that are exchangeable for the Company’s Common Stock, and the related impact on earnings, are considered when calculating diluted EPS.

 

     For the three months ended September 30, 2007  
     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

   $ 242,370     119,010    $ 2.04  

Allocation of undistributed earnings of Series Two Preferred Units

     (1,962 )   —        (0.02 )
                     

Net income available to common shareholders

     240,408     119,010      2.02  

Effect of Dilutive Securities:

       

Stock Based Compensation

     —       1,645      (0.03 )

Diluted Earnings:

       
                     

Net income

   $ 240,408     120,655    $ 1.99  
                     
     For the three months ended September 30, 2006  
     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

   $ 104,591     115,432    $ 0.91  

Discontinued operations, net of minority interest

     3,371     —        0.03  

Allocation of undistributed earnings of Series Two Preferred Units

     (652 )   —        (0.01 )
                     

Net income available to common shareholders

     107,310     115,432      0.93  

Effect of Dilutive Securities:

       

Stock Based Compensation

     —       2,296      (0.02 )

Diluted Earnings:

       
                     

Net income

   $ 107,310     117,728    $ 0.91  
                     

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

     For the nine months ended September 30, 2007  
     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

   $ 1,025,290     118,715    $ 8.63  

Discontinued operations, net of minority interest

     175,182     —        1.48  

Allocation of undistributed earnings of Series Two Preferred Units

     (12,301 )   —        (0. 10 )
                     

Net income available to common shareholders

     1,188,171     118,715      10.01  

Effect of Dilutive Securities:

       

Stock Based Compensation

     —       1,808      (0.15 )

Exchangeable Senior Notes

     —       237      (0.02 )

Diluted Earnings:

       
                     

Net income

   $ 1,188,171     120,760    $ 9.84  
                     
     For the nine months ended September 30, 2006  
     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

   $ 793,765     113,989    $ 6.97  

Discontinued operations, net of minority interest

     7,228     —        0.06  

Allocation of undistributed earnings of Series Two Preferred Units

     (16,959 )   —        (0.15 )
                     

Net income available to common shareholders

     784,034     113,989      6.88  

Effect of Dilutive Securities:

       

Stock Based Compensation

     —       2,376      (0.14 )

Diluted Earnings:

       
                     

Net income

   $ 784,034     116,365    $ 6.74  
                     

13. Stock Option and Incentive Plan

At the Company’s 2007 annual meeting of stockholders held on May 15, 2007, the Company’s stockholders approved an amendment and restatement of the Company’s 1997 Stock Option and Incentive Plan (the “Plan”) that, among other things, (1) increased the limit on full value shares (i.e., awards other than stock options) that may be issued under the Plan by 2,500,000 shares, (2) extended the term of the Plan to May 15, 2017 and (3) added provisions that allow the Company to qualify certain grants under the Plan as “performance-based compensation” under Section 162(m) of the Internal Revenue Code.

During the nine months ended September 30, 2007, the Company issued 6,536 shares of restricted stock and 156,161 LTIP Units under its stock option and incentive plan. The shares of restricted stock were valued at approximately $0.8 million ($125.46 per share weighted-average). The LTIP Units were valued at approximately

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

$18.0 million ($115.47 per unit weighted-average 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 5.3 years, a risk-free interest rate of 4.82% and an expected price volatility of 18.0%. An LTIP Unit is generally the economic equivalent of a share of restricted stock in the Company. The aggregate value of the LTIP Units is included in Minority Interests in the Consolidated Balance Sheets. The restricted stock and LTIP Units granted to employees between January 1, 2004 and November 2006 vest over a five-year term. Grants of restricted stock and LTIP Units made in and after November 2006 vest in four equal annual installments. 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 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 $2.8 million and $1.8 million for the three months ended September 30, 2007 and 2006, respectively, and $8.6 million and $5.9 million for the nine months ended September 30, 2007 and 2006, respectively. At September 30, 2007, there was $28.3 million of unrecognized compensation cost related to unvested restricted stock and LTIP Units that is expected to be recognized over a weighted-average period of approximately 2.9 years.

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 Hotel.

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, 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), income from discontinued operations (net of minority interest), gains on sales of real estate from 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.

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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

Three months ended September 30, 2007 (dollars in thousands):

 

     Greater
Boston
    Greater
Washington, D.C.
    Midtown
Manhattan
   

Greater

San Francisco

    New Jersey     Total  

Rental Revenue:

            

Class A

   $ 85,144     $ 60,630     $ 108,596     $ 50,592     $ 16,604     $ 321,566  

Office/Technical

     6,744       4,152       —         —         —         10,896  

Hotel

     8,646       —         —         —         —         8,646  
                                                

Total

     100,534       64,782       108,596       50,592       16,604       341,108  
                                                

% of Total

     29.47 %     18.99 %     31.84 %     14.83 %     4.87 %     100.0 %

Real Estate Operating Expenses:

            

Class A

     32,642       17,455       34,318       19,495       7,317       111,227  

Office/Technical

     2,009       904       —         —         —         2,913  

Hotel

     6,275       —         —         —         —         6,275  
                                                

Total

     40,926       18,359       34,318       19,495       7,317       120,415  
                                                

% of Total

     33.99 %     15.24 %     28.50 %     16.19 %     6.08 %     100.0 %
                                                

Net Operating Income

   $ 59,608     $ 46,423     $ 74,278     $ 31,097     $ 9,287     $ 220,693  
                                                

% of Total

     27.00 %     21.04 %     33.66 %     14.09 %     4.21 %     100.0 %

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

 

     Greater
Boston
    Greater
Washington, D.C.
    Midtown
Manhattan
   

Greater

San Francisco

    New Jersey     Total  

Rental Revenue:

            

Class A

   $ 77,476     $ 56,489     $ 123,675     $ 47,839     $ 16,075     $ 321,554  

Office/Technical

     6,518       3,937       —         —         —         10,455  

Hotel

     8,319       —         —         —         —         8,319  
                                                

Total

     92,313       60,426       123,675       47,839       16,075       340,328  
                                                

% of Total

     27.12 %     17.76 %     36.34 %     14.06 %     4.72 %     100.0 %

Operating Expenses:

            

Class A

     31,070       15,189       36,751       18,779       7,205       108,994  

Office/Technical

     1,426       756       —         —         —         2,182  

Hotel

     6,339       —         —         —         —         6,339  
                                                

Total

     38,835       15,945       36,751       18,779       7,205       117,515  
                                                

% of Total

     33.05 %     13.57 %     31.27 %     15.98 %     6.13 %     100.0 %
                                                

Net Operating Income

   $ 53,478     $ 44,481     $ 86,924     $ 29,060     $ 8,870     $ 222,813  
                                                

% of Total

     24.00 %     19.97 %     39.01 %     13.04 %     3.98 %     100.0 %

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Nine months ended September 30, 2007 (dollars in thousands):

 

     Greater
Boston
    Greater
Washington, D.C.
    Midtown
Manhattan
   

Greater

San Francisco

    New Jersey     Total  

Rental Revenue:

            

Class A

   $ 248,257     $ 185,361     $ 332,822     $ 150,932     $ 51,520     $ 968,892  

Office/Technical

     20,625       12,674       —         —         —         33,299  

Hotels

     24,690       —         —         —         —         24,690  
                                                

Total

     293,572       198,035       332,822       150,932       51,520       1,026,881  
                                                

% of Total

     28.59 %     19.29 %     32.41 %     14.69 %     5.02 %     100.0 %

Operating Expenses:

            

Class A

     95,691       52,717       103,445       58,081       22,128     $ 332,062  

Office/Technical

     6,554       2,723       —         —         —         9,277  

Hotel

     18,706       —         —         —         —         18,706  
                                                

Total

     120,951       55,440       103,445       58,081       22,128       360,045  
                                                

% of Total

     33.59 %     15.40 %     28.73 %     16.13 %     6.15 %     100.0 %
                                                

Net Operating Income

   $ 172,621     $ 142,595     $ 229,377     $ 92,851     $ 29,392     $ 666,836  
                                                

% of Total

     25.89 %     21.38 %     34.40 %     13.92 %     4.41 %     100.0 %

Nine months ended September 30, 2006 (dollars in thousands):

 

     Greater
Boston
    Greater
Washington, D.C.
    Midtown
Manhattan
   

Greater

San Francisco

    New Jersey     Total  

Rental Revenue:

            

Class A

   $ 228,321     $ 165,303     $ 391,247     $ 139,246     $ 48,618     $ 972,735  

Office/Technical

     19,799       11,543       —         —         —         31,342  

Hotels

     21,598       —         —         —         —         21,598  
                                                

Total

     269,718       176,846       391,247       139,246       48,618       1,025,675  
                                                

% of Total

     26.30 %     17.24 %     38.15 %     13.57 %     4.74 %     100.0 %

Operating Expenses:

            

Class A

     88,657       44,143       119,750       52,929       21,206       326,685  

Office/Technical

     4,060       2,271       —         —         —         6,331  

Hotel

     16,860       —         —         —         —         16,860  
                                                

Total

     109,577       46,414       119,750       52,929       21,206       349,876  
                                                

% of Total

     31.32 %     13.26 %     34.23 %     15.13 %     6.06 %     100.0 %
                                                

Net Operating Income

   $ 160,141     $ 130,432     $ 271,497     $ 86,317     $ 27,412     $ 675,799  
                                                

% of Total

     23.70 %     19.30 %     40.17 %     12.77 %     4.06 %     100.00 %

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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

 

    Three months ended
September 30,
   

Nine months

ended September 30,

 
    2007     2006     2007     2006  
    (in thousands)  

Net operating income

  $ 220,693     $ 222,813     $ 666,836     $ 675,799  

Add:

       

Development and management services

    5,318       4,558       15,175       14,159  

Interest and other

    25,081       14,611       68,274       25,124  

Minority interest in property partnership

    —         —         —         2,013  

Income from unconsolidated joint ventures

    1,390       20,200       19,623       23,167  

Gains on sales of real estate, net of minority interest

    168,495       17,889       788,855       604,200  

Income from discontinued operations, net of minority interest

    —         3,371       1,283       7,228  

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

    —         —         173,899       —    

Less:

       

General and administrative expense

    (20,189 )     (12,739 )     (53,288 )     (43,177 )

Interest expense

    (69,929 )     (73,571 )     (217,598 )     (226,837 )

Depreciation and amortization expense

    (71,616 )     (70,558 )     (216,715 )     (203,640 )

Losses from early extinguishments of debt

    (2,695 )     (208 )     (3,417 )     (32,132 )

Minority interest in Operating Partnership

    (14,178 )     (18,404 )     (42,455 )     (44,911 )
                               

Net income available to common shareholders

  $ 242,370     $ 107,962     $ 1,200,472     $ 800,993  
                               

15. Newly Issued Accounting Standards

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 was effective for fiscal years beginning after December 15, 2006. FIN No. 48, which was adopted by the Company effective January 1, 2007, did not have a material impact on the Company’s cash flows, results of operations, financial position or liquidity.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of SFAS No. 157 to have a material impact on the Company’s cash flows, results of operations, financial position or liquidity.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (“SFAS No. 159”). SFAS No. 159 permits entities to choose, at specified election dates, to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Unrealized gains and losses shall

 

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BOSTON PROPERTIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

be reported on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of SFAS No. 159 to have a material impact on the Company’s cash flows, results of operations, financial position or liquidity.

16. Subsequent Events

On October 1, 2007, a joint venture in which the Company has a 50% interest, placed in-service 505 9th Street, a 323,000 net rentable square foot Class A office property located in Washington, D.C. On October 17, 2007, the construction financing on the property was converted to a ten-year fixed rate loan. The construction financing was comprised of (1) a $60.0 million loan commitment, which bore interest at a fixed rate of 5.73% per annum, with an outstanding balance of approximately $50.5 million, and (2) a $35.0 million loan commitment, which bore interest at a variable rate equal to LIBOR plus 1.25% per annum, with an outstanding balance of approximately $29.0 million. The new mortgage financing totaling $130.0 million bears interest at a fixed interest rate of 5.73% per annum and matures on November 1, 2017.

On October 1, 2007, the Company used available cash to repay the mortgage loans collateralized by its 504, 506, 508 and 510 Carnegie Center properties located in Princeton, New Jersey totaling approximately $65.0 million. There was no prepayment penalty associated with the repayment. The mortgage loans bore interest at a fixed rate of 7.39% per annum and were scheduled to mature on January 1, 2008.

On October 25, 2007, the Company executed a binding agreement for the sale of its Orbital Science Campus and Broad Run Business Park, Building E properties located in Loudon County, Virginia, for approximately $126.7 million in cash. The Orbital Science Campus and Broad Run Business Park, Building E properties are comprised of three Class A office properties aggregating approximately 337,000 net rentable square feet and an office/technical property totaling approximately 127,000 net rentable square feet, respectively. The sale price for the properties exceeds the aggregate carrying value of the properties. The sale is subject to the satisfaction of customary closing conditions and there can be no assurance that the sale will be consummated on the terms currently contemplated or at all.

On November 2, 2007, the Company entered into a forward-starting interest rate swap contract to lock the 10-year LIBOR swap rate on a notional amount of $25.0 million at a forward-starting 10-year swap rate of 5.05% per annum. The 10-year treasury rate is a component of the 10-year swap rate and the referenced contract effectively fixed the 10-year treasury rate at 4.38%. The swap contract goes into effect on July 31, 2008 and expires on July 31, 2018. On November 9, 2007, the Company entered into a treasury lock that fixed the 10-year treasury rate at 4.33% per annum on a notional amount of $25.0 million. The treasury lock matures on July 31, 2008. The Company has effectively fixed the 10-year treasury rate at a weighted average interest rate of 4.65% per annum on notional amounts aggregating $500.0 million with its interest rate hedging program (See Note 5).

On November 8, 2007, the Company executed a binding agreement to acquire Mountain View Research Park for $183.0 million and Mountain View Technology Park for $40.0 million. The Research Park properties are comprised of sixteen Class A office and office/technical properties aggregating approximately 610,000 net rentable square feet located in Mountain View, California. The Technology Park properties are comprised of seven office/technical properties aggregating approximately 135,000 net rentable square feet located in Mountain View, California. The Company is in discussions with its partners in the Value-Added Fund regarding the possibility of acquiring Mountain View Technology Park through the Value-Added Fund. 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.

 

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

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

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. This Quarterly 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 and developments 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;

 

   

possible adverse changes in tax and environmental laws;

 

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Table of Contents
   

risks associated with possible state and local tax audits;

 

   

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

 

   

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

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

Overview

We are a fully integrated self-administered and self-managed REIT and one of the largest owners and developers of Class A office properties in the United States. Our properties are concentrated in five markets—Boston, midtown Manhattan, Washington, D.C., San Francisco and Princeton, NJ. 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 or core assets that command premiums from real estate investors.

Our core strategy has always been to operate in supply constrained markets, so given the combination of strong demand, increasing replacement costs and scarcity of supply, we expect our assets to continue to appreciate over time. Given current market conditions, we generally believe that the returns we can generate from development will be greater than those we can expect to realize from acquisitions. As a result, we have been focusing on selectively selling assets, thereby reducing the overall size of the in service portfolio and replacing the sold assets with substantial investments in new development opportunities. Since the beginning of 2005 we have completed over $4.1 billion of asset sales. We have started approximately $1.7 billion of developments in 2007, including commencing construction on our approximately 1.0 million square foot office tower in New York City at 250 West 55th Street and on our 815,000 square foot mixed-used Russia Wharf development in Boston. We will enter 2008 with an active development program of approximately $2.1 billion, and although we will consider additional asset sales, we do not expect our sales volume to be comparable to that of prior years. While the asset sales will have the impact of dampening our short-term, year-to-year earnings growth rate, we believe our focus on new development will enhance our long-term return on equity and earnings growth as these developments are placed in-service in 2009, 2010 and 2011.

We continue to monitor the real estate debt markets and their impact on asset pricing and our ability to find attractively priced acquisitions. We believe that if a major asset were to be financed today, CMBS investment grade debt would make up a much smaller and more expensive piece of the capital structure than over the past several years. If debt is more expensive and more equity is required to complete deals, we are well positioned to take advantage of new opportunities with our low leverage and access to multiple sources of capital.

 

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Table of Contents

The highlights of the three months ended September 30, 2007 included the following:

 

   

On July 12, 2007, we executed a lease with Ropes & Gray LLP to relocate its Boston office to the Prudential Tower. The law firm will occupy more than 400,000 square feet of office space in the top floors of the 52-story, 1.2 million square foot office building beginning in the fall of 2010.

 

   

On July 16, 2007, we entered into a joint venture with an unrelated third party to develop Annapolis Junction, a Class A office complex aggregating approximately 425,000 net rentable square feet located in Anne Arundel County, Maryland. The joint venture partner contributed the land for a 50% interest in the joint venture and the Company will contribute cash of approximately $14.9 million for its 50% interest. The joint venture has commenced construction on an approximately 117,600 net rentable square foot Class A office property on the site. On September 13, 2007, the joint venture entity obtained construction financing totaling $45.5 million. The construction financing bears interest at a variable rate equal to LIBOR plus 1.20% per annum and matures in September 2010, with two one-year extension options.

 

   

On July 24, 2007, we acquired 701 Carnegie Center, a land parcel located in Princeton, New Jersey for a purchase price of approximately $3.1 million with the title transferring pending subdivision approval. The purchase price was financed with available cash.

 

   

On July 27, 2007, we commenced an interest rate hedging program for a portion of our anticipated financing activity in 2008. As of September 30, we have entered into a series of treasury lock contracts and forward starting interest rate swap contracts on notional amounts aggregating $450.0 million for 10-year fixed rate financings estimated to occur on or about April 1, 2008 and on or about July 31, 2008. The contracts have fixed the 10-year treasury rate at a weighted-average rate of 4.68%. See Note 5 to the Consolidated Financial Statements.

 

   

On August 6, 2007, we used available cash to repay the mortgage loan collateralized by our Embarcadero Center Four property located in San Francisco, California totaling approximately $131.2 million. There was no prepayment penalty associated with the repayment. The mortgage loan bore interest at a fixed rate of 6.79% per annum and was scheduled to mature on February 1, 2008.

 

   

On August 7, 2007, we sold Democracy Center in Bethesda, Maryland, for approximately $280.5 million. Democracy Center is a Class A office complex that contains an aggregate of approximately 685,000 net rentable square feet. In conjunction with the sale, we repaid the mortgage financing collateralized by the property totaling approximately $94.6 million. We paid a prepayment fee of approximately $2.6 million associated with the repayment. The mortgage loan bore interest at a fixed rate equal to 7.05% per annum and was scheduled to mature on April 1, 2009. We will continue to have continuing involvement with this property through a management agreement with the buyer.

 

   

On September 27, 2007, we executed a contract to acquire North First Business Park located in San Jose, California, at a purchase price of approximately $71.5 million. This property is comprised of eight office/technical properties aggregating approximately 367,000 net rentable square feet located on approximately 24 acres of land. We expect to redevelop this site into approximately 1.4 million net rentable square feet of Class A office space. 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 September 27, 2007, we entered into an interest rate swap contract to fix the one-month LIBOR index rate at 4.57% per annum on a construction loan with a notional amount of $96.7 million. The swap contract went into effect on October 22, 2007 and expires on October 29, 2008.

 

   

During the three months ended September 30, 2007, we commenced the following development projects:

 

   

the Offices at Wisconsin Place, a Class A office project with approximately 290,000 net rentable square feet located in Chevy Chase, Maryland (through a joint venture in which the Company owns a 66.7% interest);

 

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701 Carnegie Center, a Class A office project with approximately 120,000 net rentable square feet located in Princeton, New Jersey;

 

   

South of Market, a Class A office project with approximately 225,000 net rentable square feet located in Reston, Virginia;

 

   

250 West 55th Street, a Class A office project with approximately 1,000,000 net rentable square feet located in New York City; and

 

   

Russia Wharf, a mixed-use project with approximately 580,000 net rentable square feet of Class A office space and approximately 235,000 square feet of residential space for rent or for sale located in Boston, Massachusetts.

Transactions completed subsequent to September 30, 2007:

 

   

On October 1, 2007, a joint venture in which we have a 50% interest, placed in-service 505 9th Street, a 323,000 net rentable square foot Class A office property located in Washington, D.C. The building is 97% leased. On October 17, 2007, the construction financing on the property was converted to a 10-year fixed rate loan that matures on November 1, 2017. The loan totals $130.0 million and bears interest at a fixed interest rate of 5.73% per annum.

 

   

On October 1, 2007, we used available cash to repay the mortgage loans collateralized by our 504, 506, 508 and 510 Carnegie Center properties located in Princeton, New Jersey totaling approximately $65.0 million. There was no prepayment penalty associated with the repayment. The mortgage loans bore interest at a fixed rate of 7.39% per annum and were scheduled to mature on January 1, 2008.

 

   

On October 25, 2007, we executed a binding agreement for the sale of our Orbital Science Campus and Broad Run Business Park, Building E properties located in Loudon County, Virginia, for approximately $126.7 million in cash. The Orbital Science Campus and Broad Run Business Park, Building E properties are comprised of three Class A office properties aggregating approximately 337,000 net rentable square feet and an office/technical property totaling approximately 127,000 net rentable square feet, respectively. The sale price for the properties exceeds the aggregate carrying value of the properties. We currently expect to complete the sale as part of a “like-kind exchange” under Section 1031 of the Internal Revenue Code. The sale is subject to the satisfaction of customary closing conditions and there can be no assurance that the sale will be consummated on the terms currently contemplated or at all.

 

   

On November 2, 2007, we entered into a forward-starting interest rate swap contract to lock the 10-year LIBOR swap rate on a notional amount of $25.0 million at a forward-starting 10-year swap rate of 5.05% per annum. The 10-year treasury rate is a component of the 10-year swap rate and the referenced contract effectively fixed the 10-year treasury rate at 4.38%. The swap contract goes into effect on July 31, 2008 and expires on July 31, 2018. On November 9, 2007, we entered into a treasury lock that fixed the 10-year treasury rate at 4.33% per annum on a notional amount of $25.0 million. The treasury lock matures on July 31, 2008. We have effectively fixed the 10-year treasury rate at a weighted average interest rate of 4.65% per annum on notional amounts aggregating $500.0 million with its interest rate hedging program.

 

   

On November 8, 2007, we executed a binding agreement to acquire Mountain View Research Park for $183.0 million and Mountain View Technology Park for $40.0 million. The Research Park properties are comprised of sixteen Class A office and office/technical properties aggregating approximately 610,000 net rentable square feet located in Mountain View, California. The Technology Park properties are comprised of seven office/technical properties aggregating approximately 135,000 net rentable square feet located in Mountain View, California. We are in discussions with our partners in our Value-Added Fund regarding the possibility of acquiring Mountain View Technology Park through our Value-Added Fund. 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.

 

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Election of New Chief Financial Officer and Employment-Related Matters

On October 22, 2007, the Company’s Board of Directors elected Michael E. LaBelle, age 43, to the position of Senior Vice President, Chief Financial Officer and Treasurer, effective November 15, 2007. Mr. LaBelle currently serves as Senior Vice President, Finance. Mr. LaBelle joined the Company in March 2000 as Vice President, Finance and he was promoted to his current position in February 2005. His primary responsibilities have included managing all debt capital market activities, including maintaining the Company’s relationships with its rating agencies and lending institutions, supervising treasury management and underwriting tenant credit capacity. In connection with this promotion, Douglas T. Linde, the Company’s current President, Chief Financial Officer and Treasurer, will relinquish the titles of Chief Financial Officer and Treasurer effective November 15, 2007. Mr. D. Linde will retain the title of President of the Company.

On October 18, 2007, the Company’s Compensation Committee (the “Committee”) authorized amendments to (1) the employment agreements by and between the Company and the following executive officers: Mortimer B. Zuckerman, Edward H. Linde, Douglas T. Linde, Raymond A. Ritchey, E. Mitchell Norville, Peter D. Johnston, Bryan J. Koop, Mitchell S. Landis, Robert E. Pester and Robert E. Selsam and (2) the Senior Executive Severance Agreements between the Company and each of Messrs. Zuckerman and E. Linde. Each of the foregoing amendments became effective as of November 1, 2007. In addition, effective October 18, 2007, the Committee approved amendments to the Company’s Senior Executive Severance Plan, Executive Severance Plan and Officer Severance Plan. The aforementioned agreements and severance plans were amended to comply with Section 409A of the Internal Revenue Code, which established new rules for deferred compensation. The amendments are technical in nature and do not materially change the benefits to participants under the agreements and plans.

Update on Recent Regulatory Initiatives

On August 31, 2007, the Financial Accounting Standards Board (the “FASB”) issued proposed FASB Staff Position No. APB 14-a “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (the “proposed FSP”) that would require the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) to be separately accounted for in a manner that reflects the issuer’s nonconvertible debt borrowing rate. The proposed FSP, if issued as currently contemplated, would require that the initial debt proceeds from the sale of Boston Properties Limited Partnership’s (“BPLP”) $862.5 million of 2.875% exchangeable senior notes due 2037 and $450.0 million of 3.75% exchangeable senior notes due 2036 be allocated between a liability component and an equity component in a manner that reflects interest expense at the interest rate of similar nonconvertible debt. The resulting debt discount would be amortized over the period during which the debt is expected to be outstanding (i.e., through the first optional redemption dates) as additional non-cash interest expense. The proposed FSP would be effective for fiscal years beginning after December 15, 2007 and interim periods within those fiscal years, and it would be applied retrospectively to BPLP’s outstanding exchangeable senior notes for all periods presented. Based on our current understanding of the application of the proposed FSP, this would result in an aggregate of approximately $18 million (net of incremental capitalized interest) of additional non-cash interest expense for fiscal 2008. Excluding the impact of capitalized interest, the additional non-cash interest expense would be approximately $20 million to $22 million, and this amount (before netting) will increase in subsequent reporting periods through the first optional redemption dates as the debt accretes to its par value over the same period. There can be no assurance that the proposed FSP will be issued in the form currently contemplated by the FASB, or at all, and therefore its ultimate impact on our interest expense may differ materially from the aforementioned estimate.

Legislation was recently introduced in Congress that would treat publicly traded partnerships as corporations for federal income tax purposes if the partnership directly or indirectly derives income from certain investment adviser or asset management services. Because certain of Boston Properties Limited Partnership’s current activities could constitute investment adviser or asset management services as defined for these purposes,

 

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unless transfers of ownership of interests in Boston Properties Limited Partnership are limited in a manner that complies with certain regulatory safe harbors or another exception applies, it is possible that this legislation, if enacted, could cause Boston Properties Limited Partnership to be taxable as a corporation. Classification of Boston Properties Limited Partnership as a corporation would also cause Boston Properties, Inc. to fail to qualify as a REIT. Under a transitional rule contained in one version of the proposed legislation, Boston Properties Limited Partnership would be exempt from the new rules until its taxable year beginning January 1, 2013. An alternative proposal, however, would shorten the transition period to make the new law applicable to existing publicly-traded partnerships beginning January 1, 2008, and it is possible that any legislation ultimately enacted could be effective immediately or possibly even retroactively.

Congress is also considering legislative proposals to treat all or part of certain income allocated to a partner by a partnership in respect of certain services provided to or for the benefit of the partnership (“carried interest revenue”) as ordinary income for U.S. federal income tax purposes. While the current legislative proposal provides that such income will nevertheless retain its original character for purposes of the REIT qualification tests, it is not clear what form any such final legislation would take. Furthermore, under the proposed legislation, carried interest revenue could be treated as non-qualifying income for purposes of the “qualifying income” exception to the publicly-traded partnership rules. If enacted, this could result in Boston Properties Limited Partnership being taxable as a corporation for U.S. federal income tax purposes if the amount of any such carried interest revenue plus any other non-qualifying income earned by Boston Properties Limited Partnership exceeds 10% of its gross income in any taxable year.

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 discount and/or capitalization rates that we deem appropriate, as well as available market information. Estimates of future cash flows are based on a number of factors including the historical operating results, known and anticipated trends, and market and economic conditions. The fair value of the tangible assets of an acquired property considers the value of the property as if it were vacant. We also consider an allocation of purchase price of other acquired intangibles, including acquired in-place leases that may have a customer relationship intangible value, including (but not limited to) the nature and extent of the existing relationship with the tenants, the tenants’ credit quality and expectations of lease renewals. Based on our acquisitions to date, our allocation to customer relationship intangible assets has been immaterial.

 

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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 following the end of each quarter and when there is an event or change in circumstances that indicates an impairment in value. An impairment loss is recognized if the carrying amount of its assets is not recoverable and exceeds its fair value. If such 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 the determination is made to capitalize a cost, it is allocated to the specific component of a project that is benefited. Determination of when a development project commences and capitalization begins, and when a development project is substantially complete and held available for occupancy and capitalization must cease, involves a degree of judgment. Our capitalization policy on development properties is guided by 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 necessary to the development of the property, development costs, construction costs, interest costs, real estate taxes, salaries and related costs and other costs incurred during the period of development. We begin the capitalization of costs during the pre-construction period which we define as activities that are necessary to the development of the property. We consider a construction project as

 

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substantially completed and held available for occupancy upon the completion of tenant improvements, but no later than one year from cessation of major construction activity. We cease capitalization on the portion (1) substantially completed 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 monitor the credit quality of our tenant base on an ongoing basis. 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 7.3 years as of September 30, 2007. 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 frequent 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. We also receive reimbursement of payroll and payroll related costs from third parties which we reflect on a net basis in accordance with Issue 99-19.

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 as well as fixed fee arrangements at the properties under management. We review each development agreement and record development fees as earned depending on the risk associated with each project. Profit on development fees earned from joint venture projects 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 nine months ended September 30, 2007 and 2006.

At September 30, 2007 and September 30, 2006, we owned or had interests in a portfolio of 138 and 128 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 nine months ended September 30, 2007 and 2006 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), gains on sales of real estate from discontinued operations (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

 

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to facilitate a clear understanding of our operating results, NOI should be examined in conjunction with net income as presented in our 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 nine months ended September 30, 2007 to the nine months ended September 30, 2006.

The table below shows selected operating information for the Same Property Portfolio and the Total Property Portfolio. The Same Property Portfolio consists of 110 properties totaling approximately 27.6 million net rentable square feet of space. The Same Property Portfolio includes properties acquired or placed in-service on or prior to January 1, 2006 and owned through September 30, 2007. In addition, the Same Property Portfolio includes our Cambridge Center Marriott hotel property, but does not include the Long Wharf Marriott hotel property, which was sold on March 23, 2007. The Total Property Portfolio includes the effects of the other properties either placed in-service, acquired or repositioned after January 1, 2006 or disposed of on or prior to September 30, 2007. This table includes a reconciliation from the Same Property Portfolio to the Total Property Portfolio by also providing information for the nine months ended September 30, 2007 and 2006 with respect to the properties which were acquired, placed in-service, repositioned or sold.

During July 2006, we placed in-service our Capital Gallery expansion project, consisting of a ten-story addition totaling approximately 319,000 net rentable square feet of Class A office space located in Washington, D.C. The project entailed removing a three-story, low-rise section of the property from in-service status and developing it into a ten-story office building resulting in a total complex size of approximately 615,000 net rentable square feet. In April 2006, tenants began to take initial occupancy. This property is included in Properties Repositioned for the nine months ended September 30, 2007 and September 30, 2006.

 

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    Same Property Portfolio     Properties Sold   Properties
Acquired
   

Properties Placed

In-Service

  Properties
Repositioned
  Total Property Portfolio  
     2007   2006  

Increase/

(Decrease)

    %
Change
    2007   2006   2007     2006     2007   2006   2007   2006   2007     2006    

Increase/

(Decrease)

    %
Change
 
    (dollars in thousands)  

Rental Revenue:

                               

Rental Revenue

  $ 901,335   $ 863,307   $ 38,028     4.40 %   $ 21,787   $ 101,182   $ 33,858     $ 2,884     $ 21,430   $ 16,788   $ 19,680   $ 14,012   $ 998,090     $ 998,173     $ (83 )   (0.01 )%

Termination Income

    4,101     4,766     (665 )   (13.95 )%     —       1,138     —         —         —       —       —       —       4,101       5,904       (1,803 )   (30.54 )%
                                                                                                           

Total Rental Revenue

    905,436     868,073     37,363     4.30 %     21,787     102,320     33,858       2,884       21,430     16,788     19,680     14,012     1,002,191       1,004,007       (1,816 )   (0.18 )%
                                                                                                           

Real Estate Operating Expenses

    314,368     295,687     18,681     6.32 %     5,889     30,134     10,652       671       5,133     2,755     5,297     3,769     341,339       333,016       8,323     2.50 %
                                                                                                           

Net Operating Income, excluding hotels

    591,068     572,386     18,682     3.26 %     15,898     72,186     23,206       2,213       16,297     14,033     14,383     10,243     660,852       671,061       (10,209 )   (1.52 )%
                                                                                                           

Hotel Net Operating Income(1)

    5,984     4,738     1,246     26.30 %     —       —       —         —         —       —       —       —       5,984       4,738       1,246     26.30 %
                                                                                                           

Consolidated Net Operating Income(1)

    597,052     577,124     19,928     3.45 %     15,898     72,186     23,206       2,213       16,297     14,033     14,383     10,243     666,836       675,799       (8,963 )   (1.33 )%
                                                                                                           

Other Revenue:

                               

Development and Management Services

    —       —       —       —         —       —       —         —         —       —       —       —       15,175       14,159       1,016     7.18 %

Interest and Other

    —       —       —       —         —       —       —         —         —       —       —       —       68,274       25,124       43,150     171.75 %
                                                                                                           

Total Other Revenue

    —       —       —       —         —       —       —         —         —       —       —       —       83,449       39,283       44,166     112.43 %

Other Expenses:

                               

General and administrative expense

    —       —       —       —         —       —       —         —         —       —       —       —       53,288       43,177       10,111     23.42 %

Interest

    —       —       —       —         —       —       —         —         —       —       —       —       217,598       226,837       (9,239 )   (4.07 )%

Depreciation and amortization

    187,083     180,134     6,949     3.86 %     2,767     15,072     17,534       1,185       6,071     5,325     3,260     1,924     216,715       203,640       13,075     6.42 %

Loss from early extinguishments of debt

    —       —       —       —         —       —       —         —         —       —       —       —       3,417       32,132       (28,715 )   (89.37 )%
                                                                                                           

Total Other Expenses

    187,083     180,134     6,949     3.86 %     2,767     15,072     17,534       1,185       6,071     5,325     3,260     1,924     491,018       505,786       (14,768 )   (2.92 )%
                                                                                                           

Income before minority interests

  $ 409,969   $ 396,990   $ 12,979     3.27 %   $ 13,131   $ 57,114   $ 5,672     $ 1,028     $ 10,226   $ 8,708   $ 11,123   $ 8,319   $ 259,267     $ 209,296     $ 49,971     23.88 %

Income from unconsolidated joint ventures

  $ 4,346   $ 5,712   $ (1,366 )   (23.91 %)   $ 15,296   $ 17,634   $ (19 )   $ (179 )   $ —     $ —     $ —     $ —       19,623       23,167       (3,544 )   (15.30 )%

Income from discontinued operations, net of minority interest

  $ —     $ —     $ —       —       $ 1,283   $ 7,228   $ —       $ —       $ —     $ —     $ —     $ —       1,283       7,228       (5,945 )   (82.25 )%

Minority interest in property partnership

                            —         2,013       (2,013 )   (100.0 )%

Minority interest in Operating Partnership

                            (42,455 )     (44,911 )     2,456     5.47 %

Gains on sales of real estate, net of minority interest

                            788,855       604,200       184,655     30.56 %

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

                            173,899       —         173,899     100.0 %
                                                     

Net Income available to common shareholders

                          $ 1,200,472     $ 800,993     $ 399,479     49.87 %
                                                     

(1) For a detailed discussion of NOI, including the reasons management believes NOI is useful to investors, see page 37. Hotel Net Operating Income for the nine months ended September 30, 2007 and 2006 are comprised of Hotel Revenue of $24,690 and $21,598 less Hotel Expenses of $18,706 and $16,860 respectively per the Consolidated Income Statement.

 

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Rental Revenue

The decrease of approximately $0.1 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 $38.0 million, Properties Sold decreased approximately $79.4 million, Properties Acquired increased approximately $31.0 million, Properties Placed In-Service increased approximately $4.6 million and Properties Repositioned increased approximately $5.7 million.

We incur certain tenant specific property costs for which we are reimbursed from our tenants. Starting in 2007, we have included these reimbursements in rental revenue and included the tenant specific operating cost within real estate operating expenses. This income and expense classification in 2007 results in a presented increase to comparable rental revenue and real estate operating expenses, however does not impact our consolidated net operating income. For the nine months ended September 30, 2007 and 2006, the rental income and real estate operating expense gross up was approximately $6.8 million and $8.9 million, respectively.

Rental revenue from the Same Property Portfolio increased approximately $38.0 million for the nine months ended September 30, 2007 compared to 2006. Included in rental revenue is an overall increase in base rental revenue of approximately $26.2 million, offset by a decrease of approximately $3.1 million related to straight line rent. Approximately $11.8 million of the increase from the Same Property Portfolio was due to an increase in recoveries from tenants which correlates with the increase in operating expenses. We collected almost $2.0 million in connection with a modification to the calculation of a tenant’s real estate tax operating expense obligation from a lease that commenced in 1999 and was adjusted for the last six years. The remaining $3.1 million increase related to parking and other income. During the third quarter we recognized unanticipated revenue related to holdover rent in Princeton, percentage rent and early rent commencement in Boston, as well as operating savings from lower energy costs and deferred repairs and maintenance expense. We expect that our straight line rent and FAS 141 adjustment to rental revenue will be approximately $9.0 million for the fourth quarter.

The acquisitions of 6601 & 6605 Springfield Center Drive, 103 Fourth Avenue and Kingstowne Towne Center during the nine months ended September 30, 2007, as well as the acquisitions during 2006, increased rental revenue from Properties Acquired by approximately $31.0 million for the nine months ended September 30, 2007 as detailed below:

 

          Rental Revenue for the nine
months ended September 30

Property

  

Date Acquired

   2007    2006    Change
          (in thousands)

Kingstowne Towne Center

   March 30, 2007    $ 7,011    $ —      $ 7,011

103 Fourth Avenue

   January 29, 2007      528      —        528

6601 & 6605 Springfield Center Drive

   January, 2007      570      —        570

Four and Five Cambridge Center

   November 30, 2006      13,079      —        13,079

303 Almaden Avenue

   June 30, 2006      4,706      1,602      3,104

3200 Zanker Road

   August 10, 2006      7,964      1,282      6,682
                       

Total

      $ 33,858    $ 2,884    $ 30,974
                       

 

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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 our 12290 Sunrise Valley development project in the second quarter of 2006. Rental revenue from Properties Placed In-Service increased approximately $4.6 million, as detailed below:

 

          Rental Revenue for the nine
months ended September 30

Property

  

Date Placed In-Service

   2007    2006    Change
          (in thousands)

Seven Cambridge Center

   First Quarter, 2006    $ 16,682    $ 14,068    $ 2,614

12290 Sunrise Valley

   Second Quarter, 2006      4,748      2,720      2,028
                       

Total

      $ 21,430    $ 16,788    $ 4,642
                       

Rental revenue from Properties Repositioned for the nine months ended September 30, 2007 increased approximately $5.7 million over the nine months ended September 30, 2006. Our Capital Gallery expansion project is included in Properties Repositioned for the nine months ended September 30, 2007 and September 30, 2006. In April 2006, tenants began to take occupancy and we placed our Capital Gallery expansion project in-service in July 2006.

The aggregate increase in rental revenue was offset by the sales of Democracy Center in August 2007, 5 Times Square in February 2007 and 280 Park Avenue in June 2006. 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 $79.4 million, as detailed below:

 

          Rental Revenue for the nine months
ended September 30
 

Property

   Date Sold    2007    2006    Change  
          (in thousands)  

Democracy Center

   August 7, 2007    $ 12,016    $ 12,946    $ (930 )

5 Times Square

   February 15, 2007      9,771      56,028      (46,257 )

280 Park Avenue

   June 6, 2006      —        32,208      (32,208 )
                         

Total

      $ 21,787    $ 101,182    $ (79,395 )
                         

Termination Income

Termination income for the nine months ended September 30, 2007 was related to thirteen tenants across the Total Property Portfolio that terminated their leases, and we recognized termination income totaling approximately $4.1 million. This compared to termination income of approximately $5.9 million for the nine months ended September 30, 2006 related to fifteen tenants. We currently anticipate realizing approximately $1.0 million in termination income for the fourth quarter of 2007.

Real Estate Operating Expenses

The $8.3 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 comprised of increases and decreases within five categories that comprise our Total Property Portfolio. Operating expenses for the Same Property Portfolio increased approximately $18.7 million, Properties Sold decreased approximately $24.2 million, Properties Acquired increased approximately $10.0 million, Properties Placed In-Service increased approximately $2.3 million and Properties Repositioned increased approximately $1.5 million.

We incur certain tenant specific property costs for which we are reimbursed from our tenants. Starting in 2007, we have included these reimbursements in rental revenue and included the tenant specific operating cost

 

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within real estate operating expenses. This income and expense classification in 2007 results in a presented increase to comparable rental revenue and real estate operating expenses, however does not impact our consolidated net operating income. For the nine months ended September 30, 2007 and 2006, the rental income and real estate operating expense gross up was approximately $6.8 million and $8.9 million, respectively.

Operating expenses from the Same Property Portfolio increased approximately $18.7 million for the nine months ended September 30, 2007 compared to 2006. Included in Same Property Portfolio operating expenses is an increase in repairs and maintenance of approximately $3.6 million. In addition, real estate taxes increased approximately $6.2 million, a 5.3% increase due to increased real estate tax assessments.

The acquisitions of 6601 & 6605 Springfield Center Drive, 103 Fourth Avenue, Springfield Metro Center and Kingstowne Towne Center during the nine months ended September 30, 2007, as well as the acquisitions during 2006, increased operating expenses from Properties Acquired by approximately $10.0 million for the nine months ended September 30, 2007 as detailed below:

 

          Real Estate Operating
Expenses for the nine
months ended September 30

Property

   Date Acquired    2007    2006    Change
          (in thousands)

Springfield Metro Center

   April 11, 2007    $ 59    $ —      $ 59

Kingstowne Towne Center

   March 30, 2007      1,817      —        1,817

103 Fourth Avenue

   January 29, 2007      448      —        448

6601 & 6605 Springfield Center Drive

   January, 2007      133      —        133

Four and Five Cambridge Center

   November 30, 2006      4,996      —        4,996

3200 Zanker Road

   August 10, 2006      1,455      46      1,409

303 Almaden Avenue

   June 30, 2006      1,744      625      1,119
                       

Total

      $ 10,652    $ 671    $ 9,981
                       

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 our 12290 Sunrise Valley development project in the second quarter of 2006. Operating expenses from Properties Placed In-Service increased approximately $2.3 million, as detailed below:

 

          Real Estate Operating
Expenses for the nine months
ended September 30

Property

   Date Placed In-Service    2007    2006    Change
          (in thousands)

Seven Cambridge Center

   First Quarter, 2006    $ 4,179    $ 2,519    $ 1,660

12290 Sunrise Valley

   Second Quarter, 2006      954      236      718
                       

Total

      $ 5,133    $ 2,755    $ 2,378
                       

Operating expenses from Properties Repositioned for the nine months ended September 30, 2007 increased approximately $1.5 million over the nine months ended September 30, 2006. Our Capital Gallery expansion project is included in Properties Repositioned for the nine months ended September 30, 2007 and September 30, 2006. In April 2006, tenants began to take occupancy and we placed our Capital Gallery expansion project in-service in July 2006.

A decrease of approximately $24.2 million in the Total Property Portfolio operating expenses was due to the sales of Democracy Center in August 2007, 5 Times Square in February 2007 and 280 Park Avenue in June 2006, as detailed below. These properties have not been classified as discontinued operations due to our continuing involvement as the property manager for each property.

 

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Real Estate Operating

Expenses for the nine

months ended September 30

 

Property

   Date Sold    2007    2006    Change  
          (in thousands)  

Democracy Center

   August 7, 2007    $ 4,202    $ 4,656    $ (454 )

5 Times Square

   February 15, 2007      1,687      11,198      (9,511 )

280 Park Avenue

   June 6, 2006      —        14,280      (14,280 )
                         

Total

      $ 5,889    $ 30,134    $ (24,245 )
                         

We continue to review and monitor the impact of rising insurance and energy costs, as well as other factors, on our operating budgets for fiscal year 2008. 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 Cambridge Center Marriott hotel property increased approximately $1.2 million for the nine months ended September 30, 2007 as compared to 2006. For the nine months ended September 30, 2007 and 2006, the operations of the Long Wharf Marriott has been included as part of discontinued operations due to its sale on March 23, 2007. We expect the Cambridge hotel to contribute between $3.5 million and $4.0 million to net operating income for the fourth quarter of 2007.

The following reflects our occupancy and rate information for the Cambridge Center Marriott hotel for the nine months ended September 30, 2007 and 2006. For the nine months ended September 30, 2006, our hotel underwent a room renovation project which totaled approximately $5.6 million.

 

     2007     2006     Percentage
Change
 

Occupancy

     80.9 %     74.5 %   8.6 %

Average daily rate

   $ 205.09     $ 188.61     8.7 %

Revenue per available room, REVPAR

   $ 165.94     $ 140.54     18.1 %

Development and Management Services

Development and Management Services income increased approximately $1.0 million for the nine months ended September 30, 2007 compared to 2006. The increase is attributed to higher fee income due to a leasing commission earned under our management contract with the buyer of 280 Park Avenue and greater work order income in New York City. We have maintained management contracts following the sale of Democracy Center on August 7, 2007, 5 Times Square on February 15, 2007 and 280 Park Avenue on June 6, 2006. As we complete our joint venture project at 505 9th Street and several large tenant improvement projects we expect development and management fee income to decrease. We expect third party fee income to be between $3.5 million to $4.0 million for the fourth quarter of 2007.

Interest and Other Income

Interest and other income increased approximately $43.2 million for the nine months ended September 30, 2007 compared to 2006 as a result of higher overall interest rates and increased average cash balances. In February 2007, our Operating Partnership issued $862.5 million of 2.875% unsecured exchangeable senior notes. On February 15, 2007, we completed the sale of our long-term leasehold interest in 5 Times Square in New York City for approximately $1.28 billion in cash. On March 23, 2007, we completed the sale of the Long Wharf Marriott for approximately $225.6 million in cash. On April 5, 2007 we completed the sale of Newport Office Park for approximately $33.7 million in cash and on August 7, 2007, we completed the sale of Democracy Center for

 

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approximately $184.5 million in cash. Interest income is projected to be between $23 million and $24 million for the fourth quarter of 2007, slightly lower than the third quarter due to the repayment of our mortgages on the 500 Carnegie series and Embarcadero Center Four prior to their stated maturities, offset by the proceeds from asset sales.

We expect that our aggregate distributions for the 2007 tax year will include, in addition to our regular quarterly distributions, at least that portion of the 2007 property sale proceeds necessary for us to avoid paying corporate level tax on the otherwise taxable gain. As our development activities intensify, the amount of our cash invested in these assets will result in a corresponding reduction in our interest income as well as an increase in our capitalized interest expense.

Other Expenses

General and Administrative

General and administrative expenses increased approximately $10.1 million for the nine months ended September 30, 2007 compared to 2006. During the nine months ended September 30, 2007, we recognized additional expenses related to abandoned project costs of approximately $4.5 million and moving expenses related to the relocation of our corporate office. The remaining increases include the final ramp up of our stock-based compensation, the change in the vesting periods to four years on grants issued after November 2006 and increases in base compensation. We anticipate our general and administrative expenses to be between approximately $17.0 million and $18.0 million for the fourth quarter of 2007.

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 vest in restricted stock and LTIP Units over a four- or five-year term (for awards granted between 2003 and November 2006, vesting is over a five-year term with annual vesting of 0%, 0%, 25%, 35% and 40%; and for awards granted after November 2006, vesting will occur in equal annual installments over a four-year term). 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 associated with approximately $11.3 million of restricted stock and LTIP Units granted in April 2006 and approximately $18.5 million of restricted stock and LTIP Units granted in January 2007. The expense will be incurred ratably over the respective vesting period.

Interest Expense

Interest expense for the Total Property Portfolio decreased approximately $9.2 million for the nine months ended September 30, 2007 compared to 2006. The decrease is due to (1) the repayment of outstanding mortgage debt in connection with the sale of Democracy Center in August 2007 and 280 Park Avenue in June 2006, which decreased interest expense by $9.5 million, (2) the repayment of our mortgage loans collateralized by Capital Gallery, 191 Spring Street, 101 Carnegie Center, Seven Cambridge Center, Embarcadero Center Three and Embarcadero Center Four, which decreased interest expense by approximately $12.2 million, and (3) an increase in capitalized interest costs which results in a decrease of interest expense of approximately $11.9 million. These decreases were offset by (1) an increase of approximately $4.4 million related to interest paid on the $450 million unsecured exchangeable senior notes issued in the second quarter of 2006 by our Operating Partnership at a per annum interest rate of 3.75%, (2) an increase of approximately $18.9 million related to interest paid on the $862.5 million unsecured exchangeable senior notes issued in the first quarter of 2007 by our Operating Partnership at an effective per annum interest rate of 3.438% and (3) an increase of approximately $1.9 million related to the acquisition of Kingstowne Towne Center on March 30, 2007. The remaining decrease is attributed to scheduled loan amortization on our outstanding debt.

 

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At September 30, 2007, our variable rate debt consisted of our construction loan at South of Market. The following summarizes our outstanding debt as of September 30, 2007 and September 30, 2006:

 

     September 30,  
     2007     2006  
     (dollars in thousands)  

Debt Summary:

    

Balance

    

Fixed rate

   $ 5,312,562     $ 4,033,323  

Variable rate

     96,706       700,000  
                

Total

   $ 5,409,268     $ 4,733,323  
                

Percent of total debt:

    

Fixed rate

     98.21 %     85.21 %

Variable rate

     1.79 %     14.79 %
                

Total

     100.00 %     100.00 %
                

GAAP Weighted-average interest rate at end of period:

    

Fixed rate

     5.60 %     6.20 %

Variable rate

     6.91 %     5.94 %
                

Total

     5.62 %     6.16 %
                

Depreciation and Amortization

Depreciation and amortization expense for the Total Property Portfolio increased approximately $13.1 million for the nine months ended September 30, 2007 compared to 2006. Approximately $6.9 million related to increases in the Same Property Portfolio and approximately $16.3 million related to the recent acquisition activity. An increase of approximately $0.9 million was due to the placing in-service of our Seven Cambridge Center development project in the first quarter of 2006 and our 12290 Sunrise Valley development project in the second quarter of 2006 and approximately $1.3 million was attributed to Properties Repositioned. These increases were offset by a decrease of approximately $12.3 million due to the sales of Democracy Center in August 2007, 5 Times Square in February 2007 and 280 Park Avenue in June 2006.

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 nine months ended September 30, 2007 and 2006 were $7.7 million and $5.0 million, respectively. These costs are not included in the general and administrative expenses discussed above. We expect capitalized wages to increase with our increased development activity in 2007 and 2008. Interest capitalized for the nine months ended September 30, 2007 and 2006 was $20.6 million and $4.6 million, respectively. These costs are not included in the interest expense referenced above.

Losses from early extinguishments of debt

On February 12, 2007, we refinanced our mortgage loan collateralized by 599 Lexington Avenue located in New York City. The new mortgage financing totaling $750.0 million bears interest at a fixed interest rate of 5.57% per annum and matures on March 1, 2017. The net proceeds of the new loan were used to refinance the $225.0 million mortgage loan on 599 Lexington Avenue and the $475.0 million mortgage loan on Times Square Tower. In connection with the refinancing, the lien of the Times Square Tower mortgage was spread to 599 Lexington Avenue and released from Times Square Tower so that Times Square Tower is no longer encumbered

 

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by any mortgage debt. There was no prepayment penalty associated with the repayment. We recognized a loss from early extinguishment of debt totaling approximately $0.7 million consisting of the write-off of unamortized deferred financing costs. In conjunction with the sale of Democracy Center in Bethesda, Maryland on August 7, 2007, we repaid the mortgage financing collateralized by the property totaling approximately $94.6 million. We paid a prepayment fee of approximately $2.6 million associated with the repayment. We recognized a loss from early extinguishment of debt totaling approximately $2.7 million consisting of the prepayment fee and the write-off of unamortized deferred financing costs.

For the nine months ended September 30, 2006, we repaid the construction and permanent financing collateralized by our Capital Gallery property and the construction financing collateralized by our Seven Cambridge Center property and, in connection with the sale of 280 Park Avenue, we legally defeased the 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. We repaid the construction and permanent financing at Capital Gallery totaling approximately $34.0 million and $49.7 million using available cash. We recognized losses from early extinguishment of debt totaling approximately $0.2 million comprised of a prepayment penalty and the write-off of unamortized deferred finance costs.

Income from Unconsolidated Joint Ventures

For the nine months ended September 30, 2007, income from unconsolidated joint ventures decreased approximately $3.5 million. On June 1, 2007, our Value-Added Fund sold Worldgate Plaza located in Herndon, Virginia for approximately $109.0 million. Worldgate Plaza is an office complex consisting of approximately 322,000 net rentable square feet. Net cash proceeds totaled approximately $50.5 million, of which our share was approximately $20.3 million, after the repayment of the mortgage indebtedness of $57.0 million. Our share of the gain is included as income in joint ventures was approximately $15.5 million which amount reflects the achievement of certain return thresholds as provided for in the joint venture agreement. On October 1, 2007, our 505 9th Street joint venture project, a 323,000 net rentable square foot Class A office property located in Washington, D.C was placed in-service. In connection with placing this property in-service, we expect to consolidate this entity as of October 1, 2007 due to the involvement we have in the venture once the property is operational.

On September 15, 2006, a joint venture in which we have a 35% interest sold 265 Franklin Street located in Boston, Massachusetts, at a sale price of approximately $170.0 million. Net cash proceeds totaled approximately $108.3 million, of which our share was approximately $37.9 million, after the repayment of mortgage indebtedness of approximately $60.8 million and unfunded tenant obligations and other closing costs of approximately $0.9 million. The venture recognized a gain on sale of real estate of approximately $51.4 million, of which our share was approximately $18.0 million, and a loss from early extinguishment of debt of approximately $0.2 million, of which our share was $0.1 million.

Income from discontinued operations, net of minority interest

For the nine months ended September 30, 2007 and September 30, 2006, the properties included in discontinued operations consisted of the Long Wharf Marriott hotel in Boston, Massachusetts and Newport Office Park in Quincy, Massachusetts.

 

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Minority interest in property partnership

Minority interest in property partnership consisted of the outside equity interests in the venture that owned Citigroup Center. This venture was consolidated with our financial results because we exercised control over the entity. Due to the redemption of the minority interest holder at Citigroup Center on May 31, 2006, minority interest in property partnership no longer reflects an allocation to the minority interest holder.

Minority interest in Operating Partnership

Minority interest in Operating Partnership decreased $2.5 million for the nine months ended September 30, 2007 compared to 2006 related to the minority interest in our Operating Partnership’s income allocation related to an underlying increase in allocable income. This increase was offset by decreases related to the redemption in ownership interests for the nine months ended September 30, 2007.

Gains on sales of real estate, net of minority interest

On August 7, 2007, we sold Democracy Center in Bethesda, Maryland, for approximately $280.5 million. Net cash proceeds totaled approximately $184.5 million, after the repayment of the mortgage indebtedness of approximately $94.6 million and closing costs of approximately $1.4 million, resulting in a gain on sale of approximately $168.3 million (net of minority interest share of approximately $29.9 million). Due to our continuing involvement through an agreement with the buyer to manage the property for a fee after the sale, this property has not been categorized as discontinued operations.

On February 15, 2007, we sold the long-term leasehold interest in 5 Times Square in New York City and related credits, for approximately $1.28 billion in cash. Net cash proceeds totaled approximately $1.23 billion, resulting in a gain on sale of approximately $605.2 million (net of minority interest share of approximately $108.4 million). In conjunction with the sale, we have agreed to provide to the buyer monthly revenue support from the closing date until December 31, 2008. The aggregate amount of the revenue support payments was approximately $1.6 million and has been recorded as a purchase price adjustment and included in Other Liabilities within our Consolidated Balance Sheets. As of September 30, 2007, the remaining revenue support obligation totaled approximately $0.2 million.

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 $581.3 million (net of minority interest share of approximately $110.0 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.

During the nine months ended September 30, 2007, we signed a new qualifying lease for approximately 22,000 net rentable square feet of our remaining 47,659 net rentable square foot master lease obligation related to the 2006 sale of 280 Park Avenue resulting in the recognition of approximately $15.4 million (net of minority interest share of approximately $2.6 million) as additional gain on sale of real estate. We had deferred approximately $67.3 million of the gain on sale of 280 Park Avenue, which amount represented the maximum obligation under the master lease. As of September 30, 2007, the remaining master lease obligation totaled approximately $26.5 million.

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

On March 23, 2007, we sold the Long Wharf Marriott, a 402-room hotel located in Boston, Massachusetts, for approximately $231.0 million. Net cash proceeds totaled approximately $225.6 million, resulting in a gain on

 

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sale of approximately $162.3 million (net of minority interest share of approximately $28.6 million). On April 5, 2007, we sold Newport Office Park, an approximately 172,000 net rentable square foot Class A office property located in Quincy, Massachusetts, for approximately $37.0 million. Net cash proceeds totaled approximately $33.7 million, resulting in a gain on sale of approximately $11.5 million (net of minority interest share of approximately $2.1 million).

Comparison of the three months ended September 30, 2007 to the three months ended September 30, 2006.

The table below shows selected operating information for the Same Property Portfolio and the Total Property Portfolio. The Same Property Portfolio consists of 112 properties totaling approximately 28.0 million net rentable square feet of space. The Same Property Portfolio includes properties acquired or placed in-service on or prior to July 1, 2006 and owned through September 30, 2007. In addition, the Same Property Portfolio includes our Cambridge Center Marriott hotel property, but does not include the Long Wharf Marriott hotel property, which was sold on March 23, 2007. The Total Property Portfolio includes the effects of the other properties either placed in-service, acquired or repositioned after July 1, 2006 or disposed of on or prior to September 30, 2007. This table includes a reconciliation from the Same Property Portfolio to the Total Property Portfolio by also providing information for the three months ended September 30, 2007 and 2006 with respect to the properties which were acquired, placed in-service, repositioned or sold.

During July 2006, we placed in-service our Capital Gallery expansion project, consisting of a ten-story addition totaling approximately 319,000 net rentable square feet of Class A office space located in Washington, D.C. The project entailed removing a three-story, low-rise section of the property from in-service status and developing it into a ten-story office building resulting in a total complex size of approximately 615,000 net rentable square feet. In April 2006, tenants began to take initial occupancy. This property is included in Properties Repositioned for the three months ended September 30, 2007 and September 30, 2006.

 

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    Same Property Portfolio     Properties Sold   Properties
Acquired
 

Properties Placed

In-Service

  Properties
Repositioned
  Total Property Portfolio  
     2007   2006  

Increase/

(Decrease)

    %
Change
    2007     2006   2007     2006   2007   2006   2007   2006   2007     2006    

Increase/

(Decrease)

    %
Change
 
    (dollars in thousands)  

Rental Revenue:

                               

Rental Revenue

  $ 312,162   $ 298,580   $ 13,582     4.55 %   $ 1,946     $ 22,768   $ 11,151     $ 1,282   $ —     $ —     $ 6,461   $ 5,687   $ 331,720     $ 328,317     $ 3,403     1.04 %

Termination Income

    742     2,700     (1,958 )   (72.52 )%     —         992     —         —       —       —       —       —       742       3,692       (2,950 )   (79.90 )%
                                                                                                           

Total Rental Revenue

    312,904     301,280     11,624     3.86 %     1,946       23,760     11,151       1,282     —       —       6,461     5,687     332,462       332,009       453     0.14 %
                                                                                                           

Real Estate Operating Expenses

    108,189     103,740     4,449     4.29 %     754       5,811     3,392       46     —       —       1,805     1,579     114,140       111,176       2,964     2.67 %
                                                                                                           

Net Operating Income, excluding hotels

    204,715     197,540     7,175     3.63 %     1,192       17,949     7,759       1,236     —       —       4,656     4,108     218,322       220,833       (2,511 )   (1.14 )%
                                                                                                           

Hotel Net Operating Income(1)

    2,371     1,980     391     19.75 %     —         —       —         —       —       —       —       —       2,371       1,980       391     19.75 %
                                                                                                           

Consolidated Net Operating Income(1)

    207,086     199,520     7,566     3.79 %     1,192       17,949     7,759       1,236     —       —       4,656     4,108     220,693       222,813       (2,120 )   (0.95 )%
                                                                                                           

Other Revenue:

                               

Development and Management Services

    —       —       —       —         —         —       —         —       —       —       —       —       5,318       4,558       760     16.67 %

Interest and Other

    —       —       —       —         —         —       —         —       —       —       —       —       25,081       14,611       10,470     71.66 %
                                                                                                           

Total Other Revenue

    —       —       —       —         —         —       —         —       —       —       —       —       30,399       19,169       11,230     58.58 %

Other Expenses:

                               

General and administrative expense

    —       —       —       —         —         —       —         —       —       —       —       —       20,189       12,739       7,450     58.48 %

Interest

    —       —       —       —         —         —       —         —       —       —       —       —       69,929       73,571       (3,642 )   (4.95 )%

Depreciation and amortization

    64,750     65,113     (363 )   (0.56 )%     —         4,086     5,781       569     —       —       1,084     790     71,616       70,558       1,058     1.50 %

Loss from early extinguishments of debt

    —       —       —       —         —         —       —         —       —       —       —       —       2,695       208       2,487     1,195.67 %
                                                                                                           

Total Other Expenses

    64,750     65,113     (363 )   (0.56 )%     —         4,086     5,781       569     —       —       1,084     790     164,429       157,076       7,353     4.68 %
                                                                                                           

Income before minority interests

  $ 142,336   $ 134,407   $ 7,929     5.90 %   $ 1,192     $ 13,863   $ 1,978     $ 667   $ —     $ —     $ 3,572   $ 3,318   $ 86,663     $ 84,906     $ 1,757     2.07 %

Income from unconsolidated joint ventures

  $ 1,469   $ 2,309   $ (840 )   (36.38 )%   $ (76 )   $ 17,891   $ (3 )   $     $ —     $ —     $ —     $ —       1,390       20,200       (18,810 )   (93.12 )%

Income from discontinued operations, net of minority interest

  $ —     $ —     $ —       —       $ —       $ 3,371   $ —       $ —     $ —     $ —     $ —     $ —       —         3,371       (3,371 )   (100.0 )%

Minority interest in property partnership

                            —         —         —       —    

Minority interest in Operating Partnership

                            (14,178 )     (18,404 )     4,226     22.96 %

Gains on sales of real estate, net of minority interest

                            168,495       17,889       150,606     841.89 %
                                                     

Net Income available to common shareholders

                          $ 242,370     $ 107,962     $ 134,408     124.50 %
                                                     

(1) For a detailed discussion of NOI, including the reasons management believes NOI is useful to investors, see page 37. Hotel Net Operating Income for the three months ended September 30, 2007 and 2006 are comprised of Hotel Revenue of $8,646 and $8,319 less Hotel Expenses of $6,275 and $6,339 respectively per the Consolidated Income Statement.

 

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Rental Revenue

The increase of approximately $3.4 million in the Total Property Portfolio is comprised of increases and decreases within the four categories that comprise our Total Property Portfolio. Rental revenue from the Same Property Portfolio increased approximately $13.6 million, Properties Sold decreased approximately $20.8 million, Properties Acquired increased approximately $9.8 million and Properties Repositioned increased approximately $0.8 million.

We incur certain tenant specific property costs for which we are reimbursed from our tenants. Starting in 2007, we have included these reimbursements in rental revenue and included the tenant specific operating cost within real estate operating expenses. This income and expense classification in 2007 results in a presented increase to comparable rental revenue and real estate operating expenses, however does not impact our consolidated net operating income. For the three months ended September 30, 2007 and 2006, the rental income and real estate operating expense gross up was approximately $2.3 million and $3.8 million, respectively.

Rental revenue from the Same Property Portfolio increased approximately $13.6 million for the three months ended September 30, 2007 compared to 2006. Included in rental revenue is an overall increase in base rental revenue of approximately $11.3 million offset by a decrease of approximately $2.4 million in straight line rent. Approximately $3.1 million of the increase from the Same Property Portfolio was due to an increase in recoveries from tenants which correlates with the increase in operating expenses. During the third quarter we recognized unanticipated revenue related to holdover rent in Princeton, percentage rent and early rent commencement in Boston as well as operating savings from lower energy costs and deferred repairs and maintenance expense. We expect that our straight line rent and FAS 141 adjustment to rental revenue will be approximately $9.0 million for the fourth quarter.

The acquisitions of 6601 & 6605 Springfield Center Drive, 103 Fourth Avenue and Kingstowne Towne Center during 2007, as well as the acquisitions of Four and Five Cambridge Center and 3200 Zanker Road during 2006, increased rental revenue from Properties Acquired by approximately $9.8 million for the three months ended September 30, 2007 as detailed below:

 

          Rental Revenue for the three
months ended September 30

Property

   Date Acquired    2007    2006    Change
          (in thousands)

Kingstowne Towne Center

   March 30, 2007    $ 3,675    $ —      $ 3,675

103 Fourth Avenue

   January 29, 2007      185      —        185

6601 & 6605 Springfield Center Drive

   January, 2007      79      —        79

Four and Five Cambridge Center

   November 30, 2006      4,606      —        4,606

3200 Zanker Road

   August 10, 2006      2,606      1,282      1,324
                       

Total

      $ 11,151    $ 1,282    $ 9,869
                       

Rental revenue from Properties Repositioned for the three months ended September 30, 2007 increased approximately $0.8 million over the three months ended September 30, 2006. Our Capital Gallery expansion project is included in Properties Repositioned for the three months ended September 2007 and September 30, 2006. In April 2006, tenants began to take occupancy and we placed our Capital Gallery expansion project in-service in July 2006.

 

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The aggregate increase in rental revenue was offset by the sales of Democracy Center in August 2007, 5 Times Square in February 2007 and 280 Park Avenue in June 2006. 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 $20.8 million, as detailed below:

 

          Rental Revenue for the three
months ended September 30
 

Property

   Date Sold    2007    2006    Change  
          (in thousands)  

Democracy Center

   August 7, 2007    $ 1,946    $ 3,868    $ (1,922 )

5 Times Square

   February 15, 2007      —        18,900      (18,900 )

280 Park Avenue

   June 6, 2006      —        —        —    
                         

Total

      $ 1,946    $ 22,768    $ (20,822 )
                         

Termination Income

Termination income for the three months ended September 30, 2007 was related to six tenants across the Total Property Portfolio that terminated their leases, and we recognized termination income totaling approximately $0.7 million. This compared to termination income of approximately $3.7 million for the three months ended September 30, 2006 related to six tenants. We currently anticipate realizing approximately $1.0 million in termination income for the fourth q