Boston Properties to Invest $1.4B in Two San Francisco Buildings

By Sharon Simonson

Boston Properties Inc. considered buying San Francisco’s 101 California St. from the Hines company but instead decided to develop the Transbay Tower with them: The yield will be better and the company will own a new building to boot.

The company expects to invest more than $1 billion along with Hines in the development of the 61-story edifice, spending in the neighborhood of $700 a foot to build 1.4 million square feet, company executives said.

The tower, reaching nearly 1,100 feet, will be the tallest in the city by approximately 200 feet and connected to a new $4 billion transportation terminal that has been labeled the Grand Central Station of the West.

The partners expect to complete the purchase of the land from the Transbay Joint Powers Authority in the first quarter of next year, paying $139 a rentable square foot, or approximately $190 million. The earliest the companies expect to initiate construction is in early 2014 with delivery expected in the later part of 2016 or early 2017.

“101 California traded at a sub-4 [percent] cap rate—in the 3s—and it is a 35- or 40-year-old building. We feel on Transbay that we can develop it for a similar cost but with a higher yield,” said Douglas T. Linde, Boston Property’s president and a director.

The company also considered 333 Market St., the Wells Fargo & Co. building, he said. “In order to get the kind of [returns] you need to rationalize those investments, the rents you need in those buildings are higher on a projected basis than the rents we would be leasing the space at the Transbay Tower in 2016 or 2017,” he said.

Linde and Boston Properties Chairman and Chief Executive Mortimer Zuckerman answered analysts’ questions and summarized the company’s outlook for nearly two hours Oct. 24—the day after the joint venture with Hines was announced. That joint venture is an even split at 50-50 on all measures, Zuckerman said.

The call was a regularly scheduled session with analysts to release quarterly results. Most such sessions are closer to an hour. Much of the discussion centered on the company’s thinking about the investment, about the San Francisco and Silicon Valley markets, and about the future of being an office landlord.

“We would have bought [101 California] if we could have gotten it at a price we were prepared to pay,” Zuckerman said in response to a question from analyst Michael Knott, a managing director for Green Street Advisors Inc.

Hines recently agreed to sell a 92 percent interest in 101 California St., a 1.2 million-square-foot, 48-story highrise in the heart of San Francisco’s Financial District, for $740 a square foot, according to published reports. The building was completed in 1982.

Boston Properties owns more than five million square feet of offices in the Bay Area including San Francisco’s iconic and imposing four-building bayside Embarcadero Center with 3.4 million square feet. The property is 96 percent leased.

On Aug. 29, the company also bought 680 Folsom St., 50 Hawthorne St. and a vacant 22,000-square-foot bulding at 690 Folsom St., which it expects to redevelop. The sellers were TMG Partners and Rockwood Capital. Boston Properties paid the sellers $62.2 million and nearly 1.6 million units of a limited partnership interest, it said in a news release. On Aug. 31, a holder redeemed not quite 367,000 units for cash, pocketing approximately $18.3 million. The company also assumed a $170 million construction loan commitment though no amount was outstanding at the end of the third quarter.

Boston Properties believes 680 Folsom, which is 85 percent preleased to Riverbed Technology Inc. and Macys.com, represents the ideal “grown-up building for a mature tenant,” Linde said. After redevelopment, the 14-story building will have a largely glass exterior with 15-foot, floor-to-floor heights and 35,000-square-foot floorplates. Macy’s Inc. is considering expanding its square footage, Boston Properties executives said; the online arm of the department store giant has already committed to leasing not quite 243,000 square feet in the building for 15 years.

His company is keenly aware that tenants are changing how they consume real estate and how much they are willing to dedicate on a per-employee basis, Linde said. “We are in fact spending an awful lot of time on how people are using space and the types of tenants who will be winners and growers on a go-forward basis and thinking about how we spend our capital to position our assets and change our portfolio so we can be successful,” he said.

The company estimates its total investment in the 522,000 square-foot Folsom Street offices and retail complex plus the neighboring redevelopment parcel will be approximately $340 million. The offices will be delivered in the first quarter of 2014, and the company expects a yield on cost of approximately 6 percent, Linde said. It is seeking rents in the low $60 a square foot a year for the building’s remaining space. That compares to an average asking rate citywide of just more than $46 a foot a year on a full-service basis in the third quarter, according to CBRE Inc.

Linde does not expect to begin construction for a year on the Transbay Tower based on the status of the current construction and design drawings. He declined to stipulate whether the company intends to go forward with construction on a speculative basis—“We don’t have to make that decision for the better part of a year”—nor would he say what kind of returns the company expected to generate, saying it was too early to project rents and costs.

But he took pains to make clear that the Transbay Tower would be a singular building in the market and as such should achieve exceptional rents. “The product we are going to be creating is going to be a pretty unique product in terms of how it fits within the context of the existing market—the height of the building and floors, the mechanical systems, the window systems,” he said. “In contrast with buildings built between 1970 to 1995 or 2000 in San Francisco, we believe it will achieve higher rents than where the market is today on a relative basis.”

Nor is he worried about all of the new construction being pondered and pursued in San Francisco, including the 400,000-square-foot, 27-story tower that Kilroy Realty Corp. announced Oct. 23 that it intended to build at 350 Mission St.

“Our view is that there are lots of tech companies that want people in the city working for them, and the commuting patterns associated with going down to the Silicon Valley are challenging, so more and more are prepared to say, ‘If we want the best and brightest, we need a location in the city to attract that kind of workforce,’” he said. “If there is a city with a chance for significant job growth and demand generation from corporate companies, San Francisco has the best chance.”

The huge San Francisco investments belie what Zuckerman said continues to be the company’s very cautious outlook on the U.S. economy. San Francisco and Silicon Valley are the strongest markets in the company’s portfolio, which includes properties in New York, Washington, D.C., and Boston.

The nation is at a crucial inflection point, Zuckerman said, with high unemployment and falling incomes. “We are four years into a recession the back of which has not been broken despite the most stimulative monetary policy in our history,” he said.  “There is a real, real change in the nature of the employment in this country, and no one knows the consequences.”

The company reported net income to common shareholders of $57.8 million for the quarter ended Sept. 30. That was down from $70.5 million in the same quarter a year ago. The company owns 152 properties, mostly Class A offices, with a total of 43.4 million square feet including eight properties under construction with 2.7 million square feet. Occupancy was not quite 92 percent at quarter’s close.