Duke Realty Corporation
Q1 2013 Earnings Call Transcript

Published: 26 Apr 2013

[Operator:]

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Duke Realty First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later there will be an opportunity for questions and answers with instructions given at that time. (Operator Instructions) As a reminder, today’s conference call is being recorded. I would now like to turn the conference over to your host, Ron Hubbard. Please go ahead.

[Ron Hubbard:]

Thank you, Allan. Good afternoon, everyone, and welcome to our first quarter earnings call. Joining me today are, Denny Oklak, Chairman and CEO; Christie Kelly, Executive Vice President and CFO; and Mark Denien, Chief Accounting Officer. 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. For more information about those risk factors, we would refer you to our December 31, 2012 10-K that we have on file with the SEC. Now for our prepared statement, I’ll turn it over to Denny Oklak.

[Denny Oklak:]

Thank you, Ron. Good afternoon, everyone. Today I will highlight some of our key accomplishments during the first quarter in both our operational and asset strategies. Christie will then address our first quarter financial performance and the progress on our capital strategy. We followed up the positive momentum from 2012 and are off to a great start for 2013 on all fronts. We signed 6.3 million square feet of leases in the first quarter and finished the first quarter at a 91.8% overall occupancy rate which includes projects under development. We started $139 million of new development projects comprised of $40 million of bulk industrial, $59 million of medical office and $40 million suburban office project. Six of our seven new development starts are 100% a pre-leased while one project is a speculative start on our land in Houston which has strong fundamentals. I’ll touch on the developments in a little more detail shortly. We continue to make progress on our asset repositioning strategy during the quarter with $223 million of proceeds generated from dispositions of primarily suburban office property as well as $30 million of acquisitions. On the capital front, we’ve raised over $820 million of equity and debt that was used for deleveraging and prefunding our May debt maturities. The redemption of the $170 million, 8.375% preferred O shares together with the $250 million unsecured debt offering issued in an effective interest rate of 3.72% will save the company nearly $22 million in annual interest and dividend cost on an ongoing basis. Christie will speak more in depth on our capital activities in a moment. From a macroeconomic perspective, the economy appears on track for another slow year of economic growth with current GDP expectations between 2% and 3% range. Even with modest growth, the demand drivers in the industrial sector remains solid with first quarter net absorption of 32 million square feet on a national basis following up on the fourth quarter of 2012 at 55 million square feet which was the highest quarter in five years. This positive activity continues across most major distribution markets with nearly 80% of the top markets recording vacancy drops the most widespread improvement in a decade. The Class A national vacancy is now in the 9% range. The tightening of key industrial market fundamentals together with trends in e-commerce and supply chain modernization should go very well for value creation opportunities from our strategic land bank, and best in class development platform. The healthcare industry trends that are driving strong demand for new modern design outpatient space remained very strong. Our team continues to be selected as one of the premier new facility providers to leading health systems across the country with a steady pipeline of deals. The suburban office sector continues to be sluggish in most markets though there are pockets where absorption is improving. The office market fundamental still favored the tenant in TIs and concession remains above the long term averages. Even so, the availability of debt at historically low rates has increased investor appetite for suburban office transaction which gives us optimism in executing our office disposition plans for this year. Turning to operations, we had a solid quarter of leasing at 6.3 million square feet. We ended the quarter with overall occupancy at 91.8%. Occupancy dropped approximately 60 basis points from the end of the year, and a couple of factors led to this decrease. First, the sale of Captrust Tower and Chambers Street portfolio which we discussed in January and disclosed in the presentation we posted on our website in March were approximately 98% occupied on combined basis. Second, we had a few larger industrial leases expire right at the end of the quarter as anticipated in our annual average in service occupancy guidance. Activity remains strong and we anticipate occupancy to head back up in the second quarter. These larger explorations also abnormally push down our tenant retention for the quarter to 49%. However, I’m pleased to note that few of these vacancies created by the expiring leases were immediately backfilled and pipeline of prospects for the remaining vacant spaces is strong. Specifically two large explorations total 1.2 million square feet yet two new leases were signed with different tenants who immediately backfill approximately 901,000 square feet of that space. Rental rate growth and renewals continue to be positive in most markets at a little under 2% overall across the portfolio with the trend line from last year continuing to move upward. With respect to same property performance, we achieved positive same property NOI growth for the 12 months and three months ended March 31 of 2.4% and 2.6% respectively. We expect the pace of same property growth moderate over the next few quarters given the expected slower pace of occupancy gains and modest rental rate growth that’s anticipated. Now let me touch on some of the key activity with any of these product types for the quarter. With respect to leasing in our industrial portfolio we do continue to see fundamentals improved with the completion of nearly 3.1 million square feet of new industrial leases and about 2 million square feet of renewal leases. Both industrial in-service occupancy at the end of the quarter dipped to 93.6% roughly 90 basis points below the previous quarter and at a steady level compare to a year ago. As noted we have some larger anticipated lease expirations in our industrial portfolio, but strong leasing backfill the number of those. Some of our larger lease deals include a 7,400 square foot expansion in renewal lease across two facilities for Netrada in Cincinnati; a 437,000 square foot lease with a major retailer in Groveport Commerce Center in Columbus and a 500,000 square foot lease with Home Depot in Savannah. In the medical office portfolio, we had a solid quarter with nearly 250,000 square feet of new and renewal leases signed. The office leasing environment continues to be challenging across most markets but we did have a solid quarter of leasing with nearly 1.1 million square feet of new and renewal leases signed. In our Sam Houston Crossing speculative office project in Houston we have now signed two leases, which bring the lease percentage to 91% for this project that will open later this year. We had $223 million of dispositions during the quarter. Most of the proceeds came from the sale of our interest in two suburban office joint ventures which we mentioned in January. We also sold a couple of non-strategic medical facilities in a small flex portfolio. Our only acquisitions during the quarter were medical office building in Tampa which we bought from an existing customer and our partner’s 50% interest in a fully leased industrial building in Indianapolis. Yesterday, we announced two significant and strategically important transactions that are now under contract for. First, we’re selling our Pembroke Gardens Retail Center in South Florida in accordance with our strategy to dispose of our remaining retail assets. This project is in a great location, on Interstate 75 in West Broward County and has performed extremely well. Interest in this center was high and the sales price will be $188 million or $480 per square foot. This sale will result in a significant gain that we reported in the second quarter and we expect the sale to close next week. The second transaction we announced is the acquisition of the bulk industrial portfolio from affiliates of USA Real Estate which has recently been reported by others outside of Duke Realty. This $311 million acquisition include eight modern bulk industrial facilities over 4.8 million square feet in key distribution markets including California, Eastern Pennsylvania and Houston. The portfolio is 100% leased to major retail tenants such as Home Depot, Kimberly-Clark and Jo-Ann stores. We expect this transaction to close in May. These two transactions will put us even closer to our asset allocation goal of 60% bulk industrial, 25% suburban office and 15% medical office. We will report cap rate ranges on these transactions in our second quarter numbers but let me say that in-place cap rate on our retail sale is over 100 basis points lower than the yield we’ll receive on our industrial acquisition so this is a great trade for us. We also had an excellent quarter on new development starts, the starts include seven projects again with an estimated total project of about $140 million. We started a 680,000 square foot build-to-suit bulk industrial facility in Nashville on our Park 100 plan or Park 840 land – excuse me. The facility will be 100% leased to Starbucks for seven-and-half years. We also started a 240,000 square foot spec industrial development in Houston on our Point North land which is located in the airport submarket where vacancy is in the 5% range. We also began a 200,000 square foot office built-to-suit in Dallas, also in our land at Duke Bridges Corporate Park. The project is 100% preleased to a healthcare services firm for a term of 16 years. Finally, we started to develop four build-to-suit, 100% preleased medical facilities during the quarter. Three of the facilities are with affiliates of Baylor Health Care, totaling 113,000 square feet with lease terms of 15 years. I’m proud to say that we’ve now engaged in 10 development deals with Baylor Health Care since 2009. The final healthcare development was a 35,000 square foot project in Waco Texas with Scott & White Healthcare. This is our fourth development project with Scott & White. Overall, our first quarter development starts with 81% preleased and are projected to have a stabilized yield of 8.0%. We’re extremely pleased with the new development business generated year-to-date, again our best-in-class development platform. Our total development pipeline as of March 31 now stands at 5.1 million square feet, totaling $621 million of stabilized cost. We are projecting a weighted average yield over the initial lease term of 8.2% on these projects. The development pipeline and strategic land bank are key growth driver for Duke Realty and we’re optimistic about being able to execute on additional build-to-suit and select respective development opportunities. I’ll now turn the call over to Christie, to discuss our financial results and capital plans.

[Christie Kelly:]

Thanks Denny. And good afternoon everyone. As Denny mentioned, I would like to provide an update on our first quarter financial performance as well as the progress on our capital strategy. Our first quarter Core FFO was $0.26 per share compared to $0.27 per share for the fourth quarter of 2012. The slightly lower Core FFO was a result of temporary dilution due to not being immediately able to utilize the proceeds from our previously discussed 41.4 million share equity offering executed in early January. Core FFO for the first quarter of 2013 in comparison to 2012 of $0.24 represents an 8.3% positive year-over-year growth rate that was primarily attributable to improved occupancy and same-property performance, as well as due to lower preferred dividends. We generated $0.23 per share in AFFO in the first quarter of 2013, which translates to a payout ratio of less than 74% compared to $0.21 per share in AFFO for the fourth quarter of 2012. Taking a look at AFFO for the first quarter of 2013 in comparison to $0.20 from the first quarter of 2012 represents a 15% positive year-over-year growth rate. Again, that was primarily attributable to improved occupancy and same-property performance, as well as due to lower preferred dividends. As Denny mentioned, our leasing volume for the quarter was strong. And in summary, our operating results for the quarter were outstanding and we look forward to continued solid results throughout the rest of the year. Turning to the capital side of our business, we executed significant transactions during the quarter, to build our track record of generating low cost capital from multiple sources. As we discussed last January, we generated $572 million in proceeds from our $41.4 million share following equity offering. We used a portion of these proceeds to redeem our 8.375% Series M preferred shares, which we would use our dividend commitments by nearly $15 million annually, on an ongoing basis. We enjoyed a successful quarter, in terms of generating capital from asset dispositions, receiving $223 million in proceeds from asset sales. In order to pre fund our May unsecured debt maturity, we opportunistically capped the unsecured market in mid March. We issued $250 million of tenured bond and an effective interest rate of 3.72%, a record low rate for Duke Realty. After being used to refinance a portion of our May maturities, this lower rate offering will save us nearly $7 million annually on an ongoing basis. As a result of our capital raising activities, we ended the first quarter with $307 million in cash which when coupled with an unsecured term loan, we will close at the beginning of May, will leave us with more than sufficient liquidity for the repayment of our $425 million of unsecured debt due this mid May. Additionally, the post quarter activity that Denny mentioned represented by the expected USAA acquisition and Pembroke disposition, is an excellent example of us funding acquisitions with dispositions accretive. I will conclude by saying that I’m extremely pleased with the results for the quarter and we will continue to execute on all aspects of our strategy. And with that, I’ll turn it back over Dennis.

[Denny Oklak:]

Thank you, Christie. Yesterday, we also reaffirmed our guidance of FFO for 2013 of $1.03 to $1.11 per share. In closing, after a solid quarter, we believe our value creation story is gaining momentum as our operations continue to show strong occupancy and modest rent growth. Our capital raising continues to be highly efficient and consistent with our delever leveraging plans. Our asset repositioning is in the process of taking another big leap with the first quarter close dispositions and the pending Pembroke in U.S.A. transactions, which we believe are very accretive to our net asset value. Finally, the development platform engine and strategic land bank are also very well positioned to take advantage of solid growth opportunities for 2013 and beyond. Thank you again for your support of Duke Realty and now we will open it up for questions.

[Operator:]

Thank you. (Operator Instructions) We’ll first go to the line of Brendan Maiorana. Please go ahead.

[Brendan Maiorana:]

Thanks. Good afternoon. Dennis, you guys on the development pipeline, the yields seem like they’re getting better, at the same time you sort of look at the overall environment and cap rates are coming down. It seems like they’re would be more likely to be pressure on development yields as opposed to development yields moving up. So, are there something specific that’s going on with the development or are there any improvement dollars that are getting amortized that are driving yields up? Or you’re just getting better economics?

[Denny Oklak:]

Generally, I think we are getting better economics right now and it’s really it doesn’t have anything to do with the amortization when you look at those projects that we talked about this quarter for sure and I would say it’s a couple of things going on. One, obviously about 50% roughly, 45%, 50% of our starts this quarter were in the healthcare area. Again a very significantly driven business, driven on relationships and so we have great relationships as I mentioned with Baylor and Scott & White. So clearly I think that our development yields are pretty competitive but it’s also relationship driven and I think that was part of it. When you look at the build-to-suit opportunities we have on the office side yields are little higher because we’re deploying our land and I would say the same with the industrial build-to-suits that we’re accomplishing today. So I think that’s another key driver as the very good basis that we have in a lot of our lands. So suffice to say I agree with your comments Brendan and I think we’re creating a lot of value through that development pipeline right now.

[Brendan Maiorana:]

Okay. And then the occupancy drop in the quarter I guess just listening to your comments it sounds like that happened at the end of the quarter. So I guess there probably wasn’t an impact if I’m taking about that correctly there probably wasn’t an impact on NOI in the quarter. But as we look out over the next few quarters for the year, how do you think occupancy trends? Because I guess as it stands now you’re at sort of the low end of your average occupancy target for 2013.

[Denny Oklak:]

Yes. I would say there’s two things. Yes, there were a couple things that happened during the quarter. We had some expirations during the quarter, mid-quarter let’s say, that we’re pretty much immediately backfilled with tenants. But then we had a couple leases near the end of the quarter that expired but it didn’t have a significant impact on first quarter NOI. Unfortunately, we have to report on four specific days of the year. It’s the way we report. So our occupancies always gone up and down a little bit, but we are sort of at the low point at the end of the first quarter, which is kind of where we thought we’d be. So, we do have, as I’ve said, there’s a lot of good activity out there I think particularly on the industrial side, business is still strong. So I think you’ll see – again see that occupancy continue to tick up throughout the rest of the year. And we’ve looked at it pretty closely and we’re still very comfortable with that occupancy range guidance that we gave for an average occupancy for the year, which was in the 92% to 94% range.

[Brendan Maiorana:]

Okay. That’s helpful. And then just the last I have is for Christie. I was looking at your same-store in the disclosure on page 21 in the supplemental. Am I reading it correctly that there’s 180 basis point improvement in occupancy in the portfolio in the Q1 2013 versus Q1 2012?

[Christie Kelly:]

Yes, you are, Brendon.

[Brendan Maiorana:]

So I guess was just trying to reconcile that with last year’s occupancy numbers because I thought that they were – I didn’t think the occupancy moved around that much and even with the adjustment in the pool that that would have happened. It didn’t seem like there is a whole lot of movement. Is there something else going on there that maybe we don’t see as we’re thinking about the same-store pool last year versus this year?

[Christie Kelly:]

No, nothing. We’re just chatting quickly here amongst ourselves, Brendan, and there’s nothing really of note.

[Brendan Maiorana:]

Okay. I mean – okay, maybe we can take that offline because, yes, I’m just having trouble looking at last year’s numbers and see whether there would be that much adjustment.

[Christie Kelly:]

Sure. We can talk offline again.

[Brendan Maiorana:]

Okay, all right. Thanks.

[Christie Kelly:]

No worries.

[Operator:]

So next, we’ll go to the line of Dave Rodgers. Please go ahead.

[Dave Rodgers:]

Yes, good afternoon. I guess with regard to the development pipeline, Denny, you talked $620 million under construction today, a pretty good yield. Where do you see that going throughout the year and I guess as you’re tie in to that, we’ve seen especially on the industrial side more and more spec construction I guess which you under took a little bit this quarter. So I guess talk about where you see the overall pipeline going this year and how spec will play into that.

[Denny Oklak:]

Sure, Dave. I think you’re going to see that pipeline likely stay at a pretty stable level, that $500 million to $700 million range. We monitor that pretty closely and actually don’t want to get that up too high as a percent of our overall asset base. However, I think the other thing strategically that you’ve seen from us is almost – I mean a very significant portion of our development now is 100% pre-lease project. So we’re so going to obviously try to finance many of those kind of accretive transactions as we can do. We’ve really been fairly limited on spec of the development far in this point in the cycle we’ve really started four projects in the last, I would say, I guess it’s been about 9 months, 9 to 12 months. We started the one office building I mentioned in Houston which is now 91% leased and will open up in July. We started now three spec industrial buildings, one in Indianapolis, one in California and now just started one in Houston, and those total about 1.25 million square feet. We have no leases signed in those yet. We’ve got a couple of proposals out on the California project. We’ve on and off have some activity on the Indianapolis project, and then actually have some pretty good activity on the Houston project even though we’re just really getting started and breaking ground on that one. So I think you’re going to see us still be fairly conservative on the spec development side. You might have seen other project or two before the end of the year but some of that is really going to depend too on how we do on leasing up some of those projects we’ve already started. So that’s really, I think, where we are, what we’re looking at through the development side.

[Dave Rodgers:]

Thanks. And then maybe for Christie just in terms of it seems like the appetite for office asset is up in terms of your ability to sell, maybe talk about where some of the funding will come from throughout the course of the year if you can relate it to the asset sales program?

[Christie Kelly:]

Sure, Dave. As it relates to the guidance in terms of office dispositions, we’re a net disposer. this year as you look at the midpoint of the guidance. And we’re on track to deliver as it relates those dispositions and our focus for this year is on as you stated Midwest office as well as retail as demonstrated by the Pembroke disposition.

[Denny Oklak:]

Yes, just to add to that, if you look at our office disposition so far, it’s the two bigger projects in Raleigh and then the Chambers Street portfolio, those were obviously really funded with mostly with institutional equity I would say. Some debt potentially, but most of it was equity and looking at some of the dispositions that we plan on the office side this year, I’d think what we’re likely to see again is secured debt, funding mortgage debt, my guess is you’re not – it won’t be consist of CMBS much, because they’re going to probably smaller portfolios but I think we’ve seen both the banks and the insurance companies fairly active in that market right now.

[Christie Kelly:]

Yes, to the point that Denny’s making, I mean that really is a change that we’ve seen, over the past year and 18 months.

[Dave Rodgers:]

And so I guess, should I take from those comments that if LTBs are generally higher than they had been and rates are lower, that the 7.75, wherever you were in this quarter for the office asset sales if fairly achievable for the remainder of the year?

[Denny Oklak:]

Well, I think it’s just depends on what the mix ends up being. Those were, I would say, probably on the lower end of the cap rates scale but I think you’ll probably again see most of our office dispositions in that low to mid 8 kind of cap rate range on, again on in-place income.

[Dave Rodgers:]

Okay, great. Thanks.

[Christie Kelly:]

Thanks, Dave.

[Operator:]

We have a question in queue from the line Josh Attie. Please go ahead.

[Joshua Attie:]

Thanks. Good afternoon. Dennis, in your prepared remarks you mentioned that industrial fundamentals seem to be getting better, but for your portfolio same-store growth is going to moderate over the next two quarters. And I understand that some of your industrial properties are probably approaching high occupancy levels, but why would rent growth slow? And I guess what are some of the items do you expect to weigh on the same-store?

[Denny Oklak:]

Well, I think when you look at the overall portfolio, I’m just talking industrial, we’ve been running at a pretty high occupancy level when you look at that. We’ve grew almost to 95%. We dropped down a little bit under 94% at the end of this quarter because of the couple of lease expirations. So, I think at this point in the economy and with the type of GDP growth we’re looking at this year, that portfolio is probably the best we’re going to get as probably 95%, 96% right now. I think when you look at it I think we will see modest rent growth across most of our industrial markets. But remember, a couple things I would say, one is, we’ve only got I think 7% lease expirations of our overall portfolio for the rest of the year. So, we’re not going to see tremendous growth out of that portfolio from rental increases on leases rolling. And then second, we have solid growth in the industrial business because most of our leases today now and most of our markets have annual rent bumps. So those rent bumps were anywhere from probably 1.75% to 3% annual rent bumps. So those will be helping to drive our continued same-property performance as long as we hold up where our occupancy points are anticipated.

[Joshua Attie:]

Thanks. That makes sense. And could you just tie that back to guidance? II know the guidance are based on a same-store growth range of 1% to 4% and you did 2.5% in the first quarter. So, it’s going to moderate from there. Should we assume that both the same-store and the FFO guidance trend toward the lower end of the range?

[Denny Oklak:]

No, I don’t think so. I mean I think we’re going to be sort of in the middle of that range. I would tell you what drives that number unfortunately more than others is just harder to predict is the dispositions. That’s why we always have to give a wider range then maybe we would like because we just don’t know which of our same properties were going to sell during the year. So, that can have an affect depending on which properties you should sell. But sitting here today looking at what we sold so far and what we anticipate selling and then what we anticipate happening in the remaining portfolio, I think towards the middle of that range is a good number for this year.

[Joshua Attie:]

Okay. Thanks very much.

[Denny Oklak:]

Thanks, Josh.

[Christie Kelly:]

Thanks, Josh.

[Operator:]

We’ll next go to the line of Vincent Chao. Please go ahead.

[Vincent Chao:]

Hi, everyone. Just a quick question. Dennis, you’d alluded to the Chino project earlier in terms of some people kicking the tires. I was just wondering if you expand upon what kind of activity you’re seeing there, types of users and maybe what’s causing them or preventing them from pulling trigger on taking some space there.

[Denny Oklak:]

Well, I think first a guy pointed out is we just really finished that up early this year probably in February sometimes. So, it’s relatively still fresh on the market. Again, there’s been good activity in the Southern California market. We’ve seen a fair amount of leasing. I think if you look at the leasing statistics out there for the first quarter, some very good activity is what you’ll see. It just depends in that situation. We’re likely going to lease that building to a single user, in my opinion. That’s a 420,000 square foot building which is kind of a sweet spot for a distributor, so it’s just finding that right tenant. We’ve talked to a couple of retailers about it. We’ve actually talked to a governmental agency about leasing the whole thing also. So I think it’s fairly broad user base out there and we’re very focused on getting that one leased up.

[Vincent Chao:]

Okay. And at this point, is it relative you’re underwriting for that project? Are you still on track or is it may be slipping a little bit in terms of timing?

[Denny Oklak:]

No, it’s not slipping.

[Vincent Chao:]

Not slipping, okay. And then maybe if I could just ask a similar question just in terms of Atlanta overall, I mean obviously that’s a tougher market but can you provide some color on what you’re seeing there? It looks like one of the late quarter move-outs might have been from that market on the industrial side.

[Denny Oklak:]

It was. We had about a 300,000 square foot tenant leave right near the end of the quarter in one of the buildings which was really most of the decrease in occupancy in Atlanta this quarter. I guess overall, my comment on Atlanta would be that market has been relatively slow and I think slower than some of the other industrial markets so far. When you think back on it, just about a year ago, we signed million square foot lease up at our Braselton project with Carter’s for their e-commerce distribution and that was a big deal obviously for us there. Since then, it’s been a little bit slow, but in talking to our folks in Atlanta, they’re starting to feel like things could pick up here pretty shortly and things could get better in the second and third quarter. A lot more people come out in the market beginning to talk about leasing some space here soon. So, I think we anticipate that occupancy improving in the second half of this year. But clearly, it has been slower than some of the other markets.

[Vincent Chao:]

Okay. Thank you.

[Operator:]

(Operator Instructions) We’ll go to the line of Eric Frankel for his question.

[Eric Frankel:]

Thank you. I would like to discuss given the repositioning plan here, long-term thoughts for some of office to suit. You guys are working where do you think the eventual home where those properties are?

[Denny Oklak:]

I think it depends. When you think about a couple, I mean the two, the bigger ones that we worked are is Primerica build to suit in Atlanta which we just completed on time and they’ve now moved in and are extremely happy with the facility. And on that one I would say, that’s on land that we own in our legacy park up in Gwinnett County. We’ve got room for a couple more buildings there. We’ve actually had other – some other discussions there on possible build to suit. So I think it’s probably likely we might hold that one for a little while as we build, potentially build out the rest of that park. As you may recall that was a 15-year lease with them, so we’ve got obviously plenty of time on the lease. I think there’s nice annual rent bumps in that one also. And then the other one we signed our Duke Bridges Park up in Frisco in Dallas 200,000 square foot project on a 16-year lease. We’ve got two more sites available in that park and then this tenant actually has an expansion option on to a site next door for I think its 18 or 24 months out. And so I think once we complete that I think you’ll likely see us pull that one at least through the time that they have the expansion option. So I think it’s going to be a case-by-case basis, Eric. They are all they’re really good projects but as you know we’re downsizing the office business and the truth is in Atlanta and Dallas for example both of those were a part of our Blackstone transaction so we sold substantially all of our other assets in those market other some other ones a couple we had in other joint ventures. But these build-to-suit office buildings don’t require they’re not really that hard to manage because it’s a single tenant. So I just think it’s not probably not answering your question but I think it’s just going to be a case-by-case basis.

[Eric Frankel:]

Okay. I do appreciate the color. Also I’m just curious about the medical office portfolio and what do you think the occupancy trajectory can be in the next couple of years? It just seem to be stay kind of flat over the last few quarters?

[Denny Oklak:]

Well, I think yes, it has and some of that was because we were some of our development we were developing with some vacancy in it. And so most of what we signed here recently has been a 100% lease so that’s not contributing to that vacancy obviously. But I think the leasing activity is pretty good. We bought a little bit of vacancy, when we bought the Seavest portfolio last year and we’re actually I think, it looks like we’re going to be ahead of schedule on leasing up some of that space, so my thoughts today would be, you’re going to see that occupancy probably start moving closer to the 94% 95% and likely stay in that area for a while.

[Eric Frankel:]

Great, thank you. And then one final question, just given your thoughts on market rent and growth trajectory, just want to get a feel for what you think the mark-to-market rent is for your portfolio?

[Denny Oklak:]

Well, people asked us that quite a bit. It’s, again a little bit hard to say because we’ve got so many different markets and submarkets and kind of buildings. But, in general today, where we are in the cycle and when you look at when we sign leases that are beginning to roll now, I would say, our rents in place were probably a little bit below market. And I’m saying, maybe 5% to 7% below market today and what’s in place. But again, it’s going to vary market and sub – by market and sub market a little bit.

[Eric Frankel:]

Great, thank you. Appreciate it.

[Christie Kelly:]

Bye Eric.

[Operator:]

Pardon me, we have a question in the queue from the line of Scott O’Donnell, go ahead.

[Scott O’Donnell:]

Yes hi, good afternoon. A question for Christie, the last two debt offerings you did were 3.875 and 3.625, I can’t for the life of me figure out why you’d be turning to the bank term loan market right now with the markets very efficient from a funding perspective?

[Christie Kelly:]

Yes, Scott. Thanks for that question. I mean I think when we take a look at the term loan there, a couple of things. First, we’re looking at a five-year term loan. We’re looking at doing floating rate paper and it’s very accretive based on our yield curve right now and we really don’t have any floating rate debt to speak of whatsoever in our capital strikes. So when you take a look at A, yes, what we’ve been able to execute and B, threading in a nice little five-year for 2018 maturity, they go up 15 really nicely with our maturity ladder at very attractive rates it makes sense for us to do.

[Scott O’Donnell:]

So there will be no swapping of that deal and no capping of the deal?

[Christie Kelly:]

No. There won’t be any swapping of the deals at the get go, I mean, to the extent that we need to fix it. We’ll take care of that as we see rates move.

[Scott O’Donnell:]

Thank you.

[Christie Kelly:]

You’re welcome.

[Operator:]

We have a question in queue from the line of Michael Salinsky. Go ahead please.

[Michael Salinsky:]

Good afternoon, guys. Just to go back to the following question. You talked about spreads, I think, you said up 2%. What occupancy level do you get a bit more comfortable pushing that a little more?

[Denny Oklak:]

I think again, it always comes back to me to what the demand is. Even when our occupancy is here at 95%, 98% which when you look at a number of our industrial markets today, we’re there. Still not necessarily a big pressure to raise rates until that demand really starts picking up. So I think we’re going to have to see some more of that demand picking up. And occupancy is good but it’s not like we have a huge backlog of tenants wanting new space that’s why you’re still seeing relatively limited spec development in most markets. So, I think we’re going to – we’ll start seeing at as we start seeing a little bit more demand pickup.

[Michael Salinsky:]

Okay, that’s helpful. Just going back to your original capital plans for the year. I mean do the shares about 25% year-to-date and also...

[Denny Oklak:]

I’m sorry. I think we...

[Christie Kelly:]

Hello?

[Denny Oklak:]

Did we lose you?

[Operator:]

Mr. Salinsky’s line is still connected. Mr. Salinsky could you check your phone for mute feature.

[Michael Salinsky:]

Can you hear me?

[Denny Oklak:]

Yes, sorry.

[Christie Kelly:]

Now we can.

[Michael Salinsky:]

Okay. Sorry about that. Just going back to with the share price of 25% year-to-date and also just given the success you guys have had on disposition front relative to the development yield, the 8% that you quoted there, is there any thoughts maybe accelerating the development starts for the year and maybe recycling a bit more or going out in maybe being a bit more aggressive on the leverage – on reducing leverage?

[Denny Oklak:]

Well, I guess let me start in the development side. I mean I think we’re doing all the prudent development today that we think is out there. In other words, we focus on the build-to-suit market. Going back to my comments on spec and so as I said I think we’re not really afraid to do really good build-to-suit yields on both the MOB and the industrial side and an occasional office one to the extend there may be on our land. So, we’ll keep pushing those as much as we can. And then on the disposition side, I think we’ve got a fairly significant disposition plan for the year and we’ve executed – we had a great first quarter and now with the Pembroke sale looking to close here in – before the end of the month. That’s a pretty good four-month start at almost $400 million. So, one of the things I you will see as do is sort of look through the portfolio a little more carefully as we’re going and take advantage of some – potentially take advantage some opportunities where we think we’ve created a fair amount of value and then move some of those properties if the timing is right, especially timing for reinvestment. We think we can have use of the proceeds either to reinvest in new development or to de-lever as we have debt maturities coming up. I think we’ll probably look at that but I wouldn’t say we have anything specific in mind right now.

[Michael Salinsky:]

Okay. So no changes with the investment plan obviously early in the year?

[Denny Oklak:]

No, I don’t think so.

[Michael Salinsky:]

Okay. Thank you.

[Denny Oklak:]

Thanks, Bill.

[Operator:]

And we have a follow-up question from the line of Brendan Maiorana. Please go ahead.

[Brendan Maiorana:]

Thanks. So, Denny, just to sort of follow-up a little bit on the disposition outlook and we’ve talked about this a bit in the past, but you’ve got a nice MOB franchise as we sort of think about it but it doesn’t fit that neatly into your portfolio mix. At the same time, pricing for MOB assets seems in an all time high. There’s seems to a lot of interest in the space. Is there a way to sort of harvest some of that value via a JV or some form like that where you don’t have to give up the upside that you seem to be creating a lot on the development pipeline but you can maybe harvest some of the value that’s been created on the developments that have been done thus far and it would be a way to sort of accelerate the deleveraging that you’d expect to do over the next few years?

[Denny Oklak:]

Well, I would first respond to that by saying I think it does fit in fairly nicely and neatly within our portfolio because again it’s a very stable product type very really good same property growth as you can see from the performance of that portfolio over the last year and the last few quarters it’s really doing well. So when a property type is performing that well, I think it fits in to my strategy so and obviously we have the platform in place to do the development and continue to grow that business. But having said that, I think there is an opportunity there we’ve been building portfolio on the development side now for about six to seven years and as we look back through that portfolio there is probably a couple of properties that are in there that we developed early in that cycle that might make less sense for us strategically than they did back then. So I think you’ll see us really look – keep a close eye on that portfolio, you might see a few assets move here or there. But again, I think you’re going to continue to see us grow that portfolio. Just in the light of that we sold two buildings out of our MOB portfolio this quarter. And those were actually two buildings that we got in the Seavest transaction that we knew when we bought them weren’t really strategic for us. They were located in truly non-core market, they have good tenancy and long term leases and they were probably 25 to 30 year old buildings. So we move I would say fairly rapidly to go ahead and relist those properties and sold them at a little bit over what we had allocated to that. So it was a good deal for us and again, they didn’t fit strategically. So I think you’ll see us continue to look at that.

[Brendan Maiorana:]

Okay. So if I hear your comments correctly on the MOB portfolio, does that suggest that this is – as you think about the business long term several years out, this is the part of the portfolio that stays within the business as you sort of see it into the future?

[Denny Oklak:]

Yes. I think we’ve stated that I think our asset strategy that we’ve been talking about here, our original target for that was about 15%. We’re kind of right there maybe even a little bit higher than that because of some of the bigger transactions we did but I think you’re going to see that portfolio stay in that range and I think overall as we look for opportunities to grow the company overall then I think you will continue to see that MOB portfolio grow but stay in that kind of a range of percentage of the overall company, 15% to 20%.

[Brendan Maiorana:]

Sure, okay. And then the flip side of that is sort of looking at acquisitions or the flip side of my question I guess would be looking at acquisitions. Do you think – as we look at this USAA deal, a large portfolio deal stabilized. So you think when you look at growth of the company from here given that you’re pretty darn close to the 60, 50 and 25 portfolio breakdown allocation that large portfolio deals are still likely to happen for Duke or do you think you’re largely done with that and most of the growth comes via development and kind of one-off deals?

[Denny Oklak:]

I think it depends. First of all, I would say that I think growth definitely will come through new development. Build-to-suit industrial deals, some speculative industrial building and pretty much on land that we owned because we can do – I don’t know I think it’s $40 million square feet of industrial roughly on our – the land that we own today. So, you’re going to see us continuing to grow there. I think you probably will see us do some one-off acquisitions in key target markets which we’ve been doing. Again just kind of depends, we’ve looked at a whole lot more and seen a whole lot more transactions than we’ve actually executed on when we look at it over the last two or three years. As far as the portfolio of yields go, again I think it depends. There is where we have a great presence in most of the major distribution markets in the country now, but there is a couple where we’d still like continuing to grow and if we saw a portfolio transaction that we thought would really help us grow in a certain area of the country or a certain of those markets that we don’t – we feel like we’re underweighted, then I think we would certainly consider that. And again just looking at the USAA portfolio very I mean strategically for us a very good transaction because a significant piece of it in California, Northeast, Houston where those are locations that we’re trying to build our portfolio so that worked very well for us.

[Brendan Maiorana:]

Sure and then last one. The cap rate spread differentially. If you talked about between the USA deal and Pembroke deal, is that – was that both cash and GAAP 100 basis point spread or was it just one or the other?

[Denny Oklak:]

Cash

[Brendan Maiorana:]

Okay, great. Thank you.

[Denny Oklak:]

Thanks Brendan.

[Christie Kelly:]

Thanks Brendan.

[Operator:]

We have a follow up question from the line of Josh Attie, please go ahead.

[Michael Bilerman:]

Yes, it’s Michael Bilerman, good afternoon.

[Denny Oklak:]

Hey Michael.

[Michael Bilerman:]

Just a question on the USAA portfolio, I guess the brokerage community is sort of painting it as a portfolio premium, very rich pricing, I guess how do you respond to that and maybe you can talk about how you sort of look at pricing for that portfolio?

[Denny Oklak:]

Sure, I would say that was a competitively bid process there, so I would say there was a number of other competitors on that portfolio so, I think it was truly market pricing. I don’t know that I would agree that there’s a portfolio premium to it. I mean it’s sort of is, what it is and they’re all really good projects. When you look at it, I think our basis, if you look at that is going to be just around $65 a foot overall for that portfolio. We do a lot of looking at replacement cost and I think we really believe we bought that portfolio, right in the range of replacement cost and again, all very good markets, very, very good buildings. So I’m not saying it wasn’t a market deal, I think it was a market deal, but I think it was a good fair deal for us. We’re very comfortable with the pricing on it and our basis and so that’s about all I can say, great property.

[Michael Bilerman:]

And where does that work out, I guess on a initial, it’s 100% lease so where – I guess where are rents sort of relative to market and what is that initial yield that you’re buying at?

[Denny Oklak:]

Well, I would say rents are really right about market and most of those buildings what we think market is today. I think the average remaining term on those leases is probably six or seven years and again all of them have annual rental rate bumps. I would say the rental bumps are in the neighborhood of 1.5% to 2% – 2% or 3% I guess.

[Christie Kelly:]

That’s right.

[Denny Oklak:]

And I’d said we typically don’t disclose yields on specific transactions, Michael, just because of competitive nature. So, it will be disclosed in our second quarter numbers along with our other acquisitions. But I also would like to say I think it’s pretty – the numbers I’ve seen our there are probably in the range.

[Michael Bilerman:]

Okay. And then just – I just wanted to come back to sort of the guidance just to really understand the moving pieces because it sounds like the acquisition or our shift position activity, I guess when you look at the retail sale and some of the office buildings to Chamber Street that could be maybe even accretive or neutral relative to the acquisition volumes that you’re doing and it sounds like going floating rate debt would be accretive. And so are we – to take it that operations a little bit behind for the guidance not to move?

[Denny Oklak:]

No. I don’t think so. I think our operations are really pretty much in line so far this year with where we anticipate them to be. You know, Mike, because you know I’m not going to move our guidance in the first quarter. I mean we said a fairly broad range and usually we’ve tightened it up the last couple of years a little bit. But we’ve got a lot of moving pieces and parts as we go through this disposition and essential acquisition and development. So there’s just a lot of moving pieces and parts in the numbers so I’m just never inclined to really try to change this early in the year unless something major would happen that we knew had a significant effect. So we’ll obviously look again at the end of the next quarter and think about where we are and see how the year is progressing and every quarter we reconsider that annual guidance. And if we think it’s appropriate to change it we’ll do that but right now I think operations are actually probably just a little bit ahead of where we thought they’d be.

[Michael Bilerman:]

Okay.

[Christie Kelly:]

And through that point Michael, we highlighted not only the year-over-year growth the FFO and AFFO but we’ve done that on the back. So moving significant dispositions as well as delivering so when you take a look at the fundamental operation and the leasing momentum it’s been very strong. So I would absolutely agree with Denny that we’re actually a little bit ahead of where we thought we were going to be.

[Michael Bilerman:]

Okay. Thank you.

[Denny Oklak:]

Thanks, Michael.

[Operator:]

We also have a follow up question from the line of Michael Salinsky. Go ahead please.

[Michael Salinsky:]

Thank you. Just to go back to dispositions since you sold both portfolio and one-offs. Any noticeable difference between portfolio pricing versus one-off sale?

[Denny Oklak:]

No. I don’t think so, each disposition, each transaction has its own story so it’s a little hard to say. But I think for that specific question Mike, the difference between single assets or portfolios, not really.

[Michael Salinsky:]

Okay. Then the question, taking I think the bulk on this report a little bit, looking at some of the smaller block space, have you seen any change in demand as we see in the single family house in the market pick up over the last couple of quarters and how much opportunity do you see there in terms of driving towards your occupancy targets for 2013?

[Denny Oklak:]

Yes. I think clearly, you’re starting to hear a lot of chatter about that in various conferences. We’ve seen it in some of the other industrial folks as public discussions or releases. I think it’s true. We’re seeing some of that and again, it varies a little bit from market-to-market. I would say clearly in South Florida which that whole economy there is driven by a lot of development and construction is a fairly big part about that – of that economy down there and that market is coming back particularly I would say on the multi-family or the condominium market in South Florida is really coming back. So we’re starting to see some of those types of tenants come back into the market and I think we’ll continue to see that, my sense is throughout the rest of this year, as the economy improves and housing markets continues to pick up.

[Michael Salinsky:]

Thank you.

[Denny Oklak:]

Thanks.

[Operator:]

Speakers, we have no further questions in queue at this time.

[Ron Hubbard:]

I’d like to thank everyone for joining the call today. We look forward to seeing many of you at the NAREIT Conference in June in little over a month or if not, we’ll reconvene during our second quarter call, tentatively scheduled for August 1. Thanks, everyone.

[Operator:]

Ladies and gentlemen that will conclude your conference call for today. Thank you for your participation and for using AT&T’s Executive Teleconference service. You may now disconnect.