Columbia Property Trust, Inc.
Q1 2017 Earnings Call Transcript

Published: 28 Apr 2017

[Operator:]

Good afternoon and welcome to the Columbia Property Trust First Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Matt Stover, Director of Investor Relations. Please go ahead.

[Matt Stover:]

Thank you. Good afternoon. Welcome to the Columbia Property Trust conference call to review the Company's results for the first quarter of 2017. On the call today will be Nelson Mills, President and Chief Executive Officer; and Jim Fleming, Executive Vice President and Chief Financial Officer. Our results were released this afternoon in our earning press release and filed with the SEC on Form 8-K. We have also posted a quarterly supplemental package with additional detail in the Investor Relations section of our Web site. Statements made on this call regarding expected operating results and other future events are forward-looking statements that involve risks and uncertainties. A number of factors could cause actual results to differ materially from those anticipated including those discussed in the Risk Factors section of our 2016 Form 10-K. Forward-looking statements are made based on current expectations, assumptions and beliefs, as well as information available to us at this time. Columbia undertakes no obligation to update any information discussed on this conference call. During this call, we will discuss certain non-GAAP financial measures. Reconciliations to comparable GAAP financial measures can be found in our earnings release and supplemental financial data. I’ll now turn the call over to Nelson Mills. Please go ahead.

[Nelson Mills:]

Thank you. We appreciate everyone's time this afternoon. As most of you know, we had a very productive first quarter. The sales of our properties in Houston and Cleveland brought us to $1.2 billion in total asset sales over the past 12 months. This essentially completes the portfolio transition we began four years ago. During this time we sold over 50 properties for $3.3 billion, acquired 7 properties for $2.6 billion, and moved from 32 markets to only seven. In addition to our portfolio transformation, we have also had much leasing and operating success across the portfolio. Along the way we have built strong teams in our three focus markets and substantially increased the quality of our portfolio not only in terms of markets and fiscal quality but also the rent rollups which now have solid growth potential across the portfolio. We have established a portfolio with an average embedded rent rollup percentage in the double-digits and we are beginning to capture that income growth. Of course, selling higher cap rate assets and reinvesting in better growth opportunities resulted in diluted earnings over the last few years but as Jim will discuss, we are now positioned to turn cash flows significantly upward going forward as evidenced by our recent leasing success. As we complete this important chapter, I would like to reiterate just a few points on the transition which I hope will provide some insight into what we are about as a company and our strategy going forward. First, while we fully committed to the transition and pushed through it relatively quickly, we did not conduct a fire sale. That might have been the correct approach had capital markets begun to [tie in] [ph]. But we were fortunate to experience relatively strong capital demand throughout our transition period. This gave us the time and opportunity to maximize our exit value of the properties. As you know, much of the legacy portfolio was concentrated in single tenant suburban buildings where value is driven heavily by credit and lease term. Because of this we look for every feasible opportunity to extend and improve key leases prior to disposition. Some examples include [indiscernible] in Baltimore, KeyBanc in Cleveland, PSE&G in Newark, CH2M in Denver, and [Bose] [ph] in suburban Boston. In many cases we provided additional capital for tenant improvements, reduced the rental rate, or allowed the tenant to contract its space. But in each instance we evaluate the overall impact with an emphasis on value rather than the earnings impact. Our teams efforts to maximize [acreage] [ph] value substantially increased overall sales proceeds which in turn created more capital for reinvestment in new properties. Of course it can be a mistake to wait too long to exit, particularly for single tenant properties. Not only is valuable lease term burning off but a disruption or deterioration in capital markets could outweigh the value of a lease extension or restructure. And of course those negotiations are never certain. Throughout our process we thoroughly weight that risk. In some cases we come out in favor of an as is sale. For example, our three properties in Houston last year, or our Lenox Park buildings in Atlanta in 2014. In other cases we have deiced to hold and work through with lease renewals and replacements such as the successes I mentioned earlier. We have also elected this approach for our three remaining non-core assets in Atlanta and Pittsburg. While they represent a relatively small percentage of our value and cash flows, we still have some work to do and capture value before our eventual exit. Let's now turn to acquisitions. We continue to take a disciplined and focused approach in identifying investment opportunities. As mentioned, we have invested $2.6 billion over the last four plus years but only in seven properties. And as we will cover in our leasing update, those properties are performing well. In most cases, beyond our expectations. We have looked at hundreds of deals. We have bid on scores of them and have gone as far as the best and final round on dozens of opportunities just to capture those few properties. We have chosen to invest and operate in some of the best and most competitive office markets in the country, and for good reasons. We believe the long term rewards from these markets are well worth the cost and effort. We believe that high demand, supply constrained markets like New York City, San Francisco and Washington DC tend to have stronger rent growth over time and will better weather market downturns. In evaluating investment opportunities, we focus on several key attributes. Attractive architecture, sound construction and mechanicals, flexible and efficient floor plates, wide [in air] [ph] and access to transportation and attractive amenities. Of course we evaluate the current rent roll and tenant profile. The competitive set for the sub-market and trends affecting both near and long-term leasing opportunities. And of course our views on overall market conditions always affect our investment underwriting as well as capital investment and leasing decisions. We have also chosen to limit our market cycle risk. A number of REITs allocate capital to development and at some point we may chose to do so ourselves. We understand that development can provide attractive returns as long as the market cycle doesn’t turn it to long time. But so far, we have been very judicious about how much market cycle risk we are going to take. We did buy buildings with significant lease roll in San Francisco in 2014 and in New York in 2015. But these allowed us to address leasing in the relatively near-term. And we balanced that risk with the stability of our other properties in each of those markets. We have also worked very hard to get that leasing done quickly. As a result, we have only 131,000 square feet of unfilled vacancy and expirations through the end of 2017 in San Francisco and only 147,000 square feet through 2017 in New York. And we expect to achieve substantial rent rollups for all of it. We understand there is substantial uncertainty in the broader economy and in our markets. Leasing demand and rental rate growth have slowed somewhat in New York City and San Francisco and the DC office market has faced challenges for some time given the modest supply absorption relative to new construction levels. With that said, these markets remain in a relatively healthy state with vacancy rates ranging from 7.8% in San Francisco, 8.5% in Manhattan, and just over 11% in DC. We expect growth in rental rates to remain slower compared to recent years in which Manhattan experienced mid-single growth and San Francisco saw double-digit increases. We are anticipating low single-digit growth over the next couple of years for these markets. However, our expectation for overall net absorption is positive and even with the anticipated supply deliveries in the near-term, we expect vacancy rates will hold steady or slightly decline. We have been successful in capitalizing on these more modest but positive fundamentals as evidenced by our strong leasing activity year-to-date. Capital demand in our key markets continues to be quite strong and this makes it very difficult to find and win compelling new investments. We continue to actively comb our markets for deals that make sense but with more concerted underwriting in this environment. We believe that disciplined underwriting along with diligence and creatively will eventually yield attractive opportunities. But we will be patient until they do. Our analysis of specific opportunities is led by our local market leaders with a close involvement of our senior team. Our board is kept well informed on our markets and opportunities and is actively involved in strategy as well as major policy and capital decisions. Our last acquisition was 229, West 43rd, that’s the former New York Times building, almost two years ago. We recently signed a contract to acquire 149, Madison, a relatively small value add opportunity in the Gramercy submarket of Manhattan. We were able to access that opportunity because of a combination of local relationships and a creative approach. One question that remains is how many markets we should pursue. We have talked before about West LA and Boston. In fact, we bought a building in the Bay of Boston two years ago and we held on to a smaller asset in Pasadena. We have also bid on a number of buildings in both Boston and West LA over the past several months but they priced beyond our underwriting. Both of these are very strong markets with good fundamentals that could potentially meet our investment objectives. But we are faced with two key challenges. How to build enough scale in one or both of these markets to be relevant and whether to spread our platform and resources across more markets. Because of this we have not been aggressive in pursuing opportunities in either of these markets to this point. We will continue to evaluate both of them for a while as we continue to weigh the advantage of having one or two more attractive markets in which to look for opportunities against our desire to build scale and presence in fewer markets. But to be clear, our team continues to be primarily focused on New York City, San Francisco and DC. We acknowledge that the competition is fierce in these markets for both acquisitions and leasing. That’s why our team and board stay focused and diligent on capital allocation decisions and while we remain committed to building and supporting talented and experienced teams in our focus markets. We have worked hard to establish credibility and relationships with the best brokers, owners and operators there too. Our successful acquisitions and leasing in New York City, San Francisco and DC provide some evidence of our improving footholds in those markets. Some of you may be aware that I have recently moved to New York. I made this decision with the blessing of our team and board because my role is largely outfacing today, focusing on things like larger leases, acquisition opportunities, potential joint ventures and relationships with others in our sector. Jim will continue to be based in Atlanta along with Kevin Hoover, our Head of Portfolio Operations, Wendy Gill, our Chief Accounting Officer and Head of Corporate Operations and the rest of the home office. Adam Popper, Dave Dowdney and their teams are already well established in our key markets. We all travel frequently and I expect to be in Atlanta every couple of weeks. My move reflects the fact that we are functioning well as a team and I believe I can add more value being more closely involved in one of our key markets. Finally, scale is an issue that our team and board have continued to weigh. While we are very pleased with the quality of our holdings, we could benefit from more presence and reach within our focus markets. Today we can't do that by issuing stock and we are not willing to add debt to our balance sheet. We believe a joint venture with a strategically aligned partner is our best opportunity to address scale and reach at this time. As we have mentioned on our last quarterly call, we have been exploring this for some time. We are pleased to announce that we are now in the final stages of documenting a joint venture agreement with an institutional partner. Even though this transaction isn't yet finalized, we believe it will be this quarter, so we decided to provide some details on today's call. We anticipate that this venture will start with slightly over a $1 billion in assets and grow to around $2 billion through new acquisitions over time. We will initially fund our share by contributing two of our West Coast properties and our partner will primarily contribute cash. We will stage the contribution so that Columbia doesn’t accumulate unacceptable levels of cash until new investment opportunities are identified. The JV partner is a well know institution who has been active in our markets and has a long-term investment focus. We will own slightly over half of the venture and we will manage it subject to shared major decisions. We will receive a management fee and although this isn't a major driver for us, this should eventually contribute modestly to our earnings. Our investments will have a long-term lockout whereby neither party can force a sale for several years. The bench will focus on acquisitions of quality office assets in our key markets consistent with our strategy. At this point we can't provide any more specifics but we are very excited about this important opportunity for Columbia. With that, Jim, I will hand it over to you.

[James Fleming:]

Thanks, Nelson. I will spend a little time discussing our results for the first quarter but mostly I want to talk about the key drivers for our business going forward. Matt and I will be glad to follow up after the call if anyone has questions about specifics on the quarter that we don’t cover today. For the first quarter, FFO was $0.28 which is on track with our guidance of $1.15 to $1.22 this year. The first quarter included about $0.01 of contribution from our Houston and Cleveland properties that were sold in January. Second quarter will also be lower due to the vacancy of Credit Suisse at 315 Park Avenue South. However, by the end of the year a number of recently signed leases will be adding to our FFO, including [rework] [ph] at both 80 M Street and 650 California, along with [indiscernible] at 315, Park Avenue South. So as we have been saying, we expect the second quarter to be our low point with substantial increases after that. FFO this year will also depend on acquisitions and so far we haven't made any. Please understand that the contribution to 2017 FFO from acquisitions is not something we focus on. Our acquisitions will likely be long-term investments and we are interested in buying additional properties only if they enhance our market presence and provide an opportunity for growth. So we are okay waiting for a while if we don’t find acquisitions that meet our underwriting. Nelson, Matt and I have been on the road a good bit lately, meeting with a number of you. One of the things we have emphasized is our cash flow bridge, which is on page 8 of the investor presentation on our Web site. This is a simplified version of our cash flow model going forward and it shows our cash NOI at a low point early this year due to our recent asset sales but with strong growth over the next couple of years. The first three blue bars in the bridge are contractual items for burn off of free rent, commencement of recently signed leases and rent increases in 2017 and 2018 under existing leases. In the bridge, these add up to $48 million per year. The remaining three bars are speculative based on our assumptions about vacancy lease up, leases rolling to market this year and next, and acquisitions. These three add up to another $48 million. The result is a pro forma NOI of $281 million which we believe should support a much improved share price assuming a cap rate in line with our peers. Of course it's one thing to talk about these bars on a graph and it's another to perform. So our plan is to report progress along the way and as of today, we have already signed additional leases that have moved $10.5 million out of the speculative piece and into the contractual piece. This year we are very focused on leasing. Part of this effort of course is renewing leases that don’t expire for a while, and this is important for the future. But the immediate priority is leasing our current vacancy and near-term roll. We began 2017 with 603,000 square feet of vacancy and we have another 330,000 square feet of lease expirations in 2017. This give us 933,000 square feet to work with. Our goal this year is to lease 547,000 square feet of the 933,000, which would take us to 95% leased overall. Fortunately, our portfolio which is very quality today and most of the vacancy is in buildings we have acquired recently. It also involves substantial rollups in rent, which is why we made most of our recent acquisitions. So far, we have signed 333,000 square feet towards our goal of 547,000. Much of this is in 650, California in San Francisco and one in Glen Lake in Atlanta. We will keep you posted on our progress throughout the year. Another element of our cash flow bridge is deploying cash on our balance sheet. Our bridge assumes we invest $500 million at a 4% initial yield. But this is just a placeholder to show potential cash flow a couple of years out. Buying a stabilized asset with a 4% yield would not be our strategy. As we have discussed, we want to build additional scale in the key markets and we are looking for investments that will allow us to create value while doing this. But we haven't bought anything in almost two years because we are not going to buy unless we believe the acquisition adds to our platform and gives us an opportunity to add value. If we can't find assets to buy, we are willing to hold cash or lower leverage to enable us to act later and will also buy stock as long as the pricing stays attractive. Nelson mentioned the substantial rent rollups we saw again this quarter. This follows leasing spreads over the past two years excluding the NYU lease at 222 East 41st Street, that have averaged 27% on a cash basis and 46% on a GAAP basis. And we anticipate this trend continuing for a good while. In fact, we believe today's market net rents for the remaining lease expirations in 2017 through 2019 are more than 20% higher than the in place cash rents. Of course, our leasing results will vary from quarter to quarter depending on where leases are signed, but overall we expect a strong positive trend to continue for a good while. Net rollups of course are only one factor in our financial picture. Occupancy levels as well as the portfolio mix and contractual escalations matter too. Because of our portfolio transition over the past four years, we have seen declining same store NOI for a while. But we expect this trend to reverse in 2017 as a number of recently signed leases commence and we lease up a good part of the remaining vacancy in our newly acquired buildings. For 2017, we expect same store NOI to be slightly down on a cash basis and slightly up on a GAAP basis. Beginning next year, we expect strong year-over-year growth in both cash and GAAP going forward. We recognize the compelling value of our stock today. As a result we purchased $28 million of stock in the fourth quarter and expect to continue to take advantage of the disconnect between our stock price and the value of our portfolio by buying more. We did not buy any stock in the first quarter but the only reason was our pending joint venture which Nelson described earlier. As the negotiations for this venture progress, we concluded that we were not in a position to open the window for stock purchases this quarter. After today's call that issue would go away. As we think about share repurchases, we have said many times that we need to be in a strong financial position so that repurchases don’t put strain on our balance sheet either on overall leverage or on liquidity. These are not issues for us today. The other question is balancing the stock price discount against the strategic value of more scale in our markets. Today, we believe there is at least 100 basis point difference between the cap rate implied by our share price and the value of our portfolio. That’s a significant discount and one we would look to take advantage of. As we have also said we believe additional scale in our key markets will help us further establish our platform and generate opportunities in the future and so our goal is to so some of both this year. Of course both are dependent on price and we would much prefer to wait a while to see if opportunities present themselves rather than make investment in a frothy market. Before I finish, I need to mention the Westinghouse campus in suburban Pittsburg. There are three buildings totaling 824,000 square feet and Westinghouse has filed Chapter 11 bankruptcy. Our belief is that they will be able to reorganize as a viable business and there are several good signs so far including the fact that they are moving utilities from other locations into our buildings. Their rent is cut and as long as they are occupying the space, future rent will be an administrative expense that generally must be paid in order for them to get a plan of reorganization approved. Additionally, their parent Toshiba has guaranteed $42 million of Westinghouse's rent. Of course, we will keep monitoring this situation. Finally, I want to note that our balance sheet remains in great shape. We are in the process of giving 263 Shuman back to the lender and we can control the timing but we don’t have much further involvement with that property. Besides that, we have only three mortgage loans. A $325 million loan on market square which we share with our venture partner, plus a $26 million loan on One Glen Lake that we expect to repay next year and $126 million loan on 650, California that is due in 2019 but can be prepaid as early this July. All of our other assets are no unencumbered and we ended the first quarter with $555 million of cash, with no borrowings on our $500 million line of credit and no significant near-tem maturities. With that, I will turn it back over to the operator to begin our question-and-answer session.

[Operator:]

[Operator Instructions] And our first question will come from Sheila McGrath of Evercore.

[Sheila McGrath:]

Nelson, I was wondering if you could comment a little on the joint venture in terms -- once it's formed, will all the acquisition opportunities of the REIT have to go into the joint venture or how would you allocate between the balance sheet and the venture.

[Nelson Mills:]

No, Sheila. So it won't be exclusive to either party. We can do investments outside the venture as can our partner. As we mentioned earlier, we do expect to see the venture initially with a couple of assets and we will stage that. So those contributions happen when we need the capital for new investments. But, no, it's not exclusive for either. We will do some inside and outside, would be our expectation.

[Sheila McGrath:]

Okay. And the assets that you would be [dealing] [ph] with are in San Francisco. Is that right?

[Nelson Mills:]

Yes. That’s the expectation. That’s right.

[Sheila McGrath:]

And then just if you -- I know it's a smaller acquisition but I think it will be helpful for us to understand your plan for the Madison Avenue property and kind of what you think that could pencil out in terms of a stabilized yield on cost.

[Nelson Mills:]

Okay. We will put more details out soon in the next few months as that comes together. At this point we are under contract to buy the land. Obviously, we have done our underwriting and we have some budgets there but generally, it's just under $88 million to purchase the land. We expect to close later this year. It is a pretty extensive rehab, it's a relatively small building, 126,000 square feet. And as you know, we have done a lot of renovations. Lobbies and common areas in buildings before so it is something we are very excited to take on. And then a couple of -- we will actually get access to the property in January. That’s when the ground lease expires. The building comes back to us. It would be empty at that point. Well before that, we are already assembling our team and doing planning and so forth as you would expect, so we want to be ready to go this fall when we get the property. So another $20 million-$25 million is probably the expected range for additional capital. Lease up periods for a couple of year as you would expect and probably we have got a reasonable shot at a seven return on cost, it could be just under that, sort of in that range. But a lot is to be determined at this point. But even under conservative underwriting, we are very excited about the opportunity.

[Operator:]

And the next question comes from Vikram Malhotra of Morgan Stanley.

[Vikram Malhotra:]

Just wanted to touch on your comments around looking at markets for additional opportunities. It sounds like, I think if I remember correctly earlier you were focused primarily on New York but now you are considering Boston as well. Is that just sort of given pricing, you are sort of looking at other markets or are you just sort of open right now across all your key markets.

[Nelson Mills:]

Hi, Vikram. So as we said, we are really focused today on the markets in which we have a substantial foothold and we have teams, that is New York, San Francisco and Washington DC. However, for some time we have been looking at Boston and West LA submarkets. We have bid on properties there. We actually own a property in the Bay of Boston. And they are very compelling markets and the fit our strategy quite well. But they are also very competitive and as we discuss, it's a matter of -- we are very attracted to those markets but we are also balancing that with the scale issue and our platform. And so I think we will continue to look in those markets, primary focus is in the big three. We are not moving them out but we just want to emphasize that the focus is really in those big three central markets.

[Vikram Malhotra:]

Okay. Sounds good. And just a question on some of the leasing, just on the renewals. I think the term, if I am not wrong, was around 36 months. Was there something unique about those leases or those tenants, just relative to the leases you have signed over the past few quarters.

[James Fleming:]

Hey, Vikram, this is Jim. That’s the way the math turned out. It does look a little odd but what we did was to extend on existing lease in New York. I think it's for a year and half and because of that that’s the way the math turned out. And that wasn’t a near-term exploration, so we wouldn’t typically do 36 month leases. I think that lease got extended to 2027 and so just because of the 1.5 year extension the math turned out that way.

[Vikram Malhotra:]

Okay. And then just last, quickly, numbers question. Can you just give us a sense of what you are budgeting for TIs in CapEx for the balance of the year.

[James Fleming:]

So, Vikram, we were in the low $20 million range for total CapEx this quarter. We haven't put out guidance in terms of CapEx and what's happening is there is a fair amount of our CapEx that’s going out today is incremental CapEx, investment capital. Nelson mentioned 149, Madison where there is $20 million to $25 million. That will show up in later years. But we have some of that now related to 650 California and 315, Park Avenue South. So we think a lot of it is going to be investment capital and that includes both the building improvements as well as some leasing the way we characterize it for the first short period of time after we are buying up property. I think it -- my guess is it will probably be a little bit higher than it was this quarter for the next couple of quarters and then settle back down. But that’s really investment capital.

[Operator:]

The next question comes from Mitch Germain of JMP Securities.

[Mitch Germain:]

Just a quick question. When I look at guidance, I know you have got acquisitions in there, does that also imply some of the debt redemption that you guys can do?

[James Fleming:]

Hey, Mitch, this is Jim. Our guidance is based on the assumption that we make $500 million of acquisitions. And that’s still our game plan but we did want to emphasize in this call that that’s really not our driver. Our driver is not to try to generate FFO for this year, our driver is try to build scale in our markets and buy assets that are going to be good investments for the long-term. So it's possible that we won't find assets to buy within the timeframe that we would originally expect them and maybe a little bit later and in that case there would be some dilution to near-term earnings. We have paid off one mortgage. We had a $73 million mortgage we paid off in the first quarter. There is another one that we could pay off in July and then there is some term debt that could be repaid as well. We haven't gotten to that point yet. So I can't really answer whether that might be the result I think at this point our goal is still going to be to try to find acquisitions. We also, as we have talked about, could do some share repurchases as well.

[Mitch Germain:]

Okay. Got you. If I look at the joint venture, are there any attributes? Is it a core acquisition, is it core plus, value add, or is it pretty much have flexibility with regards to the investments that you can complete?

[Nelson Mills:]

This is Nelson. So there is flexibility. It's the risk return spectrum is not tightly dictated. Our expectation is that the investments would likely be core to core plus for that venture. In fact as you know, the vast majority of our portfolio will continue to be core to core plus. We have a few value add opportunities from time to time that we have and will execute but our expectation with the venture at least initially will be core to core plus.

[Mitch Germain:]

Got you. Cool. I know you guys backfilled, I believe if I am not mistaken, a portion of the CSFB space. Can you just maybe update, I know their expectancy to exit upcoming in this quarter. Where that stands right now?

[James Fleming:]

Sure, Mitch. This is Jim. So if you look at page 22 of our supplemental, you will see that in the New York numbers for the -- on the very top left hand corner, [fifth] [ph] column, this quarter 138. It had been 147, they have given back one floor already. The 138 does include two more floors that we have preleased. So there is really a net of -- I think it's 98. So it's just under 100,000 square feet left to go. We have signed leases with Oracle and with [Bustle] [ph] for the three floors and we continue to have good activity on their but we have got about 98,000 square feet left to go and that’s what we will get back that will be un-leased this quarter.

[Mitch Germain:]

And in terms of the space itself, I was under the assumption -- I can't remember [indiscernible] though, I think I might have, under the assumption that it's relatively well maintained?

[James Fleming:]

Yes. There will be some demo that will need to happen. We can't do that till we get the space back. But you know this is very desirable space and it's a very attractive building. We are in the process now of redoing the lobby and Equinox is there and open. So we feel very good about getting it done. It's in our game plan to get it done this year. But it's still work to be done.

[Mitch Germain:]

Great. Last one from me. After spending some time with you I have felt pretty comfortable about the Westinghouse situation but them Toshiba obviously announced some going concern issues. So does that put the deposit at risk or is that still money good, in your mind?

[James Fleming:]

Mitch, that’s an interesting one. This whole thing, we are not any closer than you are to Toshiba. So we can't really tell you what's going to ultimately happen. But I will note that Toshiba did publish their accounting results with the going concern opinion. That day their stock was up about 5%. So I don’t think that was unexpected. And I think the whole bankruptcy reorganization is in part to protect Toshiba. So I don’t think anything has changed since we talked. We can't predict what's going to happen with Westinghouse or Toshiba but we still feel pretty okay about the overall situation.

[Operator:]

The next question will come from John Kim of BMO Capital Markets.

[John Kim:]

On the topic of the day, the joint venture. So the two assets that you are contributing, are they going to be more of your stable assets or more of the assets that have some potential upside?

[Nelson Mills:]

Hey, John, this is Nelson. So there is a 75% chance since we have identified, at San Francisco we have got four assets there and four of them are very stabilized. So we have got a 75% chance of even more, of at least one of them being -- yes, we do expect it to be the more core stabilized properties. As I mentioned earlier, that’s probably going to be the emphasis of the venture and we feel like that works well for us too.

[John Kim:]

And just to clarify, will the investments going forward also be focused on the West Coast and I just wanted to make sure what the impact to earnings would be on this?

[Nelson Mills:]

No. To answer the first question, not necessarily. We and our partner are very much aligned in terms of the markets that we are focused on, so it could be any one of the markets we are in. So, no, not necessarily just West Coast. In terms of the financial impact, a lot of that is to be determined based on the investment opportunities of course. But as we mentioned, we have a mechanism in place to time the contribution of our assets which would yield cash to us. So top that with the identification, execution of new investments to redeploy that cash. So that was something that was important to us. And that’s s combination we got to help settle on that front to keep our capital at work.

[John Kim:]

On the Westinghouse lease, do you have any expectations that they would want to renegotiate the rents during the reorganization?

[Nelson Mills:]

So, John, we mentioned the Toshiba guarantee earlier. That’s a factor that’s important. We will be following the bankruptcy proceeding. That’s all important. Our highest hope and expectation for Westinghouse is their obvious commitment to that campus. They seem to have a very vital business and they are committed for the long-term. We are seeing in the press and otherwise, we are seeing some movement of employees into that property, maybe a consolidation going on. We don’t have all the details on that. But every indication is that they are very interested in that property long term. And we have been and continue to be in discussions about a lease extension, a substantial lease extension even post-bankruptcy. So to the extent they have control on their future, we think they are very much committed to the space for the long-term.

[John Kim:]

And then once they are clear through the reorganization, do you plan to pull the asset or potentially sell it?

[Nelson Mills:]

Well, we sold 50 plus assets, a lot of them were properties just like this. This is not part of our strategy, even though Westinghouse has been a great tenant and it's a beautiful property. The single tenant suburban property is not our strategy. So the answer to that question is, yes, eventually. We need to work out the -- work through this situation, hopefully in the next few months. As we mentioned earlier, there is construction building issues, physical issues with the building that we are working through and we are well down the path of getting those addressed, related to the original construction. So once we work through couple of things, yes, I would say that we have been clear with Westinghouse on this as well. We are not a long-term holder of this property. We don’t expect that to be this year but could be or maybe next year. But first things first.

[John Kim:]

And then at 229 West 43rd, it looks like you expanded the Snap lease. So can you just remind us or update us on how much of the building they currently lease and their basic requirements are going forward?

[James Fleming:]

Sure. John, we added 26,000 square feet with Snap and they extended for 95,000 square feet. So all in, it's about 120,000 square feet in that building. And their lease term goes to 2027. So basically what happened there is they came to us and wanted some additional space and said they would make a really long-term commitment and make this their home if we could provide it. And we were able to move out a couple of smaller tenants to make room for them and that really enabled them to make this commitment to the building.

[John Kim:]

Is their demand for them to take more space or even availability for that?

[James Fleming:]

There is no availability, it's 100% full. Nelson, I don’t know if you have any thoughts about the rents?

[Nelson Mills:]

Well, at this time that additional space commitment satisfies their current need, although they had been very clear that this is going to be their home for some time and I think they would like to expand there. But there is nothing being negotiated today for additional expansion at the property.

[Operator:]

And next we have a follow up question from Sheila McGrath of Evercore.

[Sheila McGrath:]

Yes. The leasing spreads in the quarter were really strong. Can you just give a little more detail on the drivers of that? I haven't gone through the whole supplemental. Like which leases were driving that big mark-to-market?

[James Fleming:]

Sure, Sheila. A lot of it was in San Francisco. We had the rework lease out of 650 Cal, was a substantial rollup. I think we talked about the rental rate there being in the upper 60s. And as you may remember, we bought that building with rents and it varied from the upper 30s to low 40s. So those were experiencing very substantial rollups. We will see more of that in the future. And the upper floors were leasing in the 70s. So that’s a big chunk of it. We did have a substantial rollup at University Circle. The Snap lease was a bit of a rollup that we talked about. And, I am looking through a list, those were most of it. We have another lease at 650, California that actually happened this year, this quarter, excuse me, after the end of the first quarter this is a substantial rollup as well. So the others are not that meaningful. It's really those building that are contributing right now. And we do see as we move forward, I think I mentioned it earlier, we do believe this is going to continue for a couple of years. We have looked at our explorations. And we have got explorations and buildings with substantial embedded rollups.

[Sheila McGrath:]

Okay. Great. And then one last question. Can you comment on rental concession trends in your markets? Are they pretty stable in terms of TI and free rent? Are they moving directionally in one way or the other?

[Nelson Mills:]

Sheila, they seem fairly stable. As you know, in our big three markets in DC, concessions have been high. Rates have helped too in our buildings and other A class buildings. But they have been high for some time. There has been some discussion in the market, in the press, about similar trend beginning to happen in New York with landlords expanding capital so basically the whole rate. We are not seeing that, we are not doing that. We continue to see, to keep our rates and see some growth in rates, but we are holding pretty firmly on the TIs. We have seen a couple of examples of it elsewhere with other landlords but I don’t see it as a trend in New York. Same thing in San Francisco. To capture a big compelling opportunity or a unique situation occasion you will hear about larger TIs. But again, we don’t see trend there. We think those, certainly rate growth is flat, no question about it. In San Francisco and New York. But we don’t see a huge across the board jump in concessions at this point.

[Sheila McGrath:]

Okay. And you were pretty cautious on whether or not you would acquisition to this year just because you are disciplined. But I am just curious, are you in -- is it more because there is not much for sales or you missing out on stuff or are you currently looking at some acquisition opportunities.

[Nelson Mills:]

We are looking at several and at any point in time, there is seven to 12 properties in our pipeline. Some we are more excited about then others. Those usually fade away with pricing. They usually slip away from us and escape our underwriting pricing because -- and their just seem to be more activity, more coming to the market in New York than a few months ago. But as we mentioned, very competitive. There is a lot of capital from the realty world looking at opportunities in these markets. And it's just, it's hard to keep a property within inside of your underwriting. And we think we will do it with enough hard work and creativity, we think we will capture the few that we need. $500 million is not all that much. It's probably two or three properties. So we will stay after it. We are being a little bit cautious maybe in terms of expectations on how fast that will happen but we are seeing some pretty good activity on the pipeline.

[Operator:]

And this concludes our question-and-answer session. I would like to turn the conference back over to Nelson Mills for any closing remarks.

[Nelson Mills:]

Well, thank you all once again. We really appreciate your time and attention and we are available for any questions you might have. Otherwise, we look forward to seeing you all soon. Thank you.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.