Armada Hoffler Properties, Inc.
Q1 2016 Earnings Call Transcript

Published: 3 May 2016

[Operator:]

Welcome to Armada Hoffler's first quarter 2016 earnings conference call. [Operator Instructions] I will now turn the conference call over to Mike O'Hara, Chief Financial Officer at Armada Hoffler. Please go ahead.

[Michael O'Hara:]

Good morning, and thank you for joining Armada Hoffler's first quarter 2016 earnings conference call and webcast. On this call this morning, in addition to myself, are Lou Haddad, CEO; and Eric Smith, our Chief Investment Officer, who will be available for questions. The press release announcing our first quarter earnings along with our quarterly supplemental package was distributed this morning. A replay of this call will be available shortly after the conclusion of the call through June 3, 2016. The numbers to access the replay are provided in the earnings press release. For those who listen to the rebroadcast of this presentation, we remind you that remarks made herein are as of today, May 3, 2016, will not be updated subsequent to this initial earnings call. During this call, we will make forward-looking statements including statements related to the future performance of our portfolio, our development pipeline, impact of acquisitions and dispositions, our construction business, our portfolio performance and financing activities, as well as comments on our outlook. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond our control. These risks and uncertainties can cause actual results to differ materially from our current expectations and we advise listeners to review the risk factors discussed in our press release this morning and documents we have filed with or furnished to the SEC. We will also discuss certain non-GAAP financial measures including, but not limited to FFO and normalized FFO. Definitions of these non-GAAP measures as well as reconciliations to the most comparable GAAP measures are included in the quarterly supplemental package, which is available on our website, www.armadahoffler.com. I'd like to now turn the call over to our Chief Executive Officer, Lou Haddad. Lou?

[Louis Haddad:]

Thanks, Mike. Good morning, and thank you for joining us today. This morning we reported normalized FFO per share of $0.25. Based on our revised estimates for the year, we've raised both the top and bottom-ends of our 2016 normalized FFO guidance range. We continue to successfully execute across all areas of our business, demonstrated by significant year-over-year growth in NOI, same-store NOI and normalized FFO. I'll discuss the highlights of the quarter, before turning the call over to Mike to discuss our quarterly results and 2016 guidance in detail. The fundamental and guiding principles of our real estate company for the past 37 years remains unchanged, to invest in and develop the highest quality real estate in our target markets. As you will see, with a number of high-quality transactions that I will discuss this morning, we continue to aggressively manage our portfolio in order to position the company for sustained long-term value creation. We started the year with our acquisition of $170.5 million retail portfolio, totaling 1.1 million square feet across 11 assets. The core of the acquired portfolio consist of six retail centers anchored by brand name credit tenants, and well-positioned along the I-85 corridor between Raleigh-Durham and Greenville. Four of the non-core acquired assets are currently under contract or LOI for an aggregate sales price of $32 million. We expect to close on all four dispositions this year, as we had previously anticipated. The fifth non-core asset is still under evaluation. We partially funded this portfolio acquisition with net proceeds from our sales of the Oceaneering International and Richmond Tower office buildings. This allowed us to redeploy the equity from predominantly single-tenant office assets in Richmond and Hampton Roads market into a portfolio of high-quality retail assets in the Carolinas. With this transaction, we accomplished three major objectives. First, we increased our presence in the major Carolina market. Second, we decreased our overall risk profile. And third, we deferred the taxes on significant gains realized on the sales of both office building. Continuing the theme of investing in high-quality real estate, this quarter we announced our participation in a joint venture to develop One City Center in downtown Durham, North Carolina. This is a 27 storey mixed-use project that is expected to include 130,000 square feet of office space, 22,000 square feet of street-level retail space, a two-level underground parking garage and a residential component. The office space will be anchored by Duke University, which has agreed to lease 55,000 square feet. As a minority partner in the development joint venture, we intend to retain ownership of the $34 million office and retail components of the project upon completion. Our construction company will also serve as general contractor for the overall project and expect the completion in mid 2018. Just over a week ago, we announced our $42 million investment in The Residences at Annapolis Junction Town Center. With estimated completion in the first quarter of 2018, the project will pursue LEED Silver certification and feature 416 apartment units with structured parking. This residential project represents the multifamily component of our planned 18 acre mixed-use development, conveniently located adjacent to MARC Commuter Rail Station. Upon completion of all phases, the development will include office and retail space as well as a limited service hotel. Most notably, the project is located approximately 2 miles from Fort Meade, Maryland's largest employer, the nation's third largest army installation and home to both the National Security Agency and U.S. Cyber Security Command, as well as an additional 6 million square feet of commercial office park space. As both a mezzanine lender and the project general contractor, we realized market rate interest income and fees during length development and construction process, while at the same time avoiding the stress on our balance sheet during development and initial lease-up. With our option to purchase an 88% interest in the project at cost upon completion, we preserve a healthy wholesale to retail spread. One City Center and The Residence at Annapolis Junction Town Center, along with the Point Street Apartments at Baltimore's Inner Harbor, represent the next building blocks and expanding our portfolio of the highest quality River State. Our broad-based capabilities and track record allow us to selectively invest in some of the projects in our target markets. We remain confident that overtime the quality of our assets and the lower cap rates they command will translate into a higher NAV for the company as a whole. Moving from our joint venture platform and mezzanine loan program to acquisitions. Today we announced our acquisition of Southgate Square, a retail center located in Colonial Heights, Virginia, just south of Richmond. Southgate Square adds approximately 220,000 square feet or 100% occupied retail space to our portfolio. The center is anchored by a brand new Burlington store as well as Michaels, Staples and PetSmart. The center is strategically situated within submarket, adjacent to the 900,000 square foot Southpark Mall as well as a Walmart Supercenter and across the street from Dimmock Square, which we acquired in 2014. We acquired the asset for a combination of approximately $21 million of debt and nearly $1.6 million operating partnership unit, increasing our capital base and generating earnings for our shareholders. The acquisition is expected to be accretive by $0.01 to 2016 normalized FFO per share and $0.0150 per share on an annualized basis. This opportunity was born out of the same longstanding relationship that led to our acquisition of Dimmock Square nearly two years ago, and is an example of a partner taking a second meaningful equity position in our company. Shifting to the foundation of our company, our core portfolio, the stabilized assets continue to outperform. The first quarter 2016 marked our seventh consecutive quarter of significant same-store NOI growth. At the end of the quarter, our core portfolio occupancy stood at just under 95%. Occupancy across all product types at the end of the quarter remain in the mid-90s. While we continue to enjoy organic growth in our stabilized portfolio, it should be understood that the primary growth engine of our company is our investment and development platform. Next, I'll briefly touch on the projects in our active development pipeline. Both Johns Hopkins Village and Lightfoot Marketplace are on track for mid-2016 delivery. Pre-leasing for Johns Hopkins Village has been robust. As of today, 62% of the residential components and over half of the retail space is pre-leased. We expect to open for the fall semester on-time and on-budget and are confident that the assets will reach full stabilization next year. Lightfoot Marketplace currently stands at over 70% pre-leased or the anchored Harris Teeter stores scheduled to open in July. Turning to our third-party construction business. Our progress on the $170 million Exelon Tower within Baltimore's Harbor Point continues on schedule towards completion this spring. Adjacent to the Exelon's site construction on Point Street Apartments is well underway. Additionally, we've mobilized our construction company on both the One City Center and Annapolis Junction project. With over $176 million in backlog and several promising opportunities in the pipeline, we expect this segment of our business to continue to generate profits at the high-end of our historical average. With that, I turn the call over to Mike, and then we'll take your questions. Mike?

[Michael O'Hara:]

Thanks, Lou. Today I want to cover the highlight of the quarter, thoughts on our balance sheet and additional details on our 2016 guidance. This morning, we reported FFO of $0.18 per share and normalized FFO of $0.25 per share, which was at the high-end of our expectations. This quarter reported gains on the sale of real estate of $27 million resulting from two transactions. The first, a gain of $430,000 from the sale of the police precinct to the City of Newport News. This was basically a construction contract structured as a sale with the gain equating to our construction fee. Unlike the previous sales, this gain is included in FFO, because the asset was never placed in service and was a sale of inventory. The second transaction is the sale of the Richmond Tower office building, which resulted in a gain of over $26 million that is excluded from FFO. Including this sale, we have recognized over $44 million in gains, since the beginning of last year. As we've discussed in the past, asset sales and capital recycling will continue to be an element of future shareholder value creation. On a related note, because we structure these transactions as 1031 tax free exchanges, the gains from these sales are not taxable, as tax efficiency remains one of our corporate objectives. Please see Page 10 of the supplemental for the normalized FFO calculation. Excluded items this quarter consist of property acquisition costs, development and other pursuit costs and mark-to-market adjustments for interest rate derivatives. The most notable of these is a non-cash adjustment of $2.4 million related to the $50 million swap lock on our term loan. The other adjustment was $704,000 in acquisition development and other pursuit cost, which is largely due for the January portfolio acquisition. We had our seventh consecutive quarter same-store NOI growth. Same-store NOI growth was positive 2.2% on a GAAP basis and 3.8% on a cash basis. At the end of the quarter, our core operating portfolio occupancy was 94.7%, with office at 95%, retail at 95.1% and multifamily at 93.5%. Slight decrease in occupancy is due to our recent asset recycling activity. On the construction front, we reported a segment gross profit in the first quarter of $1.8 million on revenue of $37 million. At the end of the first quarter, the company had a third-party construction backlog of $176 million, which does not included the $68 million Annapolis Junction construction contract that was signed in April. Now turning to our balance sheet. We continue to take actions to enhance flexibility and strengthen our balance sheet, including increasing the capacity of credit facility, hedging our interest rate exposure and continued use of the ATM program. During the first quarter, we added eight properties in credit facility borrowing base, increased the capacity by $50 million to $250 million. This facility is now structured with $100 million term loan and $150 million revolver. In addition, we continue to use the ATM program last quarter, raising $10.1 million of gross proceeds at an average price of $10.76 per share. This amount was higher than our expectations due to a couple of reversed inquires. With the announcement of two new development projects, this quarter we decided to take advantage of these inquiries to use capital in an efficient manner. We encourage the continued use of the ATM program at this level, as market conditions are favorable in order to continuing strengthen in the balance sheet. During the quarter, we closed on 11 property portfolio acquisition. This was funded to 1031 proceeds from the sale of Oceaneering, Richmond Tower as well as cash from the credit facility. The core properties from this acquisition are unencumbered or added to the borrowing base of the credit facility. Over the five non-core properties are under contract or LOI for an aggregate sales price of $32 million. The proceeds from these sales will be used to pay down the revolving credit facility. At quarter end, we had total outstanding debt of $472 million, including $101 million outstanding under the $150 million revolving credit facility. We continue to evaluate our exposure to higher interest rates and look for opportune times to enter into hedges. During the quarter, we purchased a $75 million LIBOR interest rate cap at 1.5% for two years, it only cost $57,000. As we said before, we believe using interest rates caps is the most efficient way to hedge against increasing rates. With this new cap, 80% of our debt was fixed or hedged. We are also working on refinancing the 2016 and 2017 debt maturities. We're expecting a commitment any day now to refinance 4525 Main Street and Encore Apartments. We're also out to market to refinance the Town Center 2016 maturities with expected financing proceeds greater than the maturity amounts. Since the start of the year we have announced two new pipeline projects. The first being One City Center, the mixed-use high-rise in Durham. Upon completion, we will own the retail and office components, which represents 37% of the joint venture. Since we are the minority owners of this project, it will not be consolidated on our balance sheet. Our cost for this project is $34 million, which is funded through the joint venture construction loan and our equity requirement of $9 billion funded to our credit facility. But the impact on our balance sheet is minimal until completion in two-plus years now. The other recent announcement is the Annapolis Junction project. This is structured similar to the Point Street Apartments project with our investments funded through a mezzanine loan. The project is non-consolidated and therefore does not stress our balance sheet during construction and lease-up. Project of this size and duration require debt and equity for over two years with no return on net capital. At the mezzanine debt structure, we have paid a return on investment on our construction fee during development and have the option to purchase a controlling interest of the property upon completion. Our current investment in Annapolis Junction is a form of a $42 million mezzanine loan, which bears interest at 10%. These are the two pending projects, including the guidance issued last quarter that we anticipated being finalized in this timeframe. We now have three large pipeline projects with 24-plus months construction schedule for a neither consolidated nor stress our balance sheet during development. The structure provide significant flexibility to manage the balance sheet and preparation of acquisitions, though existing properties use the proceeds and 1031 exchange or sell the asset and monetize the wholesale to retail spread. Now, let me walk you through our full year 2016 guidance that we updated this morning. We expect normalized 2016 FFO in a range of $0.94 to $0.98 per share. This updated 2016 guidance is predicated on the following assumptions

[Louis Haddad:]

Thank you, Mike, and thank you for your time this morning and your interest in Armada Hoffler. Operator, we would like to begin the question-and-answer session.

[Operator:]

[Operator Instructions] Our first question is from the line of Dick Schiller with Robert W. Baird.

[Dick Schiller:]

You guys talked about the Johns Hopkins Village development, and I noticed in the supplement that the stabilization date was pushed from Q3 '16 to Q3 '17. What was the reason for this expansion with all the pre-leasing that you mentioned on the call? That seemed odd to me.

[Louis Haddad:]

We're trying to be cautious there with what we're reporting. The building is close to delivery. Pre-leasing has been going great. But as you know with student housing, there is going to be a big crunch right towards the end of August. We are feeling that it may well not stabilize by that time. And when it doesn't stabilize by August, then your next window isn't till January. So we wanted to be a bit conservative with our forecast there.

[Dick Schiller:]

And then with the properties that are undervaluation to be sold at this point, are those mostly from the recent retail portfolio acquisition or are those some core properties that were previously included in the portfolio?

[Michael O'Hara:]

What we referred to earlier was we had always intended to resale five of those non-core assets out of that acquisition. We now have three of them under contract and one under LOI. The fifth one is an interesting proposition that we're still looking at. It may well be something that we end up keeping, but we're not there yet.

[Dick Schiller:]

And I think, Dave in on. He might have a couple follow-ups.

[Dave Rodgers:]

I did want to touch on something. Mike you had talked about maybe a cash out refi on the bulk of the Town Center. Can you talk about the types of proceeds, maybe a range that you're expecting out of that? And did you look at that as an opportunity to kind of pay down other debt in the portfolio or is that acquisition capital that you're looking to deploy?

[Michael O'Hara:]

We have the three block account in our cost renewal in September. Have one term sheet in hand at $35 million, which is around $5 million or $6 million greater than the maturity. Expecting some more quotes in here over the next couple of weeks. Our thoughts are if we can -- to take the extra $5 million or so and take that and have that capital to put towards other things like towards acquisitions or development.

[Dave Rodgers:]

And as you look at your line, I think you said about $100 million outstanding out of the $150 million availability. You've got the asset sales proceeds coming in. Are you looking to do some kind of term debt on that or maybe increase the line to kind of pursue more acquisition? And talk a little bit about kind of the financing strategy with respect to putting more capital at work?

[Michael O'Hara:]

So we are going to take the proceeds of $32 million from the sale of those assets and pay down the credit facility. As far as to terminate out, we've done that this past quarter. We increased the term loan by $50 million, left from $50 million of $100 million on the term loan and used those proceeds to pay down the line. One reason we did that was because as part of the big acquisition, we used the line to fund the acquisition that was over and above the 1031 exchange money. And part of that, we ended up purchasing more assets that we really wanted, so hence the sale of those five assets, which were under contract to pay down the line.

[Dave Rodgers:]

Last one from me. Maybe Lou, talk about the environment for new development project. It sounds like you're seeing some good opportunities out there, but really interested in kind of how the overall pipeline fits in with the risk profile? And if you're comfortable kind of expanding that pipeline further at this point?

[Louis Haddad:]

We're continuing to see an abundance of opportunities. And again, what everybody should recognize on the phone that this is much more of a rifle approach than a shotgun. As you guys know, we look at not only markets, but submarkets and specific areas within those submarkets for the opportunities that we're going to invest in. We're seeing those types of opportunities across the board in all of our markets. And so we're basically cherry picking what we believe to be the best. We don't want to expand – we don't want to get out of our speeds. We've told people that this run rate is $150 million to $200 million every 18 to 24-month. We're skewing a little bit to the higher end of that range. But it is must be said, this isn't a commodity business. The reason we're able to make these spreads that you've seen us monetize again and again is because it takes a tremendous amount of effort and a tremendous amount of executive time in order to bring to fruition. It's not something that scales up easily nor are we that interested in doing it. We've been doing it the same way for over three decades and that's going to continue to be the process.

[Operator:]

Our next question comes from the line of Rob Stevenson with Janney Montgomery Scott.

[Rob Stevenson:]

Lou, when you look at your office portfolio today, I mean, Oyster Point's essentially under sale. Is it other than maybe the Chesapeake asset? Is there anything else that you considering non-core going forward in the office portfolio as a sort of source of funds down the road here?

[Louis Haddad:]

We still have a couple of single-tenant bill disputes. They're somewhat small. They're in the state office building that we're not really viewing as core, but we're also not anxious to sell. So we're fairly limited, again, in what else that we would recycle on that end of the portfolio.

[Eric Smith:]

And Rob, just to add on to that. So those two single-tenant office buildings went into service a little over year ago at this point in time. And under the REIT rules once we hit the two-year mark on that, we can sell those and not be a sale of inventory under the tax rules. And we could take those proceeds at that point in time to keep them in-house, not have to worry about 1031. So that's another reason I think we'll be a little more patient make sure we get beyond the two-year point.

[Rob Stevenson:]

And then I mean as you look at the retail portfolio, so the retail has gotten to be bigger percentage of the NOI. I mean is there stuff in there other than potentially the remaining Texas asset that you guys may look to call over time as you continue to add more retail? From an acquisition standpoint, is there stuffs, whatever you're calling to find the bottom cortile of that portfolio today, tenants for recycling or given the size of retail and where you want it to be, is it you're not really interested in selling retail at this point?

[Louis Haddad:]

It's a really question, Rob. It gives me an opportunity to, again, reiterate our philosophy. We don't fall in love with real estate. All these assets have a peak value. I mean we're constantly looking at the portfolio to see if we are at peak value, and are we looking at slower growth going forward. So I would tell you that there are opportunities for recycling in there. There is nothing eminent just now, but it's something we're very mindful of and not afraid to pull the trigger.

[Rob Stevenson:]

And then on the Southgate asset, you mentioned that Staples as a tenant in there. Have they already either leased or up and downsized into their smaller footprint or is that a risk for you guys going forward?

[Louis Haddad:]

I'll have turn that over to Eric Smith, our Chief Investment Officer, who headed up that acquisition.

[Eric Smith:]

So that lease is 28,000 square foot store that comes up in 2017. Our reconnaissance, our due diligence process is that they're happy at the center. We have not heard the specific request yet that they'll be looking to shave square footage off of that lease. We obviously are familiar with the general trend that you mentioned. So part of that diligence was if that tenant or quite frankly a couple of the other larger box tenant there show up and want to have that 3,000 square foot, 5,000 square foot, 7,000 square foot extra discussion to shave off some square footage, we're very comfortable in the ability to re-lease that space and arguably at a rental rate pickup in the process.

[Rob Stevenson:]

And then just lastly, on the Harper Hill Commons assets, where you're 79% occupied, is that all small space or is there some big chunks in there to lease up? And how is retenanting going in that space these days?

[Eric Smith:]

Its mostly small space or it will easily be partitioned in the small space. And the leasing, I would say is reasonably solid. We think we have some things in the pipeline that we'll be able to talk about in the near future. So we're pleased with the activity despite the fact you haven't seen that number boost instantly quite yet.

[Louis Haddad:]

Let me add something else to that, Rob, again, something else we look at very closely. When we purchase an asset particularly on these retail centers, obviously we're looking at credit and we're looking at location and all the things that you typically would look at, but something's that very near and dear to our heart is sales per square foot in the existing anchors. When we see real high volume in those anchors, then we feel real good about recapturing space and being able to re-lease it. And when we don't see that, we don't pull the trigger by the asset. I think if you look behind the numbers much more granularly into what the actual tenants are doing in the space that we've acquired, you'd be pretty impressed with the kind of sales volume that they're doing.

[Rob Stevenson:]

Is there any out far so carve outs potentially in Southgate given the size of that center?

[Eric Smith:]

There is -- don't know if we've spoken about it before, but as Louis mentioned, we acquired this asset from the same seller pool who had transacted Dimmock Square with us. And at the time that we looked at Dimmock Square couple of years back, we had looked at this Southgate asset as well. At the time it was anchored by a Kmart. We were not comfortable with the Kmart. And so we honestly we didn't transacted that time. Since then that Kmart has been redeveloped and two-thirds of that pad square footage is now the Burlington lease that was mentioned, the 15 year Burlington lease. There is the residual square footage of that pad, that's available for redevelopment. So that is one opportunity that exists. The second opportunity is there is the parking lot area out of front. It is not a near-term opportunity because it is captured in some sideline causes through some of the various leases, but longer term as those leases come up and expire or are renewed and we have the opportunity to have those discussions about those sidelines, we think there might be an out parcel opportunity there opportunity as well longer term.

[Operator:]

Our next question is from the line of John Guinee with Stifel.

[John Guinee:]

I've got some questions on Page 16, but first, Michael, could you re-explain the profit on the police station, exactly how much that was, and what lines that ran through?

[Michael O'Hara:]

We had contracted, say, to the purchase and sale agreement with the City Newport News to develop the police precinct at the Brooks Crossing project. That was structured as a sale. And negotiating the sales price with the City Newport News -- they knew our cost upfront as we went into that, and basically set that up as our gain on that sale would be equal to our construction fee, which was $430,000. On our income statement that's included on the gains on sales of real estate, so it's in there on the income statement. And in our FFO calculation, we go from net income to FFO, we back out the gains on sale. We have been only backing out the gains from the Richmond Tower and their invest leaving $430,000 in FFO.

[John Guinee:]

And then focusing on Page 16, Lou, who is the developer on Johns Hopkins Village, Point Street Apartments and Annapolis Junction?

[Louis Haddad:]

On Johns Hopkins Village it's us, and Point Street Apartments is Beatty Development Corporation.

[Eric Smith:]

Somerset Construction, or an [indiscernible] affiliate with Somerset Construction on Annapolis Junction.

[John Guinee:]

And what you've got essentially on this page, your total estimated costs plus purchase option is about $347 million against the total enterprise value of roughly $1 billion. So basically you're going to be a serial equity issuer, as these come on strain. Is that a fair way to look at it?

[Louis Haddad:]

Not really, John. Again, this is the benefit of being an integrated real estate company. As Mike alluded too, we may well monetize those upon completion. We can also use them for 1031 exchanges with existing properties. I would see – I would think it's highly unlikely that we would simply keep all three and raise equity to properly lever them. I don't believe that's in the cards. Of course, you never know, but that's not our thought at this time.

[John Guinee:]

And then on Main Street essentially initial occupancy couple of years ago stabilizing in a year, but you've got about 100,000 square feet to lease. Are there any tenants out there in the marketplace?

[Michael O'Hara:]

John, we have actively got a lease working for 14,000 or 15,000 feet right now. It's been slower than would have like to seeing. We're happy to have some capacity here at Town Center. For many years, we had to say, no, to the smallest of tenants. So we feel comfortable about having some space to lease going forward. But I would tell you that my expectation would have been that we'd be further along right now. The velocity of tenant, it hasn't been there, as far as the A payers in that upper 20 rental rate. But again, I feel comfortable that they'll be there. This remains the best address in the region.

[John Guinee:]

And then on, One City Center in Durham, my understanding is that's a official retail plus the condominium?

[Louis Haddad:]

Yes, as well as multifamily for rental.

[John Guinee:]

So you've got condo and for rent?

[Louis Haddad:]

Yes.

[John Guinee:]

You're in the entire project as a 37% joint venture, but in the office and retail 100%. I don't understand how exactly does that work?

[Louis Haddad:]

Let me make sure, we make them clear. We are not a participant in either the residential for rent or the residential through own. Our joint venture partner will own both of those segments, which will ultimately be 63% of the venture. Our 37% is a 100% stake in the office and retail. And quite frankly, we believe that our partner is going to do really well with his residential. We could not get comfortable with the underwriting in order for us to participate there. And that's again, exercising some discipline, we insisted that our stake be limited to what we felt comfortable with.

[John Guinee:]

So how are you able to do that on an off-balance sheet basis? You already are owning a 100% of two of the four component?

[Michael O'Hara:]

John, the way the joint venture is structured, so from a debt standpoint, what we have here is one loan with two notes that the joint venture took out with us guaranteeing the office and retail and our partner guaranteeing the residential piece, the big area from a GAAP standpoint, the reason that stays that way is because the notes are cross-collateralized. So there's a cross-collateralization there. But certainly we've done everything in the operating agreement to protect ourselves if anything happens with our partners during this standpoint. The other thing is we do not have majority votes in this joint venture, we have some blocking rights, but we do not control the venture.

[John Guinee:]

There were two individual construction loans each guaranteeing the cross-collateralize, which means eventually you're guaranteeing everything.

[Louis Haddad:]

Yes, through construction.

[John Guinee:]

You are guaranteeing it all, right?

[Michael O'Hara:]

Correct. But certainly, John, we spent a long time on this thing in making sure that within the operating agreement we have the protection that we need on this project.

[John Guinee:]

Help us just understand this, you are guaranteeing both loans because they are cross-collateralized, so you are effectively guaranteeing the loan on the condominium aspect of it?

[Louis Haddad:]

It's a little more complicated. Maybe we could talk about this offline, but I don't want to get into the way our partner structured his loan, but there is other aspects with the bank wanting the restructuring of the loan that we felt comfortable with. I mean, I'll gladly talk with you offline, so we don't have to get into publicly talking about someone else's loan.

[John Guinee:]

A very good friend of mine bought the top floor condo in that building, so thank you.

[Louis Haddad:]

We'd be glad to go through that with you, John, offline. We are very comfortable with the way it was structured on his end.

[Operator:]

Our next question comes from the line of Bill Crow with Raymond James.

[Bill Crow:]

Bigger picture question and then a smaller picture question. Bigger picture is with occupancy down in all three segments, and some of that due to basically just portfolio recycling, et cetera, but certainly there's got be some impact from the broader economy. I guess my question is, is feeling a little toppy, a little like we're nearing an end of the cycle, maybe it persists for a while, but have we seen the best of times now?

[Louis Haddad:]

Again, that's a fairly long discussion, Bill, I appreciate the question. First, let me say that a 100% of the occupancy was due to capital recycling. Eventually, when you sell 100% full property and acquire some that are in the 90s, that's what happens. So we have not seen any decrease in occupancy in the core portfolio. However, our take is a little bit different. We believe that we've been kind of bumping along the bottom, which were quite a while. And I'm not sure that there is an end -- and sorry, what we're not seeing and haven't seen for quite some time is the general width of our tenants expanding. And I think as long as the economy just continues to do what it's doing, we're not going to see a whole lot of internal growth from existing tenants. I hope that that happens at some point. Maybe this election will yield some results for us all. But we're not seeing toppiness, we're seeing status quo, and quite frankly, we're getting a little tired of.

[Bill Crow:]

The second question is, given the pipeline and the development in the construction company, are you comfortable at this point giving us an idea of where you think the fee income could be in 2017?

[Louis Haddad:]

We haven't run those numbers yet. I'd like to think for the third and fourth consecutive year, it's going to skew towards the higher end of the range, sort of going to be some significant backlog, but not ready to comment on that.

[Operator:]

Our next question is from the line of Laura Engel with Stonegate Capital.

[Laura Engel:]

Well, most of my questions have now been answered. But I wanted to see if there was, I guess, as far as the information you gave us on the project with The Residences at Annapolis Junction, is there a little more specifics on where you are exactly with that project as far as timing and moving on to next phases of that project?

[Eric Smith:]

We have broken ground on the project. As you can see from the disclosure in the supplemental 2Q '16 start with initial occupancy at the beginning of 2018, and stabilization approximately a year later, and so we're comfortable with that timeline.

[Laura Engel:]

And then I know you've gotten a lot of questions on industry is in your thought, but is there anything that really – what most concerns you about that coming year and changes in what you see with rates and occupancies, things you've already cover. But aside from that I know you've given a lot of positive information. Anything that really concerned you going forward a bit or that you all will really look for or avoid as you consider your capital recycling? And what type of weights you're going to put in the portfolio going forward?

[Louis Haddad:]

Well, that's a lot of question.

[Laura Engel:]

You're sleeping well at night, we're all good.

[Louis Haddad:]

I wish I could say we're sleeping well at night. Like I said before, we're not entirely comfortable with what's going out there in the economy. It'd be nice if there was a rising tide and all those boats were being lifted, that's certainly not the case. We're having to do a tremendous amount of due diligence, more than we've ever done, before we decide to pull the trigger on our project; one, because as you know the underlying economy isn't all that strong; secondly, when you look at the multifamily sector, we believe it's very late in the cycle. And so we're getting a tremendous amount of those opportunities thrown at us and for the vast majority they're going to be thrown back. But it takes a lot due diligence these days for us to decide when and if to deploy capital. Unfortunately, don't see that changing any time soon. I can't wait till we can get on the phone here and give it the all clear, but we're not there yet.

[Operator:]

Our next question comes from the line of Craig Kucera with Wunderlich Securities.

[Craig Kucera:]

I may have missed this, but what was the pricing on the OP unit issued for Southgate Square?

[Louis Haddad:]

Eric, could you?

[Eric Smith:]

So when we value that asset, as you know, price of OP units and cap rates are somewhat of a fungible conversation between the two. As we were valuing net asset, we put the value in the kind of low 7 cap rates, 7.25-ish. At the time that we were negotiating that deal our shares were trading anywhere from on the high side, just getting into the $11 handle and on the low side $10.40 or so. And so we priced those with an $11 handle, I think $11.10, which puts, like I said, the cap rates, in our minds in that lower end of the 7 cap range. But again, as you know that that math is somewhat fungible depending on, where you want to place the OP unit value at the time of the transaction and then associating cap rates?

[Craig Kucera:]

Was there any nuances to the structure, where the seller has deferred taking a dividend payment or anything like that or was it just straight OP units?

[Eric Smith:]

No, it was just straight OP units that nuanced in the previous deal was obviously associated with a Fed development opportunity. In this case, similar to the Dimmock's Square transaction, we did with the same group of folks, just last day OP unit.

[Craig Kucera:]

And going through the dispositions of the non-core retail properties, I know at the time of that acquisition, I think the overall portfolio was about a 7 cap. I think the core were at about 6.5%. Are you hitting the assets that we see consider LOI, are you hitting sort of the cap rates that you thought you would or has there been any move to the upside given the choppiness in that market?

[Eric Smith:]

We're actually really pleased the way this is unfolded, to take you on a walk through a little bit of history over the last four or five months in our disclosures. So the initial disclosure was that we were going into this portfolio on a cash basis just south of 7% of the entire portfolio. And then followed up that disclosure I think on the conversation on our previous earnings call that after we disposed off the non-core asset that would leave the residual core portfolio in kind of the 6.5 cap rate range. Through accommodation of a number of positive things, our asset management team giving hold of the assets, scrubbing the various contracts with vendors and managing expenses as our asset management team does very well, getting into leasing activity both renewals and some smaller new leases, et cetera, they were able to add some NOI to the ones we're selling and improve the sales price relative to the acquisition price for the non-core ones under contract, which obviously helps to apply that those increased proceeds against the price of the remaining core asset. You then combine those same asset management activities on increased NOI, and leasing, et cetera, to the core. All that ends up putting you at a going in cap rate on the whole portfolio on a cash basis at the 7.2% range and it leaves you with the core asset after you dispose off the 4% we've talked about in a 6.8% cap rate range, which on a GAAP basis is a little bit north of 7.2%. So we're really pleased that we've seen about 30 basis points of movements whether you talk about the entire portfolio or you're talking about the residual cap rate on the core portfolio in the I-85 corridor.

[Craig Kucera:]

One last one here, just because we're getting towards an hour, just want to talk about the mezzanine loan funding, the new loan at Annapolis Junction at a 10%, is that all current or is any of that accrued?

[Michael O'Hara:]

Yes, it's all current.

[Craig Kucera:]

And how should we think about the funding of both of that and Points Streets. Will those capital outlays be sort of put down inline with any other debt or how should we think about when those will be fully deployed?

[Michael O'Hara:]

So certainly deployment is going to be based upon the construction schedule and draws as we go along here, it will take probably most of the year until those funds are out.

[Craig Kucera:]

So as we look at our 2017, then you should have, call it, $57 million outstanding at least until you guys decide whether or not to exercise your options, is that correct?

[Michael O'Hara:]

Correct. Yes.

[Louis Haddad:]

I'd like to make one point clear on the question earlier about OP units. Since our IPO, we've done a number of these transactions and now with this latest one, we're getting, we're closing in on $50 million with the OP units that we've issued in acquiring property. In each of those transactions, the units were priced higher than the stock price. And in each of those transactions, the unitholder has made money. As you might expect that has more and more people bringing properties to our door. We're going to continue to be selective about what we add to our portfolio, but that program is working exactly as we had hoped and the opportunities are continually increasing.

[Operator:]

The next question is a follow-up from the line of John Guinee with Stifel.

[John Guinee:]

Just going back to these mezz investments, I think just to clarify, somebody had asked you whether these were current or accrued, and you answered current. In reality the interest payments on these mezz loans are being funded out of the loan proceeds, correct?

[Michael O'Hara:]

Correct. Just like a typical bank loan works the same way as the construction, as an interest reserve built within the loan and it funds out of that.

[John Guinee:]

And then if these deals work well, it's very easy to understand your purchase option at 88% upon completion, but if they don't work out well, you're still essentially buying these aren't you, because you're in the mezz financing position? This isn't really an option, and that on the downside you almost have to buy them because you're the mezz lender?

[Louis Haddad:]

Like any mezzanine lender we have that right, obviously. The developer has the right to take us out. We feel very comfortable with the investments that we've made, again, as a mezz lender would. And we feel comfortable at a level that we're in at on that wholesale level. But, yes, in essence, you are in first position to take that asset good, better and different.

[John Guinee:]

So when you're sitting there with your Board and you're talking through this kind of situation, are you better off being a general contractor with this [ph] friction and an option and protecting your balance sheet optically, I think, or are you better off just being a 100% primary developer or something like this?

[Louis Haddad:]

Again, you don't have the ability to be a 100% primary developer, because you have developers that have worked for few years to get these things to where they are. And those people want their share of equity, as well as development fee. So more properly you have the option of being a joint venture partner from day one with essentially the same investment, but without any benefits that Mike has described.

[Operator:]

At this time there are no further questions. I will turn the call back to management for closing remark. End of Q&A

[Louis Haddad:]

Thanks very much. I appreciate all the time that you guys have given us this morning. We appreciate you following the story. And we look forward to having a great year. And hopefully, you'll continue to follow it. Thank you for your interest.

[Operator:]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.