Duke Realty Corporation
Q1 2008 Earnings Call Transcript

Published: 2 May 2008

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Duke Realty quarterly Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session. Instructions will be given at that time. (Operator Instructions). As a reminder this conference is being recorded. I would now like to turn the conference over to our host, Shona Bedwell. Please go ahead.

[Shona Bedwell:]

Thank you, Roxanne. Good afternoon everyone and welcome to our quarterly conference call. Joining me today is Denny Oklak, Chairman and Chief Executive Officer; Matt Cohoat, Senior Vice President of Finance; Bob Chapman, Chief Operating Officer; and Randy Henry, Assistant Vice President of Investor Relations. Before we make our prepared remarks let me remind you that statements we make today are subject to certain risks and uncertainties that could cause actual results to differ materially from expectations. Some of those risk factors include our continued qualification of the REIT, general business and economic conditions, competition, increases in real estate construction costs, interest rates, accessibility of the debt and equity capital markets and also other risks inherent in the real estate business and for more information about those risk factors we would refer you to our 10-K we have on file with the SEC dated February 29, 2008. And now for our prepared statements, I will turn it over to Denny Oklak.

[Denny Oklak:]

Thank you, Shona. Good afternoon everyone. Thank you for joining us today. Let me begin by discussing our leasing and development activity year-to-date in our view of the state of the real estate markets. Leasing activity in the first quarter remained very solid. We leased 6.9 million square feet, which was our highest first quarter of the last three years. Renewals were particularly strong at 2.7 million square feet with a growth in net effective rents of 6.8%. Highlights of some of the major leasing activity include 127,000 square foot lease with Monsanto to take 100% of our speculative office project at Lakeside Crossing in St. Louis. This project will be completed in June and will open fully leased. We leased 75,000 square feet to Northside Hospital in our Center Point Medical office building in Atlanta. You'll recall that Center Point is an office complex we required last summer on Pill Hill in northern Atlanta with the intent to convert to a medical office complex. We leased 45,000 square feet in our 120,000 square foot Regency Creek office building in Raleigh to ABB. This building will be complete in July and we are now already 64% pre-leased. We also leased 100% of our 630,000 square foot speculative bulk industrial building at AllPoints at Anson in Indianapolis to Aamazon.com on a long term basis. I am also pleased to report that subsequent to quarter end, we signed another lease with Amazon.com for our entire 513,000 square foot speculative distribution center at our Goodyear Business Park in Phoenix. This building will be complete in the second quarter of this year. This lease alone increases our lease percentage on products we deliver in the second quarter from 23% to 35%. As you may also recall, we completed 604,000 square foot lease with Amazon at our Buckeye Logistics Center in Phoenix last summer. We are very pleased with this national relationship with Amazon now totaling over 1.7 million square feet. This is a great reflection on the continuing success of our national distribution platform. While leasing activity remains near historical highs, our in-service occupancy decreased by 3.5% during the quarter for two reasons. First, some speculative and partially pre-leased properties were placed in to service during the quarter. This cost 2% of the decrease on in-service occupancy. The largest of these projects is 1 million square foot project at Grand Lakes in Dallas, which represents just under 1% of the change. We are 100% leased at our other Grand Lakes project. Secondly, we've experienced 626,000 square foot lease expiration in a bulk building in Dallas and the bankruptcy of a retail tenant, the Bombay Company in a distribution building in Indianapolis. The expiration in Dallas was a short-term lease in our new distribution facility in south Dallas near the UP Intermodal. This is our only vacancy in the submarket, so we anticipate quickly backfilling that space. The Bombay space totaled 300,000 square feet and represented 60% of our bankruptcy square foot total. We are anticipating improvement in our occupancy during the remainder of the year as we have only 5% of our portfolio leases expiring during the remainder of 2008 and we anticipate a moderating speculative development starts for the rest of the year. Overall, we are very pleased with the continued pace of leasing activity to date. Activity continues at levels higher than we might have expected considering other issues facing the economy. As we announced last week, we started 86 million of new developments in the first quarter. This consists of five projects including two from our healthcare group. One of the healthcare projects is our first project with Baylor Healthcare Systems in Dallas. This is an 80,000 square foot administrative office building on their downtown campus, which they have pre-leased 100% for a 16 year period. We also signed 90,000 square foot office build-to-suite project at Det Norske Veritas in Houston. The only speculative project that was started during the first quarter is a bulk distribution facility in our joint venture at Rickenbacker Global Logistics Park in Columbus, Ohio. We are 100% leased in our Columbus industrial portfolio and already have great activity now at the adjacent 300 acre Norfolk Southern Intermodal facility is open and operating. These starts are in line with our reduced assumption for development starts in the $750 million to $1 billion range for all of 2008. The yield on our health rental development pipeline under construction decreased by 20 basis points to 8.84%. This decrease resulted from placing in service $173 million of properties, removing them from the development pipeline with those projects had an estimated stabilized yield of 9.51%. We added to the pipeline three projects totaling $43 million with an estimated stabilized yield of 8.3%. These include two medical offices and one industrial property, which are all significantly pre-leased. In general, yields on industrial and pre-leased development properties tend to be lowered in the speculative projects because there's less risk involved. On the disposition side, we were not able to complete the disposition of our remaining Cleveland office portfolio. Ultimately, the party we were negotiating with for several months was unable to obtain financing on acceptable terms to be able to close the transaction. They obtained a first mortgage commitment for approximately 50% of the acquisition price, but needed some additional mezzanine financing, which they were unable to secure. Our plan is to continue to operate and lease the properties for the foreseeable future until the capital markets allow for a sale at a price that is acceptable to us. We still have a property management and maintenance team in place in Cleveland and we use our other Ohio offices and local brokers to lease the properties. It is still our intent to dispose of these properties at the appropriate time, but today we cannot with any certainty provide you a time frame. We are pleased to report that we anticipate completing our industrial build-to-suit joint venture within the next few days. Terms have been agreed to and documents are being finalized. We are not at liberty to disclose the name of our partner today, but we'll provide disclosure through a press release once the documents are executed. The terms of the joint venture are in accordance with the terms we previously discussed. Those terms are ownership of 20% by Duke and 80% by our partner. There are six initial properties were identified for the venture with initial value of about $250 million. Those projects include, a two, amazon.com projects, one located at Buckeye Logistics Center in Phoenix and the other located at AllPoints at Anson in Indianapolis, two Unilever build-to-suit, one in Jacksonville and one in Dallas, a distribution facility at AllPoints Midwest in Indianapolis leased to Prime Distribution Services and a build-to-suit for Kelloggs in Columbus, Ohio. The closing on the FirstAmazon.com property is anticipated to occur in May. The closing on the remaining initial properties will occur as the projects are completed between now and year-end. The joint venture will serve in the take out vehicle for additional bulk industrial build-to-suit projects we developed during the next three years. In turn the party uses for the joint venture to ultimately own approximately $800 million of assets. The term of the venture will be 10 years. We are targeting leverage in the venture of 50% to 65% and we are currently in discussions with a lender for a secured loan on the initial properties. We will receive our standard operating fees for property management, leasing, and construction, as well as an asset management fee and a promoted interest. To provide some perspective on this venture, the final terms are fully in line with our original concept when we began marketing the venture last Summer. The pre value of the properties represents about a 25 basis point increase in cap rates over where we originally anticipated the properties to trade when we entered the leases. Our margin on the sale is within our previously stated a 10% to 15 % range. We're extremely pleased to have this venture in place to fund significant industrial development opportunities over the next three years. We're also pleased with the acquisition of two additional fully leased properties at the Port of Savannah totaling 789,000 square feet. We now own 5.2 million square feet of 100% leased distribution facilities in Savannah. We anticipate closing on another 800,000 square feet of fully occupied properties later this year. The East Coast Ports continue to post increasing container volume leading to impressive activity and opportunities. The capital markets continue to be challenging. As we previously noted, we have sufficient funding available to complete all of our projects we have under way while continuing to have ample room under our debt covenants. The completion of the industrial joint venture will provide additional funds from the initial properties as well as a funding source for future build-to-suit developments. I would also point out that we have only $385 million of debt maturities between today and the end of 2009. As you know, in the last several days, the corporate unsecured debt market has opened up some for replacements. We view this as a very positive sign for the credit markets going forward. Our FFO per share for the quarter was $0.58, a decrease of $0.04 from the first quarter of last year. The primary reason for this decrease relates to a significant level of landfill gains in the first quarter of 2007. Core operations from our rental portfolio actually increased from the first quarter of last year. In addition, we closed at only one property from our build-for-sale portfolio during the quarter. The property sold was 100% leased bulk industrial building from our Columbus joint venture. We achieved a solid 18% pre-tax margin on that sale. We remain comfortable with our guidance of $2.60 to $2.90 of FFO per share for 2008. And with that, we'll open it up for questions.

[Operator:]

(Operator Instructions) Our first question comes from Lou Taylor with Deutsche Bank. Please go ahead.

[Lou Taylor:]

Thanks, Denny. Denny, can you just talk about the timing of the properties going in to the JV? Does it look like they will go in when their venture funds and whatever is done will go in and then rest upon completion or is it going to be a different schedule?

[Denny Oklak:]

That's correct, Lou. Once the venture closes, as I said which we anticipate in the next few days, some time shortly after that, the first property will go in. There's only one of the properties of the six properties that are completed today, and that's the Amazon property out in Buckeye Logistic Center in Phoenix and that will be funded and go in to the venture. The rest of the five properties finish mostly in the fourth quarter this year, I think may be some late third quarter and fourth quarter and then upon completion of those properties, certificate of occupancy, they will go in to the venture.

[Lou Taylor:]

Great. Thank you.

[Denny Oklak:]

Thanks, Lou.

[Operator:]

Your next question comes from Michael Knott with Green Street Advisors. Please go ahead.

[Michael Knott:]

Hi, Denny. I didn't hear you address the office portfolio and I thought, I heard you say renewals were strong but it looked like in the office portfolio, renewals were actually weaker than they have been for some time. Can you just talk about that?

[Denny Oklak:]

The office portfolio is -- there was a little bit of an occupancy decline in the quarter, but I think it really stayed pretty solid. I did mention, Michael, the very significant activity we've had on the office side in the speculative lease-ups, particularly the Monsanto lease in St. Louis which was really a great lease, also in the 45,000 square feet in our Regency Creek office building in Raleigh. So there's good activity on the office side. We're very pleased. There wasn't really any significant expirations on the office side that I'm aware of.

[Michael Knott:]

That renewal rate doesn't cause you any concern, 55% renewal?

[Denny Oklak:]

No, not really. I think that's, I wouldn't say that's a long term trend, Michael.

[Matt Cohoat:]

And Michael, this is Matt. There was a couple of lease expirations, one in Chicago, that was anticipated. We knew that it was coming and they did not renew, but it was not across-the-board and one lease buyout as well, so that overall it was not across-the-board.

[Michael Knott:]

Thanks.

[Operator:]

Our next question is from Sloan Bohlen with Goldman Sachs. Please go ahead.

[Sloan Bohlen:]

Good afternoon, guys. Quick question, just on the properties that are brought in to service, partially leased, can you give us a sense of what the gap between the initial yields and what your stabilized yields are? And then, as a follow-up, just have you adjusted what your lease-up period for those are?

[Denny Oklak:]

Well, clearly, it just depends on how much pre-leasing we have in those properties. You can see in our under development pipeline those are estimated stabilized yields, so if a project comes in service 50% leased then it's about 50% of that. We're not, we really haven't significantly changed our lease-up period expectations. For the most part, we have been on projections, may be slightly behind but when you look at most of the projects, we're in good shape as far as our leasing estimated period going forward. So we haven't really lengthened those.

[Matt Cohoat:]

And Sloan?

[Sloan Bohlen:]

Yeah.

[Matt Cohoat:]

Just a couple other points to add to that is that after the lease that Denny mentioned in our undeveloped pipeline to Amazon in Phoenix, where actually every quarter we have coming in to service in the future is above our budget or our projections at this point in time in leasing So we've been beating our expectations and in addition to that, I'm sorry, I lost my thought there. I think the main thing was the leasing is ahead of the projections.

[Sloan Bohlen:]

Right. Well, thank you. That's helpful.

[Operator:]

Our next question is from Jamie Feldman with UBS. Please go ahead.

[Jamie Feldman:]

Great. Thank you very much. So, Denny, I thought you said you kept your development start guidance for '08 or $750 million to $1 billion. Can you talk a little bit about may be the mix? Has that changed at all? And then can you also address, we have some pretty cautious commentary already on the North American industrial market from some of your peers this quarter. So, where are you seeing weakness, where are you seeing strength, if you can address that also for the office portfolio?

[Denny Oklak:]

Sure. I would say just going back to the second question, we really haven't seen that much change quite honestly in our industrial activity. As I mentioned, when you look at the significant leases we did with both Amazon in two places and other leasing activity, the industrial remains a little solid. We've seen a little bit of weakness in actually a couple of the major cities like Chicago has been a little bit of weakness and Atlanta has been a little bit slow, but the rest of the market seemed to be holding on pretty well. Bob, do you have any other comments on the level of activity on bulk?

[Bob Chapman:]

Well, I'd say yeah, I'd add to that list Dallas. Chicago is the bigger market. Chicago, Atlanta, and Dallas seem slower than the smaller markets, and particularly with retail related users. On the good news side, the port markets were in like Savannah, in Houston and we consider Columbus to be a port market because of the Heartland Express, are very strong particularly on the export side. So, those are my comments.

[Denny Oklak:]

And Jamie, go back to the first part of your question again?

[Jamie Feldman:]

Just have you changed at all the mix of your development starts?

[Denny Oklak:]

Oh, yes, sorry.

[Jamie Feldman:]

I'm just curious if may be you're doing more healthcare because of the environment?

[Denny Oklak:]

Yeah, I think clearly when you look at the starts this year, we're anticipating probably 40% to 45% of those starts will be in the healthcare area, got a lot of opportunities there that we're pursuing and they are in various stages of being completed. Again, I think with the remaining, it will be made up of probably a little bit more industrial and then some build-to-suit office opportunities. I think we've got some very solid build-to-suit office projects that we're in the market with. Again, as I mentioned, I don't think you'll see a very significant speculative activity as far as start this year, unless something in the economy changes and we feel better about things heading in to '09.

[Bob Chapman:]

We have a very strong pipeline of build-to-suit activity in all three product sectors, healthcare, industrial, and office.

[Jamie Feldman:]

It went like a dollar amount of that pipeline?

[Bob Chapman:]

No, I'd just say a lot, a significant share of that projected development starts will be filled with build-to-suits.

[Jamie Feldman:]

All right, thank you.

[Operator:]

Our next question is from Chris Haley with Wachovia. Please go ahead.

[Chris Haley:]

Good afternoon. Denny and Matt, I look at the first quarter leasing activity and then take in to account the amount of expirations you have left for your office retail and industrial, and then look at what your goals have been regarding occupancy and estimate at the pace of aggregate leasing volume that would be required for the 2008 calendar year would approximate the pace of 2006 and may be only 10 to 15% below that of 2007. And given the economic climate, which has certainly slowed and what we're seeing in your numbers regarding slightly higher tenant bankruptcies defaults, what we're hearing elsewhere in terms of decisions being delayed. Could you give us some color on the levels of confidence you have in terms of obtaining your occupancy levels and therefore your original guidance levels from an operational perspective?

[Denny Oklak:]

Sure, Chris. When I look at it, we really focus on the stabilized in-service properties, because that's once the properties are in-service and we get them leased and they start generating revenue for us. We have been running for the last number of quarters, right around the 95% level. We had a little drop in that down to about 93%, a little under 93% this quarter. And that's what we're focused on getting back up in to that 95% range. So by my calculations, that's only 2.3 million, 2.4 million square feet of net absorption in that portfolio. And so we feel very good about being able to have that level of leasing and stabilized portfolio. As I mentioned, I'd say two key transactions in that portfolio this quarter. One was that this expiration in Dallas down by the UP Intermodal and I can give you some color on that the one.

[Chris Haley:]

That was only one year lease, so you knew that though?

[Denny Oklak:]

Yes, we knew that. Actually, we thought they were going to renew. This is with P&G lift the whole building and then they didn't, because they had some issues with the product hat they were trying to store in that facility. So, they didn't renew, and then the other one was a 300,000 square foot Bombay bankruptcy here in Indianapolis, we've already got very good activity on backfilling that space out in Plainfield. And, we've looked through it. You never know, Chris, but I would say that we're not anticipating any other significant bankruptcies right now, and we are on our watch list, looks pretty solid. Again, you never know, but we're pretty confident in the quality of the tenants.

[Matt Cohoat:]

Yes, Chris, This is Matt. As Denny mentioned, with the defaults, the number of tenants that default is really right in line with what we saw last year which was the lowest that we had seen in probably four or five years. And the square footage from Bombay, when you take that out, we're really right in line with the square footage as well. So, we're not seeing anything, our agings are in good position as they've been in probably 18 months. So overall, we don't have a lot of concerns in that lease expirations on a square footage basis, what we had coming in to this year over half of them were in the first quarter. So it's just an inordinate amount of activity that we had for renewal in the first quarter, but with only 5% for the rest of the year, we're feeling pretty good.

[Chris Haley:]

Got it, now the guidance was predicated upon a combination of the stabilized in-service, plus the development assets that were moved in to in-service portfolio and a combined occupancy target was 90 to 92 of those for the 2008 guidance.

[Denny Oklak:]

Right. And if you get up to 95 on the in-service and you would only need about another 3 million square feet in that underdevelopment pipeline. I think you get it to those numbers. And again, I understand everybody is being cautious and we are too, Chris, but as I said, this was the highest first quarter leasing activity we've had in the last three years and April I think has been a very solid month with clearly with the Amazon lease that we signed was 500,000 and actually moved our second quarter occupancy number for the items to be placed in-service in the second quarter by 12%.

[Chris Haley:]

Thank you.

[Denny Oklak:]

Thanks, Chris.

[Operator:]

Our next question is from Michael Bilerman with Citi. Please go ahead.

[Michael Bilerman:]

Hi, good afternoon. Iain Griffin is on in front me as well. Denny you spoke in your opening comments that in the industrial take out fund that you will announce shortly. That cap rates are only up about 25% and that your margin would be between 10 and 15. You had talked I guess 1.5 year ago when you start talking about setting up a take out fund, it would be tax efficient, in order to selling them in to a fund. Is your 10 to 15% that you're quoting a pretax or an effective that you're going to not have leakage?

[Denny Oklak:]

Michael, first of all, the 25 basis point change, not 25%, so I just want to make sure everybody understood that. This is tax efficient that our 10% to 15% range really represents both the pretax and after tax, because we're doing this in the nontaxable or tax deferred transaction, if you will.

[Michael Bilerman:]

And next, Iain can have one question at the same time?

[Denny Oklak:]

Okay.

[Iain Griffin:]

Thank you. I just had a question on the build for sale pipeline. As for the last couple of years going in yields have compressed, I would imagine so has the implied profit margin on exit and with that being the case and the pipeline being very highly leased. I was wondering how you weigh the need to sell the assets to reduce your leverage versus potentially holding on to them for longer, getting the accretion in your NOI and waiting for a better transaction environment to liquidate?

[Denny Oklak:]

Well, Iain, on a lot of those projects, we are not seeing all that significant of cap rate change, if you will, because these are all new projects, mostly fully leased. And for example, in that pipeline that we have, which includes underdevelopment and completed projects, which is a little over $1 billion, $220 million or some of that is industrial joint venture that Michael just asked about with the 25 basis point movement, but we are constantly monitoring this portfolio. There's some that we knew we weren't going to sell right upon completion, but there was some lease up required in those projects. So, we knew that some of those wouldn't be sold even until '09, there's a couple in there. So, we haven't really had to pull any of those projects, because we didn't get pricing that we didn't like. There's one I would say may be that you could say it's pulled a little bit. We have a fully leased building at DFW Airport. And it's on the airport ground, it’s a 40 year ground lease. And so, we've had a little bit of pushback on the ground lease, but it's just a matter of finding the right person that's comfortable with that 40 year ground lease and we're pretty certain we'll find that, but other than that everything has moved pretty much according to plans.

[Operator:]

Our next question is from Mitch Germain with Banc of America. Please go ahead. Mitch Germain - Banc of America Denny, just remind me, how should we be looking at the development for sale and which assets will be targeted for the fund?

[Denny Oklak:]

Well, let me answer the second one and then I will comeback because I'm not sure I understood the first part of that quarter.

[Mitch Germain:]

Well, I'm just trying to figure out in going forward, is it the intent that just the build-to-suit or is it going to be pretty much everything that's developed going to be….

[Denny Oklak:]

Got you, I'm so sorry. Yes, the way that the provisions of the venture are is that any build-to-suit that we do for a tenant that takes the entire building is over 200,000 square feet on the industrial side, has a lease term of seven years or longer, basically, is presented to the partner to accept in to the joint venture. There's some provisions in there where over the whole term of the joint venture that they can reject a couple and it won't affected for whatever reason. And we have the same provision that we can keep a couple or not present those to them, but for the most part it's going to be any industrial build-to-suit that we do. It doesn't apply to the spec development that we may be fill with a single tenant, although, it also doesn't preclude us from offering those type of projects to the joint venture. The one thing we really wanted to get out of this venture was when we're chased in these build-to-suits a little bit better upfront pricing certainty in this market. So, our plan is as we're pursuing these we're going to be in very close contact with our partner on pricing and terms, as we're completing the transaction. So we'll be in sync there.

[Mitch Germain:]

Great, it's very helpful, thanks.

[Operator:]

Our next question is from David Fick with Stifel Nicolaus. Please go ahead.

[David Fick:]

Good afternoon, gentlemen. Your for-sale portfolio shows an 8.3% stabilized yield. Where do you think weighted average sale of those assets is going to price on a cap rate perspective?

[Denny Oklak:]

Weighted average, I don't have a calculation of that in front of me, but I would tell you, David, I think you can back in to this by again saying, we're very comfortable with that 10% to 15% margin on sale. So, I think that's may be 100 basis points, somewhere to 75 to 100 basis points spread.

[David Fick:]

And would you looking forward think that that is an adequate risk spread given the current environment for new projects?

[Denny Oklak:]

Right now, we want to be in today's risk environment if we're doing a build-to-suit for sale we're generally looking at 15% to 20% is the margin we want to anticipate going in. yes, you can't change the pipeline you have in process overnight, as the world changes. We've done very well on the margins on that business over the last few years and have always said, we thought the margins long term in that business we're somewhere in the 15% range, give or take a couple percent. Our sense is that in today's market, those margins have comeback to that level up from significantly higher than that previously.

[David Fick:]

Okay, and my follow-up is that where are you on your CFO search today in terms of timing, when do you expect to have an announcement?

[Denny Oklak:]

Well, we have a search firm engaged and I've met with them and they have several initial candidates that we're going to talk to here in the next few weeks. And again, we've just said that that's probably something that's our original anticipation would be that's probably a third quarter slot that would be filled, but things are progressing.

[Operator:]

Our next question is from Lou Taylor with Deutsche Bank. Please go ahead.

[Lou Taylor:]

Thanks, Denny, with four months behind you for the year. Can you just may be touch on what's the scenario where you see yourself at the low end of guidance and what gets you to the high end?

[Denny Oklak:]

Sure. I think the low end of the guidance would probably be, we aren't able to close as many land sales as we originally anticipated, although we've got some good activity there. Our lease buyouts that we projected for the year, that's something, Lou, that we've never been able to exactly predict. We just look at history to try to estimate that each year. We had a fairly large one in the first quarter which is something that we knew was coming from last year but there's still some risk in the lease buyouts but, again, I think that we're probably pretty close on that number. Chris Haley was talking about the occupancy and we need to hit those numbers to make sure that we're well within the middle of the range and again with the activity we've got, right now, we feel good about it. On the upside, I think hitting a few more build-to-suit developments, potentially accelerating the disposition of some of our held-for-sale properties, if we hit on some leasing and are able to sell a couple more of those late this year that we didn't anticipate, that we were sort of counting on as '09 transactions, could accelerate it. Again, if we exceed our land sales with a couple of big transactions, we could be towards the top end of that range.

[Lou Taylor:]

Great. Thank you.

[Operator:]

Our next question is from Chris Haley with Wachovia. Please go ahead.

[Chris Haley:]

Speak of the devil. I wanted to ask a question about the Fund. Are there any gains that you're forecasting as part of this Fund in your guidance?

[Denny Oklak:]

Yeah. The gain on the sale if you will, of 80% of the asset in to the joint venture will be a gain that we recognize as part of our held for sale portfolio. Obviously, we didn't recognize any gain on the 20% we retained. A couple of those properties are in joint ventures. So we don't recognize the full amount of the gain. But the gains in those are included in our guidance.

[Chris Haley:]

And I'm sorry, Denny, for asking if this was before the magnitude or the size and recognizing this is kind of a first step. I recall some earlier discussion may be prior discussion, $750 million?

[Denny Oklak:]

Yeah, that's the range. $700 million to $800 million is what both parties would like this to be.

[Chris Haley:]

Yeah.

[Denny Oklak:]

Again, over the next three years, obviously clearly that will be based on the level of activity that we have in that area, but as Bob said, we're seeing a lot of good build-to-suit activity.

[Chris Haley:]

Okay, great. And any comment on the service operations for the first quarter and the rest of the year?

[Denny Oklak:]

Another third party construction is holding up fairly well. You can see in our value creation pipeline that we've got some really nice fee margins on that third party business. We have now in our pipeline, I think it's over 18% on average on that now. And there's continued third party opportunities that we're chasing at pretty good margins, so I think that will hold up fine.

[Matt Cohoat:]

I think if you look in the supplemental, you really see that the service operations are continuing to be pretty steady on a net basis. On the GAAP income statement, just to point out that there is one of the properties that we sold in our held for sale portfolio was out of a joint venture and so on the GAAP income statement, that gain is up in the equity and earnings line but we pull that out in our FFO component schedule so you can really see the service operations and the gain on property sales.

[Operator:]

Our next question is from Paul Adornato with BMO Capital Markets. Please go ahead.

[Paul Adornato:]

Yes and thanks. Good afternoon. I read about some headcount reductions in the Chicago office. I was wondering if you could comment on staffing levels in that office and in the Company, overall?

[Denny Oklak:]

Sure, Paul. We did have some staffing reductions in the first quarter this year. We just made the decision looking at the volume that we anticipate for the rest of this year at least and then hopefully the volume we anticipate we can maintain going in to 2009 that there was, that we needed to reduce our staff a little bit, that it was fully appropriate to really right size to the business that we have. The total adjustments that we made to the Company were about 45 people out of about 1350 people across the Company, and our plan is for that to be, to get us through this year and '09.

[Paul Adornato:]

Any comment on the functional areas that were reduced?

[Denny Oklak:]

I'm just trying to think.

[Matt Cohoat:]

It was really a pretty much across all disciplines both back office and various areas, various field office levels but there was no concentration. It was spread across all of the disciplines.

[Paul Adornato:]

Okay, thank you.

[Operator:]

Our next question is from [Derek Bower] with Merrill Lynch.

[Chris Pike:]

Hi, guys, it's Chris. Hi, Den.

[Denny Oklak:]

Hi, Chris.

[Chris Pike:]

You talked about the Cleveland assets and you even threw in there the fact that may be you will wait until a point where you can obtain the pricing that you think is appropriate? Can you talk about the implied delta between what you believe the lenders were able to or willing to provide proceeds for and what you think the assets are worth? Or was it a situation where the lender just didn't provide any funding?

[Denny Oklak:]

Going back, I'll give you what I know about it. As I mentioned in the prepared remarks, they had a first mortgage loan of about 50% loan-to-value which I would tell you is relatively typical today. That on secured debt you're probably in the 50, may be depending on the assets upto 60% leverage. And in this situation, unfortunately, again when we were initially discussing this last Fall, their first quote was for more like a 80% loan and then just as the Fall got worse the lenders backed that down to about 50%. So they went in to the transaction originally with 20 to 25% equity and then they only ended up with a 50% first mortgage loan so they needed to clear the gap and save 20% to 25% roughly and they were willing to do that with some mezzanine financing but they just could not find the mezzanine at what terms they thought were acceptable and so finally, I think the equity sources just said, okay, we're going to back off on this one for now.

[Matt Cohoat:]

Yeah. And just to be clear that the loan-to-value was on our purchase, on the sale price that we were comfortable with.

[Denny Oklak:]

Yeah.

[Matt Cohoat:]

So it wasn't a valuation issue. It was a funding issue.

[Chris Pike:]

I don't know if you'd be privy to this but where do you think coverage came in, debt service coverage came in when it was 80% LPVs down to 50? Where do you think coverage moved?

[Denny Oklak:]

We really weren't privy to all their interest rates and their carries.

[Matt Cohoat:]

Yeah

[Denny Oklak:]

So, we don't really know that.

[Chris Pike:]

Okay. And then just to be …

[Operator:]

The next question is from Michael Bilerman with Citi. Please go ahead.

[Michael Bilerman:]

I feel bad now, Chris got cut off. Going back to actually on the Cleveland, did you think about providing the mezz piece?

[Denny Oklak:]

Michael, did you get cut off?

[Michael Bilerman:]

No, Chris got cut off.

[Denny Oklak:]

I'm kidding, I'm kidding.

[Michael Bilerman:]

Okay.

[Denny Oklak:]

We thought about it a little bit and we had some preliminary discussions with them, but it was clear that what would have been acceptable to us on that wasn't going to be acceptable to them so they didn't go very far.

[Michael Bilerman:]

Right. And then can you just review for us -- you talked on Lou's question about what would take at the high and low end. Can you actually review just laying out the guidance assumptions for these more volatile income streams for development gains and land sales, lease term fees, and G&A, just so that we're clear as to what baked in to your numbers and what you're expecting?

[Matt Cohoat:]

Michael? This is Matt. I'll do that. On the lease buyouts, our guidance is $17 million to $22 million. On the gain on held for sale properties, it's $50 million to $60 million and that's net of tax and that was our initial guidance on that one and we've reduced that by about 10%.

[Denny Oklak:]

10% to 15%.

[Matt Cohoat:]

And then the gain on land sales was of $15 million to $30 million and G&A of $34 million to $39 million.

[Michael Bilerman:]

Okay, and now I know you guys don't give quarterly guidance and given the large numbers on a yearly basis and now that you have the Fund, sort of targeted, you at least have some sense getting in to the second quarter where things may shake out?

[Denny Oklak:]

Well, again, we have provided quarterly guidance in the previous years, Michael. The reason we didn't do it this year is because we just weren't comfortable with the timing of the closing of transactions and I would say that's still the case. I wouldn't, we are not providing guidance for the second quarter and I would say the same issue sort of precludes us from even giving you a sense. It's just what's going to close when and it's just too hard to tell this year.

[Operator:]

Our next question is from David Fick with Stifel Nicolaus. Please go ahead.

[David Fick:]

Good afternoon and again your debt maturities look favorable through 2009 and I know this is pretty far out, but you are close to $2 billion maturing in the following two years, 2010 and 2011, average cost of 4.5%. How are you thinking about that part of your capitalization going forward?

[Matt Cohoat:]

I'll let Denny chime in, but just to give a couple of specifics. The biggest piece in that 2010, 2011 is our revolver is in 2010 and there's over $600 million outstanding in these numbers. So, that's one of the items that will, it's a four year revolver with some extension options, so we'll be looking at that as we get closer to 2010 for a renewal and then it's really going to be in part based upon where the convertible debt markets are and to determine whether or not we would replace the convertible debt that we have with convertible or use some other vehicles when we get to 2011 which is when we have $575 million maturing at that time. It was at a coupon of 375.

[Denny Oklak:]

Yeah. So, David, I'd say we're already considering our alternatives for that. I can't give you anything specific today, but that's something clearly just like with you, it's clearly on our radar screen.

[Operator:]

And our next question is from Chris Haley with Wachovia. Please go ahead.

[Chris Haley:]

Well that just ruins all that. I got cut off?

[Denny Oklak:]

Well, we haven't cut you off yet. We let you back in.

[Chris Haley:]

Well, that's very kind of you. I really appreciate it. And related to the converts, have you thought about buying back some of those converts and including the gains in your results? You don't have that in your guidance, do you?

[Denny Oklak:]

No. We're much more focused on liquidity and funding our development pipeline which we're in really good shape with that through with well in to 2009.

[Chris Haley:]

Okay, and on the -- when you guys provided your two or three year outlook, could you give us a sense as to how the Fund contributions may have helped the 2008, 2009, 2010 numbers? Was it a ratable contribution of developments or was it front end loaded in terms of the gains that would go in that would be recognized as part of this in that three year outlook? It was all '08, was it evenly spread between 2008 and 2009, or was it evenly spread through the three years?

[Denny Oklak:]

Well, I would say it was more evenly spread. Again, that's when you look at it if we've got $250 million going in and we've got $750 million total, we got $500 million that our assumption would be over a three year period, we would do that sort of ratably in '09 and 2010. And, when you think about it the first 250 was really, those have all been done in the last year, basically, so what our pipeline has been was about $250 million of those a year. We've been able to find and identify, in land.

[Operator:]

And our next question is from [Derek Bower] from Merrill Lynch which will be our last question. Please go ahead sir.

[Derek Bower:]

Hi, guys. No need to cut me off because we have the successful [man] this year. I think you're still bitter about that. But you got to get over it. Hey Denny, just to be clear on the 20 basis point reduction in terms of the development pipeline, the for sale development pipeline, that's all a function of mix, in other words, out with the old and with the new versus any kind of cost overruns or construction delays, softer leasing or anymore systemic issues within the pipeline? It's just a mix issue?

[Denny Oklak:]

That's correct.

[Derek Bower:]

Okay. Thanks a lot.

[Denny Oklak:]

Thanks.

[Operator:]

There are no further questions. If you'd like to conclude?

[Shona Bedwell:]

We want to thank you for joining our call today. Our first quarter call is tentatively scheduled for July 31, at the same time, 3

[Operator:]

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.