Duke Realty Corporation
Q2 2013 Earnings Call Transcript

Published: 2 Aug 2013

[Operator:]

Ladies and gentlemen thank you for standing by and welcome to the Duke Realty Second Quarter 2013 Earnings Call. At this time, all participants are in a listen-only mode. Later we will conduct a questions-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, today’s conference is being recorded. I would now like to turn the conference over to Mr. Ron Hubbard, Vice President, Investor Relations. Please go ahead.

[Ron Hubbard:]

Thank you. Good afternoon, everyone, and welcome to our second quarter earnings call. Joining me today are, Denny Oklak, Chairman and Chief Executive Officer and Mark Denien, Executive Vice President and 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 quarter in both our operational and asset strategies. Mark will then address our second quarter financial performance and progress on our capital strategy. Then I finish up with our prepared remarks with some comments about our outlook for the remainder of 2013. By all accounts the second quarter was a great success for Duke Realty and I’m very proud of our team for their accomplishments. We signed 6.2 million square feet of leased and finished the quarter at 93.1% overall occupancy rate which includes projects under development. This is the highest overall occupancy rate for the company since 1996. We had only 25 million square feet of properties. We also acquired 5.9 million square feet of modern bulk industrial product and key distribution markets including 405 million at an initial cash yield of 6.3% with nice future annual rent bumps resulting in a GAAP yield of 6.7%. We essentially funded these acquisitions from cash on our balance sheet at the beginning of the quarter and from executing $202 million of dispositions during the quarter. These dispositions had an in place cap rate of 5% and thus the acquisitions are immediately accredited to FFO and AFFO in alignment with our asset repositioning strategy. Also during the quarter we begin $82 million of new development projects with a weighted average stabilized cash yield of 8.2%. I’ll talk more about these investment transaction shortly. On the capital front we repaid $425 million of maturing unsecured notes a portion of which was funded with the new $250 million floating rate term loan matures in 2018. We also issued $1.5million shares of common equity through our ATM program during the quarter raising proceeds of $27.4 million. Mark will speak more in depth on our capital activities in a moment. From a macro perspective half way through the year the economy is limping along in a one plus percent growth rate lower than the beginning of the year expectations. The lack of subjective job growth continues to present challenges for the real estate industry. These factors are key contributors to our cautious outlook towards spec development. While the amount of spec stays relative to total inventories maybe low compared to historic levels other than in a couple of markets we’re not seeing significant dimensions or that new space. Looking at the rest of the year current forecast call for improvements in GDP near the 2.5% level for the second half of the year. This would obviously be a positive for real estate fundamentals. We’ll also make a quick comment on interest rates given what has transpired with fed and in the capital markets recently while we believe there are rest and certainly volatility related to the fed tampering over the immediate term. We don’t view the most recent range of long-term rates as being adverse to growth and demand for our space or in our ability to generate new development starts. Despite this sluggish economic growth our leasing operations performed very well across our entire portfolio this quarter. While we did expect an increase in occupancy over our prior quarter levels the 130 basis point increase was a bit better than expected. The positive absorption was fairly broad based across all product types end markets that give full credited to our talented and D teams in each of our markets for the success on their performance. Now let me touch on some of the key activity within each product type. On industrial the preliminary indications from costar for the second quarter is at national net absorption maintained its strong pace in the first quarter with projections of about 35 million square feet driving vacancy rates down to the low to mid 8% range. We are seeing solid leasing demand as well as new build-to-suit development opportunities across our industrial markets. We continue to see activity on the build-to-suit for us and slower economic growth for its tenants time to carefully plan ahead for space modernization or expansion needs. With respect to leasing in our industrial portfolio the fundamentals remain solid with the completion of nearly 1.9 million square feet of new and about 2.7 million square of renewal leases. Bulk industrial in service occupancy at the end of the quarter rose to 94.4%, 80 basis points above the previous quarter and also 80 basis points higher than a year ago. Nine of our 18 major markets are now at least 95% leased on the industrial side and only three are under 90%. Three in the medical office portfolio beyond campus medical office business remains robust, which bodes well for our portfolio, we had a solid quarter with new lease of 260,000 square feet of new and renewal leases signed, growing our in-service occupancy by 180 basis points to 92.7%. Development opportunities are also strong, which I will touch on a little later. Now I’ll talk a little bit about our suburban office business, generally speaking this product type has been challenging and probably will be until we see more meaningful job growth. Having said that, we’ve actually seen some markets with quite a bit of activity more significant Houston, Raleigh, South Florida and our Midwest markets. Overall we had a nice quarter on the suburban office leasing side as well executing nearly 1.3 million square feet of new and renewal leases. In the Midwest, we signed five leases that were each 3,000 square feet or large that’s the best quarter of activity for office leases of this size in the Midwest in several years. We also had significant new leasing totaling a 186,000 square feet in Raleigh related to pre-leasing of a recently announced speculative development project that I’ll speak about in a moment. Overall, we increased our in-service suburban office occupancy by 200 basis points to 86.5%. We also made excellent progress on our asset strategy during the quarter, as we announced on last quarter’s call and as disclosed at a recent investor presentations in late May we closed on the acquisition of 4.9 million square foot USA and eight industrial portfolio for $315 million. The portfolio includes eight 100% leased amount of bulk industrial facilities in key distribution markets including California, Eastern Pennsylvania and Houston. We’re extremely pleased with the strategic split and extremely high quality of this portfolio. We also acquired two bulk industrial facilities totaling 950,000 square feet in central New Jersey, these two facilities were developed in the last 10 years and located just off I-95, equal distance between Philadelphia and New York, both facilities are 100% leased to Crate and Barrel until 2020. Last year you only acquired a 123,000 square foot industrial building in Southern California in the Mid-County submarket, facility is currently 100% leased with the entire space rolling later this year, we now expect rental facility to be above our original pro forma when the tenant rolls. Let me also point out a couple of other things on our industrial acquisition strategy. I know that some of you have questioned our acquisition of 100% leased facilities in the value creation opportunities. Since we began our asset repositioning strategy back in 2009, our acquisitions and dispositions have been roughly equal at just under $3 billion each. Other than our South Florida acquisition we’ve been mostly focused on larger distribution buildings, 500,000 square feet plus in major distribution markets. We focused on larger bulk buildings, because we feel that as a future of the bulk distribution business in major market. When these larger bulk buildings trade, they are almost all leased 100% leased, you just don’t see 500,000 square foot plus buildings trade at 50% or 75% lease. We would gladly consider buying those if available, so if you see any let us know. These assets also had nice annual rental rate increases which contributes the solid store and AFFO growth in future years. Our value creation has also come from over $1 billion of new development starts over that same period and we continue to find more great value creation opportunities through development. As for dispositions we had an excellent quarter generating $202 million of proceed that were used as a source of capital to fund the aforementioned acquisitions, a $188 million of the proceeds came from the closing of our previously announced disposition of Pembroke Pines retail center in South Florida, which was 90% leased and sold at a 5% in place cap rate. These repositioning transactions put us just a few percentage points away from our bulk industrial investment target of 60%. Furthermore the acquisition transactions were essentially funded from year-to-date dispositions and/or accretive to our cash flow both short and long-term. We also have a number of other assets are being marketed for sale including a 2.3 million square foot suburban office portfolio located in Cincinnati, Cleveland and St. Louis. We’re in the final stages of evaluating offers we’ve received on this portfolio and believe we’re likely to close on multiple transactions totaling over $250 million in the third quarter and fourth quarter of this year. Now I would like to touch this a little bit on our land bank, if you remember a few years ago we went through a thorough process to differentiate each land parcel between parcels of the one at development and parcels that were non-strategic to be sold. These parcels that were identified for disposition started at a basis of about $230 million after impairment charges. Today we still have about $145 million of this non-strategic land, our books that’s impaired basis, a few of these disposition parcels were reclassified to our to be developed land, but mostly reduction is from sales over the last 3.5 years. I would like to point out that in the aggregate these sales transactions produce a positive margin from the book basis. I would also like to report that in July we sold a 30 acre parcel of office land in Northern Virginia for $22.2 million. This parcel was actually in our to be developed plan, but we received an unsolicited offer and we liked the pricing and believe it would be sometime before we would develop this parcel given the suburban office conditions in this market. This sale and increased interest in land from purchasers let us to increase our guidance from landers position yesterday to a range of $40 million to $50 million. In addition of this parcel momentum on land sales we also have utilized about $40 million of land bank over the last year or so for our development projects. Overall, we feel confident on our ability to monetize our current land bank through development and dispositions add values in excess of our current book basis. Now turning to development, I’m pleased to report that our development starts year-to-date are off to another strong start, a testament to what we believe as a strategically located land bank investing class development team. In total, we began $82 million in new projects during the second quarter bringing our year-to-date total starts to $221 million. We started a 206,000 square suburban office project in Raleigh located in our land and parameter, in our parameter part development. The project was approved at a 52% pre-lease level and I’m pleased to announce the just after quarter and our Raleigh team signed another lease in the building totaling about 78,000 square feet which increases the pre-leasing level to 91%. We also started three new medical office projects during the quarter; we started two new projects with Baylor Health Care totaling 54,000 square feet in the Dallas area, both the 100% pre-lease for 15 years. These are the 11th and 12th projects we’ve done with Baylor in the last seven years and demonstration of our outstanding execution track record in exceptional relationships will talk to your health systems. The third medical project is a 60,000 square feet and located in Missouri also 100% pre-leased for 15 years to a joint venture between Centerre Health and Mercy Health. Our second quarter development starts are 93% pre-lease when you include July leasing and are projected to have a stabilized cash yields of 8.2% and a GAAP yield of 9.3%. As of the second quarter, we have 3.3 million square feet across 18 projects under construction that are 90% pre-leased in the aggregate with the total budgeted cost of 513 million at a projected GAAP yield of 8.4%. Overall, we’re extremely pleased with the new development business generated year-to-date and based on the pipeline of prospects a very optimistic about future development starts for the remainder of the year. I’ll now turn the call over to Mark to discuss our financial results and capital plan.

[Mark Denien:]

Thanks Denny. Good afternoon everyone. As Denny mentioned I would like to provide an update on our second quarter financial performance as well as the progress on the capital strategy. Our second quarter 2013 core FFO was $0.27 per share. The $0.01 improvement in the core FFO per share from the first quarter was mainly driven by an increase and an in service non occupancy of 107 basis points an improved operating performance throughout our entire portfolio. I would like to highlight that we’ve recorded income from lease buyouts of approximately $3.8 million this quarter which is just slightly higher than our normal run rate. This increase was due to a couple of opportunistic office transactions where we had tenants looking to downsize an immediate landfills were available for their space allowing us to collect some fees and retain our occupancy levels. Our growths in average net effective rent on renewals was about 2% for the quarter. We are starting if we able to push rents a little in those markets especially on the industrial side. I would also point out that we did experienced positive rental rate growth on our suburban office renewals this quarter as well as that market is improving somewhat as indicated by the leasing activity Denny mentioned. With respect to same property performance we achieved positive NOI growth through the 12 months and 3 months ended June 30, of 2.7% and 3.4% respectively due to increased occupancy and increases in the rental rates. At the beginning of the year we provided guidance on same property NOI growth on a 12 months – over 12 month basis of 1% to 4%. With our success thus far and expectations for further improvements we now believe that our same property NOI growth for the year will be towards the upper end of our guidance. We generated $0.24 per share in AFFO which equates to a conservative dividend payout ratio of slightly below 71%, compared to $0.23 per share of AFFO for the first quarter of 2013. The improvement in AFFO was driven by the same factors as core FFO, as second generation capital expenditures were consistent between the periods. We continued to be pleased with our growth in the AFFO on a consistent basis which validates our asset repositioning strategy. We’re pleased with our operating results for the quarter and anticipate continued solid execution throughout the rest of the year. Turning to the capital side of our business we executed transactions during the quarter that reduced our borrowing cost and diversified our resources of capital. In May we executed a $250 million variable rate term loan with our credit facility lending group that bears interest at LIBOR plus 1.35% and matures in May 2018. This term loan may be prepaid at any time with no penalty which allows us flexibility in managing our debt maturities over the next five years. We used the proceeds from this term loan to partially fund the mandatory of unsecured notes totaling $425 million which had a weighted average effective interest rate of 6.4%. In May we also executed a new ATM program that allows for the issuance of up to $300 million of common stock. During the quarter when considering issuances under the new program as well as the completion of our previous $200 million ATM program we issued approximately 1.5 million shares of common stock generating over $27 million of net proceeds at an average price of $18.33 per share. As we have said we will continue to look to the ATM program as a source of capital that partially fund future development activity. As Denny mentioned, we’ve generated $202 million of proceeds from non-strategic assets dispositions during the quarter, driven mainly by the $188 million on proceeds from the disposition of the Pembroke Gardens Retail Center. Although acquisition activity outpaced dispositions during the quarter when looking at the entire first six months of 2013 proceeds from dispositions have essential funded acquisitions. Our liquidity is very solid, when considering we completed the quarter with only $88 million in borrowings outstanding on our $850 million line of credit and our debt maturities for the remainder of the year totaled only about $82 million. In fact, we don’t really have any debt maturities of significance in for august of 2014 when we have $215 million of unsecured notes maturing. As indicated in our guidance, we anticipate being a net disclosure of properties for the remainder of the year which will allows us to repay our current line balance and partially fund development costs. We also achieved improvements on our leverage metrics during the second quarter, with a fixed charge coverage ratio of $1.92 for the rolling 12 months ended June 30, compared to $1.86 for the rolling 12 months ended March 31, looking at just the second quarter which gives the full effect of our deleveraging efforts so far this year our fixed charge coverage ratio is 2.1 net debt to EBITDA and net debt plus preferred to EBITDA for the rolling 12 months ended June 30, 2013 was 7.57% and 8.35% which is a slight increase in the prior quarter. This increase was due to the timing of acquisitions and dispositions. We’re looking at just the second quarter adjustments for the timing of these dispositions and acquisitions, net debt to EBITDA is 6.64% and net debt plus preferred to EBITDA is 7.32% which were accurately depicts our improving leverage profile. I would also like to point out that these leverage coverage metrics will continue to improve simply by completing our projects that are currently under construction because that pipeline is 90% leased and the balance sheet already a reflex most of the costs without the benefit of the earnings. I will conclude by saying that I’m very pleased with the operating results for the second quarter and the condition of our balance sheet which allows us flexibility to execute on other aspects of our strategy. With that I’ll turn it back over to Denny.

[Denny Oklak:]

Thanks mark. Yesterday we tightened our guidance for core FFO to $1.07 to a $1.11 per share which raised the midpoint by $0.02 to $1.09 per share. This change is the recognition of the effective execution of our asset in capital strategy, our positive leasing activity so far this year and our overall operational performance year-to-date and a positive outlook for the remainder of the year. We also have a strong backlog of new development projects that we believe we can execute during the second half of the year. Even with the moderate economic growth we are successfully executing our 2013 plan and are confident Duke Realty is in a solid position to capture market share, continued steady rent growth and execute on accretive development opportunities across all of our markets. Thank you again for your support of Duke Realty. And now we’ll open it up for questions

[Operator:]

(Operator Instructions). Our first question today is from the line of (Paul) (indiscernible). Please go ahead.

[Unidentified Analyst:]

Thanks very much. Denny, I was wondering if you could fill us in on plans with respect to the medical office portfolio, specifically are there certain assets that you might look to dispose off in the near future.

[Denny Oklak:]

Yes Paul but I think we are taking a look at that I think there is small relatively speaking small portfolio of assets that we will look to print. We’ve been in that business now when you go back to including when we start at the joint venture with (Tim Brenner) and his company for almost nine years now. And so we’ve got some assets that are little bit older in that portfolio and also I would say we’ve got some assets that are less strategic to us today than may be they were when we developed most of these back in that 8 to 9 years ago. And by less strategic there with hospital systems that may be we’re not we don’t see a lot of future business with. So we’re taking a look at that and I think you could see us market a portfolio here sometime and start marketing here sometime in the third quarter.

[Unidentified Analyst:]

Okay, great. And could you give us the range of cap rates that you see in the market both for top quality and lower quality medical office assets?

[Denny Oklak:]

Yeah we really haven’t been buying much since – when build I think it’s all since last fall when we tend to see that transaction I would say so we haven’t I may not be as close because we haven’t follow that quite as close because we’re really focused on the development side in that business. But I would say you’re probably seeing cap rates in low-to-mid 6s on the very high quality portfolio may even lower than that I suppose depending on the situation and that will be the length of term remain term under lease, the rental, the percentage rental increases in the lease and those types of things but it’s probably in the sort of in the low 6s and the good quality portfolios today.

[Unidentified Analyst:]

Okay, great. Thank you.

[Denny Oklak:]

Thanks, Paul.

[Operator:]

We have a question from Josh Attie. Please go ahead.

[Josh Attie:]

Thanks. Denny on the guidance increase I know that there are a lot of things that contributed to it. Can you just kind of give some sense for how much of it was same-store performance versus your expectation as oppose to asset sale timing, termination fees and also the term loan which I don’t know if that was in your original outlook or not?

[Denny Oklak:]

Yeah Josh almost all of it really is from just higher occupancy for the year. We always factor into our guidance some base level of lease termination fees and while it might have appeared to be a little bit higher this quarter. It was just for the year its right in line with where we thought it would be and again on our refinancing that we were assuming this year I think the interest rates are right about where we thought they would be overall. So I think again most of it is really coming just from increased occupancy and probably a little bit better rent growth on some of the renewals that we thought that we might have this year.

[Mark Denien:]

Yeah Josh I would add that keep in mind that the occupancy number if we reported on our lease signing basis. So the substantive increase in occupancy that we had this quarter some of that won’t really materialized in the rent growth until the third quarter. So we still in a positive in the third and fourth quarter from some of the leasing that you’ve seen the starts right now.

[Josh Attie:]

Okay. Thanks that makes sense more of a leased percentage than an occupancy number.

[Mark Denien:]

Correct, correct.

[Denny Oklak:]

Yeah.

[Josh Attie:]

Okay and secondly on the acquisitions in the quarter if we strip out USAA it seems like you bought Southern California and New Jersey with around of 5.5 cap blended and $85 million of first blended I guess two questions. One, there is numbers right and then also can you tell us what each of those were individually are on a cap rate basis?

[Denny Oklak:]

Well Josh we’ve historically not given cap rates by individual transaction just for various competitive reasons and I think it just sort of sets at all when you look at what we acquired which was primarily I guess really entirely this quarter 100% leased industrial property and the average cap rate was what we disclosed was six in a quarter. So I really don’t have much to say about it other than that I think we did very well on those acquisitions. I’m very pleased with the where we came out I no way think that we paid anything above market on those acquisition. So I think we’re just very pleased.

[Josh Attie:]

Okay. And then just lastly and I’m not sure if you can comment on this or not because I know you are closed to transaction but on the Midwest office portfolio is there any sense you can give us on pricing?

[Denny Oklak:]

Well Josh I’d rather not be there today because as you said we are serving negotiations here. So obviously we’ll see what happens over in the next 90 to 120 days and then we’ll disclose everything when we finally close this.

[Josh Attie:]

Okay. Thank you.

[Denny Oklak:]

Thank you.

[Operator:]

Question from (Jamie) (indiscernible). Please go ahead.

[Unidentified Analyst:]

Thank you. You had mentioned you are seeing some rent growth in your bulk industrial markets. Can you talk a little bit about the pace of market rents like where do you think your year-over-year and maybe what you’re expecting going forward?

[Denny Oklak:]

Yeah Jamie again I think we seen I would look back more over sort of a 12 to 24 month period and over the last 12, 24 months as market occupancies have increased I certainly think and almost all markets we seen greater we see rent growth in the industrial side kind of depends where but we are probably 15% up are at the bottom of where rents work and today again I think we are still, we are still seeing some positive pressure I call it on rent. So I think we’re going to see some more increases but I think our increases going forward are going to be more in the 2% to 4% kind of annual range and again some of that’s going to depend on a little bit what happens with interest rates and obviously on the industrial side what happens with spec development.

[Unidentified Analyst:]

Okay. And the acquisition as you mentioned where is the annual rent bumps I think you said a six, seven GAAP yield and six in a quarter cash?

[Denny Oklak:]

Yeah I think those the annual rents in most of those are anywhere between 1.5% and 2.5% and almost of all these industrial leases today and almost all markets we have, we had the bumps like that and that was acquisitions are the same.

[Unidentified Analyst:]

Okay. And then I don’t know if I heard you clearly before but I think you have made a comment about concerns about new development in your market and rest absorption but you may have heard that wrong?

[Denny Oklak:]

What I said was what we are seeing now is their spec development certainly has come back in the last 12 months. There is more spec development in almost all markets then there has had them for three or four years. I say it still probably fairly significantly below on a historic run rate and still a relatively small percentage of the existing stock but I’ll also what I also said was we are not seeing that space get absorbed very quickly right now. So I think we’ll see over the next few months how the demand is and whether it kicks up and whether that space starts getting absorbed because other than a couple of markets that space is a kind of sitting there right now.

[Unidentified Analyst:]

Okay. Very helpful so which market would you say and is it maybe the space is too modern for the market once like how why would you, why you think that’s happening?

[Denny Oklak:]

No, I think this is just what we been saying really for the last year Jamie as we just haven’t, we haven’t seen, we seen the demand it take existing space but we have been comfortable with the demand was there to absorb a lot of newly developed space. And other than a couple of markets which I would say Houston in particular I would say and maybe a little bit in South Florida we haven’t seen a lot of demand to just absorb all that space it’s been build right now. So hopefully I would also say that typically early part of third quarter late second quarter and early part of third quarter would summer vacations and things is typically a little bit slower time for industrial. So I think post labor day this quarter to see how things pick up. We’ll be interesting to see if more that space starts getting absorbed.

[Unidentified Analyst:]

What would you say the worst markets for that the ones that cause you the most concerned?

[Denny Oklak:]

Well I would say clearly Southern California has a lot of speculative space out there. I would say Chicago has quite a bit of speculative space and we've seen some in the kind of the Pennsylvania markets there has been a fair amount of speculative space out there and even maybe Dallas a little bit a number of spec buildings going out there that haven’t been absorbed yet.

[Unidentified Analyst:]

Okay. Thank you. And then my final question is for the term loans that floating very long correct?

[Denny Oklak:]

Correct.

[Unidentified Analyst:]

So is that you have any plans to fix it or how are you thinking about the risk of raising rates here?

[Denny Oklak:]

No plans right now Jamie if you think about it back when we did this in early May. We probably could have got a two low two on a five year fix maybe two in a quarter 2.3 right now that’s five year rates risen called 50, 60 basis points but the fact is was the floating we have, we haven’t lost anything I mean we are still at the same labor plus 135 and labor hasn’t moved and the short-term rates were still in our favor right now. That’s really the only floating rate that we have out there which is less than 5% of our total debt. So we are pretty comfortable with that.

[Unidentified Analyst:]

Okay. And then I guess just finally the Denny you talked about potential growth in the development pipeline as we roll into 2014 how big is your kind of list the conversations of what you could do because it starts to equal to ‘13 maybe even higher?

[Denny Oklak:]

Yeah I think Jamie we did about five a little more 500 million of new development starts last year. We are at sort of that $212 million level for the first half of this year. Right now I would say that I think we can continue to maintain that space we really think there is a good, there is a good backlog. So today I would tell you sort of the net $450 million to $500 million on an annual basis is a good run rate for us.

[Unidentified Analyst:]

Okay, great. Thank you.

[Operator:]

You have a question from Dave Rodgers. Please go ahead.

[Dave Rodgers:]

Yeah, Denny maybe just follow-up on that question. In terms of the development pipeline in that $450 million or $500 million at start of the year. How is that breaking down between property taxes at least as you see it today kind of what’s in the pipeline, you done a little more office but I think some people expected that you’ve had good success there. So maybe just a recap on where you’re going.

[Denny Oklak:]

Yeah, I think that’s right Dave. I think generally speaking I would tell you that, that would be roughly 50% MOB and 50% industrial but it’s very – it’s been very interesting because we’ve had some opportunities to do some office development. So I think and it’s really been driven by our existing land positions obviously as well as demand in the market. And one thing I didn’t mention in the prepared remarks that building we started about a year ago in Houston opened up and it’s now 100% leased mentioned in the one in Raleigh that’s 30% leased. So again looking forward, I would say maybe 40% to 45% MOB, 40% to 45% industrial and 10% to 15% office as far as the starts go.

[Dave Rodgers:]

Great, thanks. Then you talked also which I think very early in your comments that you didn’t think that the rising rates would impact really the tenant demand for space they get, let met talk about how you handicapped the risk associated with underwriting those assets is that really a spot decision and you just kind of move forward in that point of time?

[Denny Oklak:]

Yeah, I think that’s more of a spot decision, we obviously look at transactions individually when they come through and look at what’s going on in the market, our cost of capital and those type of things when we make those decisions.

[Dave Rodgers:]

I don’t know if you said that where you in the running for the portfolio that I guess received recently from your big competitors, did you get bit on that?

[Denny Oklak:]

No, if I could it’s – what I’m thinking you’re talking about, no.

[Dave Rodgers:]

Okay, okay. So any particular reasons for you not to be involved in that?

[Denny Oklak:]

Well, let’s just make sure we’re talking about…

[Dave Rodgers:]

I’m sorry in the capital transaction.

[Denny Oklak:]

Yeah, that’s just really not our process to product type that we’re looking for.

[Dave Rodgers:]

Okay.

[Denny Oklak:]

If you look at that that’s I think those the average size of the building international transactions in the 125,000 130,000 square foot range. And as I mentioned in our remarks we’d really been focused mostly on those about 500,000 square foot buildings.

[Dave Rodgers:]

And you think better rent growth in the bigger spaces versus a smaller spaces as a result of kind of your activity there?

[Denny Oklak:]

I wouldn’t say – I think the demand is going to be better in the larger spaces over the long term, I really think that’s the way the business is evolving. And I don’t see a big difference in rent growth between larger spaces and smaller spaces going forward.

[Dave Rodgers:]

Okay. And then lastly maybe just for Mark. I know previously the company had wanted to leave those preferreds that are out there just over 6.5 I think $500 million or so. Have you had any change in thinking about what you might want to do with the outstanding preferreds that are callable?

[Mark Denien:]

Yeah, not at this time Dave. I think we’re still pretty comfortable with where we are there. Dave Rodgers – Robert W Baird Great. Thank you.

[Operator:]

Question from Bin Kim. Please go ahead.

[Bin Kim:]

Thanks. Couple of quick follow-up questions. The Midwest portfolio that you’re looking to slow, I understand I guess too much because I have given that suppose here but mainly you can put some quality parameters around that. What the rent per square foot look like on that group of assets?

[Denny Oklak:]

I’m thinking about your keeping because I don’t have that number in front of me but I don’t know for sure but I’m going to make a guess that it’s probably in the 13 to 15 bucks net range on that portfolio, it’s kind of very quiet a bit because little different sub markets and things like that and different cities. So the stuff in St. Louis is going to have a higher net rental rates than the stuff in Cincinnati and Cleveland, so it varies a little bit but on average that would be my guess.

[Bin Kim:]

Okay. And on the Cabot transaction, just want to see your take on. Did you look at that portfolio couple of years ago?

[Denny Oklak:]

Yeah, there was – I don’t know what’s what to be honest with you but there was a Cabot marketed a portfolio couple of years ago that wasn’t as big as what Liberty bought but it was – I’m not going to say I don’t know 12 million 14 million square feet. We didn’t really look at it we did build on it because once again it just wasn’t the type of product that we’re really looking for.

[Bin Kim:]

Okay. And just last question, I guess thanks for – maybe bring some more color on your acquisition strategy. And given that they are 100% leased assets this quarter for 400 million of acquisitions. Whatever you – I think it’s changed here underwriting strategy at all for the rising rates it’s actually because if they’re 100% leased assets with ten year leased terms go after it’s very bond like and with half year cost of fund this company going off that side I would think where you have a somewhat material impact on your exit values and I was wondering if you got and totally have changed your hurdle rats at all especially for 40 day side acquisitions.

[Denny Oklak:]

Yeah, my answer that would be yeah I’d say they can probably have most of those acquisitions that we closed this quarter closed before we saw the spike in interest rate. So what – you just really I think you have to look at the – well is it at the kind of asset is it the quality of asset, is it the location of asset, you have the kind of tendency that you want and cap rates can be a little bit fluid because as we see interest rates just if you look at the tenure probably moved a 100 basis points and in 60 days now. So you can’t just base your acquisition on where interest rates are at a particular time, we’re looking on most of it almost all the acquisitions we’ve done it been really funded this disposition process. So, we sort of time that unfortunate to be able to time that very well and we feel like we’re getting good cap rates on the dispositions and we’re getting what we believe are good long-term assets on the acquisitions.

[Bin Kim:]

Okay. Thank you guys.

[Operator:]

We have a question from Brendan Maiorana. Please go ahead.

[Brendan Maiorana:]

Thanks. Good afternoon. Denny I don’t want to cast this in a negative light but if I take your comments your occupancy which is I think is the highest it’s ever been or at sort of peak levels. And you’ve got development that is increasing in your markets but it’s difficult for developers to find out for those properties. Does that make you concerned at all that there it could be downward pressure on occupancy as you look at over the next 6 12 months or so?

[Denny Oklak:]

No, not really I don’t think there is going to be necessarily downward pressure on our occupancy, one of the things that we pay a lot of attention to Brendan is our lease expiration schedule and try to keep that balance. So we never have in any one year more than 10% 11% rolling. And you’re going to hit some ups and downs in the markets as those things roll. Again I’m just saying Brendan this is really I believe what we’ve been saying for the last year or so we’ve been very cautious and expect development because we’re just waiting to see the demand that’s really going to absorb that space. As we said in our prepared remarks almost all of our markets today our portfolios on the industrial side are over 95% so that’s excellent. And we see enough demand that that’s going to hold up, I’m just – I won’t say I’m terribly nervous I’m just this is why we’re pointing out over the last year or so we got to see the demand is going to take that new space off the market.

[Brendan Maiorana:]

Yeah, no I can appreciate that I mean it seems like you’re doing a very good job leasing up – very good leasing quarter and your overall occupancy it seems like it’s pretty high it seems like that’s moving in the right direction, but then you’re saying that you didn’t see sort of as much demand at the core levels so. The – this is probably for Mark, what was the impairment on in the quarter?

[Mark Denien:]

The impairment related to the landfill transaction Denny mentioned that are actually closed in July Brendan it was a parcel land like Denny mentioned it we had actually planned on developing. We got an unsolicited offer and sold this. So it had not been previously impaired it was at its original book basis and it was related to that.

[Brendan Maiorana:]

Yeah so I guess the land impairment is call it 15% it’s a $3.7 million and $23 million but how you kind of reconcile that Mark on the land with the earlier comments that as you kind of look at the land that you are holding for development. Do you think you are going to be able to put that into motion at values that are above what the current basis is give like you just sold a property at land that you felt like you had a good price on for 15% below book?

[Denny Oklak:]

Well I think Brendan you got to you really got to look at it parcel by parcel. Two things that we said one was we impaired a fairly significant portfolio gone four years ago now and what we said is we’ve sold anything we’ve sold a lot of that portfolio we’ve sold at a profit from that impaired basis. And as I recall we impaired that basis above of 30%, 35% roughly back then and we’ve sold a little bit above that. So probably a 5% margin on that impaired basis on average. And then we’ve not impaired any of the development land and all the development yields come out when we put that land into use include that original basis in that lands. So you see the development yields that we are getting today and we think those are definitely very market development yields. On this particular land this was land we bought as part of the weaker acquisition way back when and I would tell you that we have done very, very, very, very well on that land. We sold a big chunk of that land to the Department of Defense when we get the BRAC project and did very well in that sale. We sold another big chunk of land out into by Dallas to a company and by the name of aerospace where we are doing some third-party development on and we did very well on that land and really this was this land sale was basically all the rest of the land there is a little piece of industrial and one other little office piece. So we’ve sold all of that land from the weaker transaction now and this was the only land where we have slight impairment on.

[Brendan Maiorana:]

Yeah. Okay I know it’s helpful did it looks like did you guys buy land in the quarter as well because it looks like your balance went up by I don’t know $13 million, $14 million something like that?

[Denny Oklak:]

Yeah we bought an industrial parcel in Houston up in the Northwest is we are basically out of land in the Northwest side of Houston. So we can do about 800,000, 900,000 square feet.

[Mark Denien:]

One thing I’d like to point out to Brendan there are a couple of things on the land is I think you’ll see for the rest of the year. We’ll end up the year like for at this level. We hit our guidance our revised guidance at $40 million to $50 million in land proceeds. We’ll actually end up with the total pretty nice profit margin on that land this call it 20% give or take and that includes this right down we just got and then the other thing I would just like to point out in case of any confusion. We do not count any land so I have to take that call it 20% margin or whatever ends up being that will not be part of our core FFO and that had nothing to do with our core FFO guidance change.

[Brendan Maiorana:]

I think you answered my last question before I could ask it. Alright thanks Mark.

[Mark Denien:]

Okay.

[Operator:]

We have a question from John Stewart. Please go ahead.

[Eric Frankel:]

Thank you. This is Eric Franklin here for John. Sorry to hop on the land bank question for a second but for another minute but I just want to ask what do you think your ideal size that your land bank. You are at 600 million now and so how long will it take it to get to that, how long will it take it to get to that ideal size?

[Denny Oklak:]

Well I think the ideal size always depends on the level of activity on the development side. Again what we’ve been saying here for the most recent past was obviously the land bank was larger than we won it when we headed into this down term economy when development slowed down. We are now back to somewhat of a normal development cycle I wouldn’t say we are ahead a normal development cycle yet but we moved a lot of that land into the held for sale when we made the decision to get out of the merchant building business. So that was part of the reason that land bank was higher and now we’ll as we move through that, that won’t be part of the land bank any more than second thing is we are doing, we are moving more and more out of the suburban office business and more and more into the bulk industrial and MOB business at a bulk industrial land is significantly cheaper in most markets then office land. So I think overall the investment in land will be less when we have, when we go to more industrial business and then we are not really buying any office land we are developing through the land that we have on the office side and we still got some great positions that’s indicated by the success we’ve had there just recently. So again Eric I think if you are really looking at where if we are in the $500 million of new development and it’s half industrial and half MOB I think we could have a land bank lot in the $300 million to $400 million range and be fine.

[Eric Frankel:]

Okay. Thanks that’s helpful. Final question obviously we you know you all recognized that you need to further or gradually improving could you possibly comment on what cash releases for the entire portfolio new annual leases?

[Denny Oklak:]

Well we don’t we never really track that just because basis are different and all that and we never had. So but I guess I would say anecdotally I think clearly cash rents generally speaking from, if again, you are assuming leases in place had annual rental rate growth I think we are seeing probably maybe slightly negative to slightly positive in most markets on cash rents today to go from an old to a new fees. And so what I’m saying I guess and that is probably anywhere from 1% to 1.5% negative. So 1% to 2% positive.

[Eric Frankel:]

Great and final question I guess I’m not sure if anyone would simply asked us but is there are there any properties that you’re bidding on currently we actually noticed that change in pricing as a result of the interest rate increase?

[Denny Oklak:]

I’m sorry I didn’t quite understand any properties.

[Eric Frankel:]

On the properties you might be bidding on at this point in time, have you noticed that change in pricing or change in the pricing environment as a result of the recent interest rate increases.

[Denny Oklak:]

Well not really to be honest with it. Although I just I think activities been a little bit slower here in the last 45, 60 days but no quite honestly Eric I don’t think we’ve seen cap rates moved much but we’ll have to see this these transactions take while it get completed and we are seeing some of these not get closed that were probably under negotiation and getting pretty close before this spiked interest rates. So I think if you see over the next 30 to 60 days of the interest that you see what trend we see in some of the cap rates.

[Eric Frankel:]

Alright, great. That’s it from me. Thank you.

[Denny Oklak:]

Thanks.

[Operator:]

Question from Michael Salinsky. Please go ahead.

[Michael Salinsky:]

Good morning afternoon guys. Denny you talked a lot about dispositions could you give us as a sense we’ve seen a lot of portfolio transactions I believe could you characterize the overall acquisition market at this point and what you are seeing in?

[Denny Oklak:]

Well I think on the acquisition market as I just said it’s been a little bit slow over the last 60, 45, 60 days I mean we closed most of our transactions more in the early in the second quarter and got some things out there today but I would say nothing that we are looking to close here in the like eminently I would say. So I think they are little bit slow they are done a couple other portfolio transactions that we weren’t success bidders on for whatever reason I mean that we bid there on that we weren’t successful mostly pricing obviously and obviously the large transaction that was announced no matter where that was last night or today was it looks to me like mostly an off market transaction. So I think you just never know you kind of abs and flows Mike so we could my sense is sellers probably are waiting a little bit to see what cap rates are going to move on since the moving interest rates and if they if interest rates are settled down here a little bit which other than maybe the day look like they settle down pretty well. I think we’ll see some more activity later into third quarter.

[Michael Salinsky:]

So the overall, the amount of – the overall pipeline at this point is it down significantly from the first half of the year out significantly, is that how you characterize that?

[Denny Oklak:]

I would say it’s down a little bit, down a little bit.

[Michael Salinsky:]

Okay.

[Denny Oklak:]

There were some big transactions in the first half of the year so yeah its down a little bit right now.

[Michael Salinsky:]

Okay fair enough. I want to go back to one of your, in your prepared comments you talked about blocks of 500,000 square feet bulk industrial seeing better growth opportunities and in realized you’re growing that but as you look at renewal spreads cash per growth, can you break out kind of what the growth you’re seeing on the bulk industrial versus some of the smaller foot prints?

[Denny Oklak:]

Again we just average it all together because the truth is almost all of our portfolio is true bulk. Today less than 10% of our portfolio is in buildings under 100,000 square feet and I think it’s now up to about 40% of our portfolio is in buildings over 500, 000 square feet. So most of what you’ll see in our statistic is going to be true bulk types statistics. And we just don’t have that much small space anymore around that I can give you as strong sense of what’s going on in the smaller spaces.

[Michael Salinsky:]

Fair enough and final question just you guys are marked really it sounds like there is the Cleveland, Cincinnati portfolio what’s the buyer, potential buyer profile on that are you seeing institutional investors or is that mostly families one-off buyers?

[Denny Oklak:]

I would say its one-off buyers and private equity kind of buyers not institutional which we never expected so private equity both smaller and maybe some larger private equity money out there.

[Michael Salinsky:]

Mostly value added yield focused?

[Denny Oklak:]

Value add I would say today.

[Michael Salinsky:]

Thank you.

[Denny Oklak:]

Welcome.

[Operator:]

Mr. Salinsky do you have any additional question?

[Denny Oklak:]

No I think he is done.

[Operator:]

We have a follow up from Ki Bin Kim. Please go ahead.

[Ki Bin Kim:]

Thanks. Could you give a little more detail around your service operation income more specifically are there any lumpy redevelopment projects you’re working on for third-parties that are conducing for that $50 million revenue run rate currently?

[Mark Denien:]

No, Ki Bin there is really nothing too lumpy I mean I think it set a pretty good run rate now I think as we go forward to may be 2014 what we try to do with that business is we size it according to the development projects we have for our own account so to the extent our development pipeline pitched up even more than it is today. We’ll probably turn away some third party what we can focus more on doing a development for ourselves. So I think as you get out in the 14 you may expect a smaller run rate but as of today there is not too much lumpiness in there.

[Ki Bin Kim:]

And overall that if you take the opportunity, if you concept that maybe I’ll ran on and let’s say there is less development that you have to do for internally on your balance sheet and what if the depth of that market that they probably develop more – is it I guess in a way very easy to hit that $50 million run rate?

[Mark Denien:]

A $50 million run rate Ki Bin?

[Ki Bin Kim:]

$50 million per quarter I guess is that easy to maintain that if things did turn the other way where for some reason you decided not to develop as much on balance sheet and you had – G&A flowing there is that $50 million is easy to ramp it up a little bit is that how deep that market is?

[Denny Oklak:]

Are you talking about revenue for instance.

[Mark Denien:]

Revenue basis yeah. Yeah I think Ki Bin a couple of things I’d point out. Part of that service business is our asset management property management business it’s not all just a development. But from a development/construction standpoint we currently business all the time now the – the honest answer it’s not usually a real high margin business and we would rather resources fully for account. In times where development pipelines had dried out take 2009, 2010 we have been able to take on more work there, there seems all to be work out there it’s just lower margin and it’s not a preferable work.

[Ki Bin Kim:]

Okay and can you break out the 450 million this quarter you’ve had this five different piece to that.

[Denny Oklak:]

I don’t have that in front of me Ki Bin. The majority of it is our development/construction work but we can dig that up for you off line.

[Ki Bin Kim:]

Okay thanks.

[Operator:]

(Operator Instructions). This time there are no further questions in queue. And there are no further questions in the queue at this time.

[Denny Oklak:]

I’d like to thank everyone for joining the call today. We look forward to reconnecting during our third quarter call tentatively scheduled for October 31st. Thank you very much.

[Operator:]

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