Elme Communities
Q2 2015 Earnings Call Transcript

Published: 24 Jul 2015

[Operator:]

Welcome to the Washington Real Estate Investment Trust Second Quarter 2015 Earnings Conference Call. As a reminder, today's call is being recorded. Before turning over the call to the Company's President and Chief Executive Officer, Paul McDermott, Tejal Engman, Director of Investor Relations, will provide some introductory information. Ms. Engman, please go ahead.

[Tejal R. Engman:]

Thank you. Good morning, everyone. Please note that our conference call today will contain financial measures such as core FFO and NOI that are non-GAAP measures as defined in Reg G. Please refer to the definitions found in our most recent financial supplement available at www.washreit.com. Please also note that some statements during this call are forward-looking statements within the Private Securities Litigation Reform Act. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ materially. We provide this list in our SEC filings. Please refer to pages 8 to 22 of our Form 10-K for a complete risk factor disclosure. Participating in today's call with me will be Paul McDermott, President and Chief Executive Officer; Steve Riffee, Executive Vice President and Chief Financial Officer; Tom Bakke, Executive Vice President and Chief Operating Officer; Laura Franklin, Executive Vice President and Chief Accounting and Administrative Officer; and Kelly Shiflett, Director of Finance. Now, I'd like to turn the call over to Paul.

[Paul T. McDermott:]

Thank you, Tejal, and good morning everyone. Thanks for joining us on our second quarter 2015 earnings conference call. We continue to make great progress on our strategic plan to elevate the quality of our portfolio while driving operational performance. We delivered second quarter core FFO of $0.42 which is a $0.04 increase over the first quarter and a $0.01 increase over the second quarter 2014. Our operational performance in the second quarter has strongly rebounded from the first quarter, unheeded by the adverse weather related expenses we experienced last quarter and boosted by a slight increase in office and multifamily licensing. Importantly, we continue to expect $0.20 to $0.23 of additional NOI upon stabilization from the three assets in our portfolio with a great lease-up potential, Silverline Center in Tysons, The Maxwell in Arlington, and 1775 Eye Street in the Central Business District. We have seen a marked increase in activity at the Silverline Center where we have proposals out for approximately 240,000 rentable square feet with three projects interested in 50,000 square feet or greater. We have signed 10 leases of 75,000 rentable square feet since our new marketing campaign last fall and our rents are meeting or exceeding performance. The planned addition of a white tablecloth restaurant and a high-end conference facility has further improved the competitive positioning of this Class A office building which offers heartland and metro access as well as unique subway [indiscernible] opportunity. Silverline Center is currently 61% leased and is projected to continue to lease up over the next 18 months. The Maxwell, our newly delivered 150 per unit multifamily project, continues to show positive leasing velocity and is currently [54%] [ph] leased with a weekly leasing run rate and price per square foot that remains in line with our expectations and with stabilization projected to occur by year-end. 1775 Eye Street has seen a steady increase in leasing activity. We are now 80% leased at this asset with either letters of intent or proposal out for the remainder of the building. We expect the lease0up of 1775 Eye Street to be completed this year with leases commencing over the next 12 months. While on leasing, I should mention that [indiscernible] lease for the112,000 square feet of space that is subleased to the Advisory Board and due to expire on April 2017 is at final [indiscernible] to be extended coterminous with their existing lease that expires in May 2019. Although our continued dialog with the Advisory Board indicates that renewing the lease at 2445 M Street remains their most economically viable proposal on the table, if their final space requirement is for 500,000 square feet or more, we are unlikely to be able to accommodate them. I would like to address the acquisition of The Wellington which is a 711 unit apartment community located at the eastern end of Columbia Pike in South Arlington. The Wellington is a high quality well-located asset with strong [indiscernible] and walkable amenities. It also offers compelling value-add potential through a planned unit renovation of over 680 units and the opportunity to use on-site density to develop approximately 360 additional units. We began our pursuit of Wellington over 12 months ago. Driven by our disciplined in-house research team, we narrowed our investment targets in multifamily in submarkets with limited supply delivery and the greatest Class B rental growth prospects. It was this granular approach that focused us on the South Arlington Class B multifamily submarket and the Wellington. Our analysis has been firmly validated by Delta Associates' recent report saying that the South Arlington Class B multifamily submarket has achieved the highest rental growth rates in the region with 9.8% rental growth in the past 12 months. Our planned unit renovation of over 680 units further capitalizes on the strong rental growth trends in this submarket. Based on the CapEx incurred and the rental growth achieved by the units that have already been renovated, we expect the unit renovation program to generate returns as well exceed our typical targets of a 10% average yield on cost. We remain committed to prudent capital allocation as evidenced on our last earnings call when we reviewed our 2015 acquisition guidance to represent the Wellington which was the value-add acquisition opportunity that was then visible to us. Furthermore, we guided to legacy asset sales as our chief source of capital for acquisition and the cornerstone of our portfolio repositioning strategy in the currently favorable investment sales climate. After our successful sale of Country Club Towers in the first quarter, we placed four additional legacy assets including land on the market. We are on track to meet our 2015 dispositions guidance of $130 million to $150 million and are preparing to accelerate additional legacy asset sales of approximately $250 million over the next 18 months. Now I would like to review the performance of our portfolio during the second quarter and touch on some of the broader trends we are seeing in the overall DC market. Some good news came in the office sector where we saw positive absorption in both DC and Northern Virginia. Concurrently we saw increased activity levels in our portfolio, especially for assets and locations proximate to metro and other [trains] [ph]. Tysons continues to see strong activity with many companies attracted to the amenity-rich environment now served with metro. That being said, many large blocks of competitive vacancy remain an ongoing challenge in this submarket. Although Northern Virginia had an excellent quarter from a net absorption standpoint, much of the absorption came from three large deals, two of which were building purchases from non-traditional industry segment, with [indiscernible] charge followed by 202,000 square foot building in Tysons and a German [indiscernible] legal purchasing a 210,000 square foot building in [indiscernible] city. This bodes well in terms of taking space off the market but may not be a sustainable trend. As mentioned previously, we see increased activity in our Silverline project and continue to seek the right tenants to anchor this high-profile asset. Across the other office markets, activity in Downtown DC remains reasonably positive in the small to midsized range and we have been effective at infill leasing in our small remaining vacancies. Suburban Maryland had another quarter of negative absorption but execution of aggressive tenant retention strategy has allowed our portfolio to consistently outperform this market over the past several quarters. Resale in the region is benefiting from significant uptick in job growth in the Washington Metro [indiscernible] last two months and the market vacancy rates for neighborhood and community shopping centers in Northern Virginia and suburban Maryland are modestly lower in the second quarter. Compared to the last quarter, we have demonstrated greater ability to push the rents higher on renewals and are successfully leasing up the vacancy created by a few known tenant move-outs in the second quarter. Multifamily supply continues to deliver in record numbers and while demand has kept up with supply, there has been some impact on effective rents. In our project located in submarkets such as [indiscernible] and Shaw where there is significant new supply, we have had [indiscernible] market from an effective rent perspective to retain occupancy. In summary, the overall portfolio has reached a consistent level of stabilization with the exception of our development and redevelopment assets which represent additional growth opportunities. Our focus on delivering the highest level of customer service with a commitment to tenant retention remains our principal operating strategy going forward. Now I'd like to turn the call over to Steve to discuss our financial and operating performance.

[Stephen E. Riffee:]

Thanks, Paul, and good morning everyone. Second quarter core FFO increased 2.4% to $0.42 compared to $0.41 in the second quarter of 2014. Same-store cash NOI increased 1.3% over the prior year. Same-store cash rents increased 120 basis points year-over-year and same-store physical occupancy at the end of the quarter was 92.8%, which is 30 basis points higher than the second quarter of 2014. Core funds available for distribution, or FAD, was $0.38 per share. For the full year, we expect a core FAD payout ratio in the high 80% range and project coverage to further approach in 2016. Office same-store cash NOI grew 2.5% year-over-year driven by 90 basis points of occupancy gains over the prior year as well as annual rental rate increases at several of our properties. Office same-store physical occupancy was 91.8% at quarter end. Our same-store Washington DC office portfolio continues to outperform its submarket with a vacancy of approximately 3% compared to the submarket's 11%. Our office portfolio also continues to outperform the suburban Maryland and Northern Virginia where our same-store vacancy rates are nearly 7% and 10% of the vacancies in those markets. Office leasing for the quarter totaled approximately 129,000 square feet with 58,000 square feet driven by new leases signed in the quarter. For new leases, we experienced a 14.5% improvement in GAAP and a modest rollup in cash rent spreads, while renewals have seen a 4.9% increase in GAAP and a 5.1% decrease in cash rent spreads. Retail experienced a robust 2.2% cash rate growth year-over-year. Retail same-store cash NOI declined 70 basis points with physical occupancy declining 140 basis points year-over-year, primarily driven by expected tenant move-outs. Of the three primary move-outs, at least two and we have letter of intent for the third. Retail leased approximately 130,000 square feet in the quarter with 35,000 square feet driven by new leases. For new retail leases, we experienced an 18.5% improvement in GAAP and a 4.4% improvement in cash rent spreads, while renewals has seen a 28% improvement in GAAP and a 14.6% improvement in cash rent spreads. Retail same-store physical occupancy was 92.8% at the end of the quarter. Multifamily same-store cash NOI grew 70 basis points year-over-year as 90 basis points of occupancy gains over the prior year offset 2.7% of rent roll-downs. Multifamily same-store physical occupancy was 94.5% at the end of the quarter. Turning to guidance, we tightened our 2015 core FFO by $0.04 to a range of $1.58 to $1.72. We changed the midpoint of our previous guidance range. The following assumptions underpin our narrowed guidance range. Overall same-store NOI growth ranges from negative 0.5% at the bottom end to positive 2% at the top end, with the same-store office portfolio growing 0% to 2%. Retail ranges for negative 1% to positive 1% and multifamily ranges between 0 to 1%. As a reminder, same-store growth is impacted by the large year-over-year increase in Washington DC real estate [packages] [ph]. We currently expect $0.01 per share NOI contribution in 2015 from The Maxwell which remains to in fact stabilize by year-end. While there is a late delivery, [indiscernible] timing of Maxwell's expected contribution to NOI, it remains projected to grow to approximately $0.04 to $0.05 per share annually upon stabilization. We continue to expect the Silverline Center to contribute $0.06 to $0.08 to NOI per share in 2015 with the lease-up gathering greater momentum into 2015. Our entire acquisition guidance assumes the acquisition of the Wellington. While we continue to thoroughly evaluate and underwrite value-add acquisition opportunities, our prudent guidance does not contemplate additional acquisitions in 2015. Our interest expense is projected to range between $60 million to $60.5 million and our G&A guidance remains unchanged at $19 million to $20 million. Finally, our guidance does not assume any equity issuance. Our acquisition of the Wellington creates the opportunity to reflect additional legacy assets for the low tax basis and a very tax efficient manner utilizing reverse February 1 exchanges. Of the four legacy asset sales including land that Paul mentioned earlier, two are on the contract and the third is in active contract negotiation. Based on our assessment of market conditions, we are planning additional legacy asset sales over the next 18 months with approximately $250 million of dispositions to [indiscernible] the assets we currently have in the market or under contract. We will monitor market opportunities and if appropriate we'd accelerate the $250 million of asset sales which are currently not included in our 2015 guidance of an expected $140 million to $150 million of dispositions. The sale of our interest in one parcel of the aforementioned land is close in value to the land we just acquired with the Wellington. Our capital allocation positions are informed by our in-house research. This concluded that the South Arlington submarket was significantly superior in terms of its demographics and rental growth potential than the submarket we [unlanded] [ph]. The managed sale under contract allocates our capital to the land associated with the Wellington, and thereby to what we believe is a superior [indiscernible] opportunity. In addition, we plan to sell another parcel of land valued at approximately $12 million. We repaid our $150 million of 5.35% bonds that matured in May by drawing on our credit facility. Instead of terming that out through an index eligible bond offering as previously discussed, we now plan to term out $150 million through 2021 with a term loan and did swap that loan for fixed rates. This will fit well in our debt maturity ladder and provide us with greater flexibility to [indiscernible] legacy asset sales if appropriate as compared to issuing a minimum $250 million of investment eligible bonds. The maturity of secured debt in 2016 and 2017 should help provide opportunities to continue to term out debt in those years by accessing bond markets. We target ending the year in an annualized fourth quarter net debt to adjusted EBITDA ratio of approximately 6.9x and are targeting to achieve a 6.5x net debt to adjusted EBITDA in 2016 as additional NOI contributions through the Silverline Center, The Maxwell and 1775 Eye Street are expected to increase EBITDA. We have a new and expanded presence that increases our line of credit to $600 million while extending maturity including financial covenants, lowering pricing, and better revising the terms of the facility with our value-added business model. And with that, I will now turn the call back over to Paul.

[Paul T. McDermott:]

Thank you, Steve. To conclude, we remain committed to prudent capital allocation as demonstrated by our value-add acquisition of the Wellington where we expect our unlevered IRR to well exceed our cost of capital. Additionally, we have significantly increased our legacy asset disposition plan in a continued effort to capitalize on the currently favorable investment sales environment and help us opportunistically transfer risk while elevating the quality of our portfolio. We have confidence in the success of Silverline Center, The Maxwell and 1775 Eye Street and continue to expect them to contribute 20% to 23% of NOI upon stabilization. In addition, we look forward to evaluating further development, redevelopment and renovation opportunity embedded in our existing portfolio. I would also like to emphasize that we are deeply committed to our investor relations outreach which began in mid-May this year and has led to a meaningful dialog with numerous stakeholders and other dedicated investors. We greatly value investor feedback and look forward to an active schedule of meetings with investors for the remainder of the year. And finally, our region saw job growth of 68,500 jobs between June 2014 and June 2015 compared to our 20 year average of 41,700 jobs. Similarly strong April and May data suggests that the Washington Metro area economy may have turned the corner in the last few months. Encouragingly the job growth has been driven by specialized professional, scientific and technical services as well as by healthcare and is reflective of the private sector gradually reducing its dependence on government spending. We look forward to the continued improvement in market fundamentals and believe that improving the quality of our portfolio now will better position us for future real estate growth. Now I would like to turn the call back over to the operator to open it up for questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Dave Rodgers with Robert W. Baird. Please proceed with your question.

[David Rodgers:]

I wanted to ask you about the $250 million of potential additional asset sales and it sounds like there is some opportunity to move that up, and I guess the two questions would be, what are you really looking for to move that forward if you were to do that, and I guess the second thing would be, do you see yourselves kind of deleveraging with that additional $250 million or would that be all 10/31 as you look at that group of assets?

[Paul T. McDermott:]

First off in terms of the $250 million and the composition of itself, obviously we are – I think as we've said on prior calls, we feel just looking at our own eye, we're over-weighted in office and we see opportunities in terms of our suburban office properties that we did not see probably 12 months ago. I can give examples, Dave, of a couple of funds that have recently been raised and are actively out pursuing opportunities over the last 12 months specifically targeting certain suburban office market domestically. So, I think that we are looking right now, we're having dialogs with a number of different private equity sources that [indiscernible] about opportunistically transferring those assets. In terms of accelerating those assets, I think it's really contingent on the timing and the type of pricing and structure that we can get. We are being very sensitive since we do have some tax issues with some of those assets. We are trying to integrate that into our strategic exit on those. And then in terms of how the capital is going to be reallocated, we are considering a number of opportunities to reutilize that capital. I think paying down debt could be one but also we could use other 10/31 signalling there are other investment vehicles.

[David Rodgers:]

And I guess just playing off of that last comment, Paul, in terms of acquisitions, what are you seeing? Are you still finding acquisitions that are attractive or you're just struggling with kind of capital allocation against those or has the pool of assets that you're looking to acquire maybe thinned out or just become too aggressive?

[Paul T. McDermott:]

I think in terms of prioritization, what we want to do and I think the signal that we have sent out to our investors and our shareholders is we want to capitalize on this window in terms of selling some legacy assets where we don't see the growth prospects and we see another opportunity. I can only point to, Dave, an opportunity like the Wellington. It took a long time to put that deal together and we basically had our eyes on that for about 12 months before closing it. I do think the amount of transactions in DC has thinned out but we still are – we are being paid to be the local sharpshooter. I think we've identified some good opportunities but again these opportunities are timing opportunities and they have to hit our pretty rigid value-add criteria.

[David Rodgers:]

Last question for you, Paul, in terms of the renovations at the Wellington, can you talk about kind of what the spend might be, the timing and should we see any impact on earnings performance over the next couple of quarters as you move through those on rollovers?

[Paul T. McDermott:]

Sure. So we have, it's a 711 unit property, we have about 680 units to renovate. And stepping back, the Wellington itself for us, one of the criteria that I talked about, and I think I talked about it on several calls, was really what attracts us to that and why would we allocate capital there. We love to grow prospects in that South Arlington, specifically that Class B market. Second is, we think we are operating this property and we acquired it at about a 40% discount to replacement cost. We think that adding probably between 8,000 to 10,000 per door, Dave, is what we are going to be looking at. At a minimum we think we'll be juicing rents probably about $100 a door and we will, as we see that phase in, that's probably going to be about a 30 month renovation for the entire project. We see that adding approximately about 50 bps as each one of those newly renovated units come online.

[David Rodgers:]

Alright, great, thanks for the detail, Paul.

[Operator:]

Ladies and gentlemen, our next question comes from the line of Brendan Maiorana with Wells Fargo. Please proceed with your question.

[Brendan Maiorana:]

Steve Riffee, just a bunch of questions for you, so you mentioned that the EBITDA end the year at 6.9, you think it probably be next year 6.5. Is that contemplated on a leveraged neutral basis or is that assuming that you're going to take some of the proceeds of the $250 million of assets that you've guided for next year and you've not paid out [debt] [ph]?

[Stephen E. Riffee:]

Brendan, we're not giving full guidance for next year but there is just an element of the $250 million that we would likely want to reinvest for tax purposes, but we keep doing our tax planning and modelling so that we have the greatest flexibility possible to consider delevering it all. So I think just it's really driven primarily by the growth in EBITDA that we are anticipating from our lease-up of our value-add properties, the Silverline, the Maxwell, and even 1775. So it's more driven by growth in EBITDA than change in that level.

[Brendan Maiorana:]

Sure. So you guys have – you mentioned $0.20 to $0.23 of EBITDA growth from the three assets, and I think this year kind of midpoint of guidance is that they would contribute about $0.09 a share to this year's FFO, and most of that is that Silverline and I know that lease right there has been pretty steady over the year although I think you've had move-in and out, is the $0.09 that you're getting, is that earned pretty ratably over the year or is that predominantly backend weighted?

[Stephen E. Riffee:]

So if you take the tail guidance point that I just talked to David, so that we have changed this year's contribution from the Maxwell to $0.01 and we've had very little or close to zero contribution in the first half of the year on a net basis, so that $0.01 is earned ratably over the second half of the year. And then we are at the $0.04 to $0.05 for next year on the Maxwell as we stabilize at the end of the year. The guidance that we are giving on the Silverline, the $0.06 to $0.08, so if you took the midpoint that would be $0.07. So I would say that's about $0.08. Of the Silverline, we're just under $0.03 in the first half of the year. So you would take that range minus the approximately $0.03 and that would be your expectation for the second half of the year.

[Brendan Maiorana:]

Okay, and then 1775 Eye, is that – I think it's $0.01, so is that about ratable for the year?

[Stephen E. Riffee:]

The leasing on 1775, the incremental leasing is getting done in this year but it really starts rent commencement in 2016. So I'm not expecting additional NOI from that in this current year and the guidance that I just gave.

[Brendan Maiorana:]

Okay. And then you're going to [indiscernible] your credit facility balance, it was 185 at June 30, then the Maxwell closed July 1, but to bring that number up, it's around 350, you've got the asset sales I guess about 110 going to the back half of the year, and then you're going to do the term loan, so how do we think about kind of longer-term how much you'd be comfortable running on the credit facility?

[Stephen E. Riffee:]

Number is 340 today, okay, not 350. So it's a little bit lower than we thought. I expect to term out 150 as you said. So that will bring it down. And then we do have the asset sales that are already in the guidance and I think you've got the range well there and I'm leaving some flexibility to increase some of the $250 million of asset sales into this year. So maximum under that math would be, you might be sitting at $100 million out on the line and we could drive it down to zero if we accelerate additional asset sales. My general philosophy on line use is, try to use no more than half of it in general or if you put outstanding, and when you get to above half you should be thinking about terming out debt, and the size that we negotiated for this line, that means we should be thinking about long-term index saleable bond offerings as are more typical way of terming out debt. So that's how I plan to manage the line.

[Brendan Maiorana:]

Okay, great. But then just perhaps one, Paul, so really appreciate all the transparency that you've given over the past several quarters on Advisory Board, my recollection was that there was, maybe there was a decision between Advisory Board and Epstein Becker and you couldn't kind of keep both of them, but I think Epstein Becker their expiration is sometime next year, when do you think you'll have a sense of what's likely between either of those two tenants that may remain in the building?

[Thomas Q. Bakke:]

Brendan, this is Tom, Paul just looked at me for the answer on that one, but I think we're parallel passing both of those and engaged with both. We've heard Advisory Board is going to make a decision this year. That's certainly going to be a driver on Epstein Becker. Epstein Becker would like to stay from what we hear, although they are engaged in the marketplace just because that's smart business. We're going to hopefully retain – we'd like to retain both but more than likely we'll retain one of them and we're going to work on that in parallel path.

[Brendan Maiorana:]

Okay, all right, thanks for the time.

[Operator:]

[Operator Instructions] Our next question comes from the line of John Guinee with Stifel. Please proceed with your question.

[John Guinee:]

Just I guess, Steve, for the rest of the year should we just assume that Wellington is match-funded against your credit line and is that part of a 450 basis points of [half] [ph] spread?

[Stephen E. Riffee:]

No, I think the timing is we are going out to do the term loan in the third quarter, John. So I expect to be terming that out and swapping it to fixed, probably 5.5 year term loan, then swapping it to fixed in the third quarter and then I expect us to be closing the asset sales which sequentially are a part of our capital allocation back towards the Wellington throughout the year. So I would expect that the third quarter is probably about $0.01 higher than the fourth quarter as we start to term out debt and close asset sales in terms of that expectation of timing.

[John Guinee:]

Okay. And then which assets did you take the impairment and which assets did you have a gain?

[Stephen E. Riffee:]

So speaking to the impairment, that related to going under contract after the quarter ended on a piece of ground that was slated for multifamily development in Alexandria that we decided was not as attractive a submarket for multifamily rental growth as the one that we had an opportunity to get into through the Wellington. So we negotiated a contract and basically adjusted that land value to what we think we're going to close under the contract. That happens to be almost exactly the amount of money that we believe is allocated towards the ground associated with the Wellington. So from a capital allocation standpoint, we took a non-earning asset and replaced it with one that we think has a greater future NOI potential. We had a small gain on a property up in Maryland, a retail property where the state actually took a piece of ground and reimbursed us for it to expand the local growth, and that created that small gain.

[John Guinee:]

Okay, so both of those ran through NAREIT to find FFO that were actually yours?

[Stephen E. Riffee:]

That's correct.

[John Guinee:]

How interesting. Okay, all right, thanks a lot guys.

[Operator:]

Our next question comes from the line of John Bejjani with Green Street Advisors. Please proceed with your question.

[John Bejjani:]

Quick question on just the broader DC office environment, so improving job growth appears to already be a pretty clear positive for both retail and the multifamily but also absorption seems to not benefit as much and leasing costs are still pretty high, is there any further insight you can share [indiscernible] or what needs to happen for leasing to start pulling back down to earth?

[Paul T. McDermott:]

I'll start, John, and then I'll ask Tom to jump in with probably a little bit more real time color. I mean when we look at DC right now and we look at our portfolio, I mean we're happy with it in terms of the retention statistics we're seeing. I think just looking at the last quarter alone, we had about 275,000 square feet of positive absorption, about 55,000 in the East End and about 1.25 in the CBD. The CBD for the first time in a long time is below 10% in terms of vacancy and the East End is also coming down. I think we are still seeing the smaller tenants right now that are kind of ruling the day and where smaller tenants just have optionality. When I say the smaller tenants, I'm kind of talking to 6,000 to 10,000 square-foot tenants that kind of dominate this space. And we just don't see that changing the small pocket with primary space and shadow space and sublease space. We still see that being an ongoing challenge through the remainder of 2015. Tom, do you have any?

[Thomas Q. Bakke:]

Yes, so to add to that, I think there's always a lag effect on sort of job creation and absorption, and I think we're definitely seeing some good job activity. We had good absorption in Northern Virginia, I think as Paul said in this opening comments about some of those were non-traditional users, but absorption is absorption, we'll take it. I think we're seeing positive indicators. That being said in Northern Virginia overall 18%, Maryland high teens, as well some people say Maryland is at 20%, DC on average at 10% which is good but the suburbs, they've just got a long way to go. But the indicators seem to be gradually improving and I think that's what everybody seems to be saying out there.

[Paul T. McDermott:]

I think the last point I'd add, John, and it's really just running on Tom's [indiscernible] a little bit, our observation would be that some of these employment numbers take a while to bake in. If you look at the average rent year-over-year for DC in general, I think we were at $50 or $50.10 last year, I think we're up $0.52 over [indiscernible] on a gross basis. We're moving in the right direction, we're just not moving at the trajectory that we would all hope for.

[John Bejjani:]

Thanks for the color. Paul, I have just a follow-up on the Wellington acquisition. Can you elaborate on your unlevered IRR commentary, what kind of returns are you guys underwriting and where do you see your cost of capital?

[Paul T. McDermott:]

We went in just a hair under 6. As I said, we expected those with the renovations to stabilize in the mid to upper 6 as those units come online. And then if you look at the development component, we are at north of 100 to 150 basis points above that when we bring the development in [queue] [ph].

[Operator:]

[Operator Instructions] Our next question comes from the line of Chris Lucas with Capital One Securities. Please proceed with your question.

[Christopher Lucas:]

Paul, just a follow-up on the Wellington commentary, what is your thought process as it relates to starting the development planning process?

[Paul T. McDermott:]

We are looking at it right now, I mean we spent some capital looking at drawings and we've got the option, Chris, as you know, to build 360 units. We want to get underway with the renovation program but we think it tend to end the development process would probably be I'd say 30 months and 18 to 22 to build with them leasing. We're specifically targeting right now, Chris, a window of delivery when we don't see competitive supply forces. And so I think we'd be looking at in late 2016 or early 2017 breaking ground and then taking it from there.

[Christopher Lucas:]

Okay, thank you. And then I guess, Steve, on the Silverline Center, I'm just trying to understand the guidance contribution. So with the first half of the year was call it roughly $0.03, how do you get to $0.08? Are there leases that have been signed that need to commence or how do you get to $0.08, I guess is what I'm trying to figure out here, given that the leasing level has stayed pretty consistent?

[Stephen E. Riffee:]

It has to do with leases and some contributing before the end of the year. I'll let Tom give you a little color on some of the leasing activity that's underway even since quarter end.

[Thomas Q. Bakke:]

We've got as you know in your recent visit, we've got good activity and we have about 24,000 feet that we've recently signed and about 15,000 that's going to probably occupy or get going in the third quarter. There's a little bit of slippage potentially on some construction starts, but nonetheless I think – and then we've got some potential for some others to occur later in the year, we've also got a full floor tenant LCC, they just came in and we'll get a full six months out of them.

[Paul T. McDermott:]

They just partially contributed to the quarter.

[Thomas Q. Bakke:]

Yes, they didn't contribute much in the first quarter, for the first two quarters.

[Christopher Lucas:]

Thank you for that. And then just a final question as it relates to just the retail portfolio, the shopping center peers tend to run right now at a 95%, 96% lease rate and you guys have been sort of in this lower 92%, 93% range for a while. What is your expectation for what you think is a stabilized sort of maximum lease rate for that portfolio?

[Thomas Q. Bakke:]

I think we've been up around 95% before. We had some known vacates that hit us in the first half of the year which two of them are leased and the third is at LOI, and those were, one was a 25,000 foot vacancy out at Bradlee that is leased with a small portfolio. So a 25,000 foot deal is a big mover. And then we had a 30,000 foot space that were an LOI. So we'll get back up to the mid-90s, sort of that peer benchmark here in a couple of quarters.

[Christopher Lucas:]

Okay, great. Thanks a lot guys.

[Operator:]

[Operator Instructions] Our next question comes from the line of John Guinee with Stifel Nicolaus. Please proceed with your question.

[John Guinee:]

Just because Wellington is 5% of your total capitalization and you've got big plans for it, just sort of walk through, I think what you're saying, you paid about 230,000 a unit for it and that 60% replacement cost, that implies you're going to build 400,000 square foot product there, are you also going to have to decommission all the surface parking and make the entire project structured parking, what's the grand plan for that location?

[Paul T. McDermott:]

I think we paid just on my math, John, I think we're about 214 a door with a $15 million land contribution, and yes we will be using some of the excess surface parking. It will fence with the Texas Donut with parking with [thicker of a top] [ph] and it will be with some additional [indiscernible] included but that's the plan right now.

[John Guinee:]

So what you're thinking is you're all in to develop Texas Donuts or a 5-over-2 when you have to sort of create an immense amount of parking for what was previously surface park for the other 700 units?

[Paul T. McDermott:]

I think our basis were in, just going back on it, I think we're in close to I want to say upward 200 a door.

[John Guinee:]

Okay, great. Thank you very much.

[Operator:]

Our next question comes from the line of Brendan Maiorana. Please proceed with your question.

[Brendan Maiorana:]

Couple of follow-ups. So one, Silverline, so the lease rate remained at around 60% and I think you guys had maybe a couple of tenants that moved out and a couple that moved in, if you look at the existing tenant base today, is that stable so really the leasing is just focused on getting tenancy for the remaining roughly 200,000 square feet that's un-leased?

[Thomas Q. Bakke:]

Yes, Brendan, that's the right way to look at it. We had a couple of renewals downsize. These are folks that stayed with us during the redevelopment, so we got them to stay, a couple of them downsized in the last quarter but the existing tenant base now is stable and we're going up from there.

[Brendan Maiorana:]

And are some of the [indiscernible] tenants that you mentioned that were over 50,000 square feet each, are they all candidates or is it something where you can only accommodate maybe one or two of them, you couldn't do all three?

[Thomas Q. Bakke:]

I think the hard part is what's attractive to the big user is to be sort of the anchor and to get the sign on the building and you're probably going to do at most two of them, we won't do all three just because they won't want to sort of complete for that visibility or share that visibility should I say. And so I think two is – one maybe 60, one 40, that would be a nice mix.

[Brendan Maiorana:]

Got you. Okay, great. And then last one, Paul, you mentioned kind of the dispositions probably likely oriented towards some of the legacy suburban office stuff that's there, that has historically been in a higher CapEx product type for Wash REIT. If you're selling stuff broad-brush, what you think the economic cap rate would be after CapEx cap rate is likely to be on some of that you market?

[Paul T. McDermott:]

Brendan, that's pretty asset specific because we have varying degrees within our probably suburban portfolio. I think as we talked about at NAREIT when we met, if this conversation was taking place 12 months ago we wouldn't even been able to really talk about monetizing some suburban office product. I think right now we're looking at probably a low to mid-7 cap rate range. That's our observation on some deals that are actually out there right now. Even if I look at an asset like our 6110 property, I mean what we had to do is I think we've been pretty consistent about positioning these assets for sale and that's buttoning up leases. So something that's not in the numbers that we just disclosed, we just backfilled the old Wash REIT space last night, almost all of it with the new tenant. So we have to continue to do those types of leasing pushes as we position those assets for sale to try to bring that cap rate down to kind of a more palpable number from a dilution basis.

[Brendan Maiorana:]

And I think that low-7 number, that's probably a nominal cap rate. Is it fair to think that getting into the specific assets may or may not help it over time that those assets have had maybe 20% of their NOI on an annual basis has been taken away by CapEx spending?

[Paul T. McDermott:]

Not being specific, I mean one of the things I would say that just having just walked several of these assets, I think that Wash REIT, one of the things that it wasn't shy about was spending money on CapEx for its properties. I think most of these assets are in good shape. I think, Brendan, if there's going to be any type of punitive pricing, I think it's probably going to be on a submarket basis probably more than it is going to be on an asset specific basis.

[Brendan Maiorana:]

Got you. Okay, thanks guys.

[Operator:]

There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

[Paul T. McDermott:]

Thank you. Again, I would like to thank everyone for your time today. As we announced in the first quarter, Laura Franklin, our Executive Vice President of Accounting and Administration, will be retiring at the end of this year. As this will be her last earnings call with us, I would like to take this opportunity to thank Laura for over two decades of valuable service. Laura has played an integral role in building our solid financial foundation and helping us successfully implement our strategic plan. She is a well-respected leader whose loyalty and dedication has significantly contributed to the Company's growth and success. On behalf of all of us at Washington REIT, we wish Laura all the best in her future endeavors. In conclusion, we are excited about the future of Washington REIT and its ongoing transformation into a best-in-class operator real estate in Washington DC. We remain committed to executing our strategic plan by making prudent capital allocation decisions and driving operational performance. I look forward to updating you on the progress on our next call. Thank you everyone.

[Operator:]

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect.