Highwoods Properties, Inc.
Q4 2007 Earnings Call Transcript

Published: 13 Feb 2008

[Operator:]

Good morning, and welcome to the Highwoods Properties fourth quarter and year end conference call. (Operator Instructions) Ms. Zane, you may begin your conference.

[Tabitha Zane:]

Thank you and good morning. On the call today are Ed Fritsch, President and Chief Executive Officer, Terry Stevens, Chief Financial Officer, and Mike Harris, Chief Operating Officer. If anyone has not received a copy of yesterday's press release or supplemental, please visit the website at www.highwoods.com or call 919-431-1529 and we will email copies to you. Before we begin, I would like to remind you that this call will include forward-looking statements concerning the Company's operations and financial condition, including estimates and effects of asset dispositions, the cost and timing of development projects, rollover rents, occupancy, revenue trends and so forth. Such statements are subject to various risks and uncertainties. Actual results could materially differ from those currently anticipated due to a number of factors including those identified at the bottom of yesterday's release and those identified in the company's annual report on form 10-K for the year ended December 31, 2006, and subsequent reports filed with the SEC. The company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events. During this call we will also discuss non-GAAP financial measures such as FFO and NOI, definitions of FFO and NOI, and an explanation of management's view of the usefulness and risks of FFO and NOI can be found toward the bottom of yesterday's release, and are also available on the Investor Relations section of the web at, again, www.highwoods.com. I'll now turn the call over to Ed Fritsch.

[Ed Fritsch:]

Good morning and thank you for joining us today. 2007 was another year of solid accomplishments for Highwoods. Full year FFO per share was $2.77 excluding impairments and stock redemption charges and FFO from core operations was $2.40 up 9% from 2006. We were also CAD positive for the year. In addition, in 2007 we entered the year with 92% occupancy, started $124 million of new development that is 59% pre-leased, delivered $201 million of development that is 90% leased, sold $144 million of non-core properties at an average cap rate of 6.3%, sold $37 million of non-core land for a $16 million gain, retired $62 million of high coupon preferred stock, paid down $92 million of secured debt and issued $400 million of 5.85% unsecured bonds. All-in-all it was a very productive year and we ended the year strong, with just under 2 million square feet of first and second generation space leased in the fourth quarter. While our customers are being more deliberate in their decision making process, leases are still being signed. From what we see, the general mood of small to medium sized businesses, which is our sweet spot, is cautiously optimistic. Mike will go into further detail regarding our top five markets. On January 28, we published our 2008 guidance projecting FFO from core operations to increase 5% from 2007 at the midpoint of our 2008 range. The projected growth of core FFO demonstrates that we are reaping the rewards of the key initiatives of our long-term strategic plan. Since implementing our plan in January of 2005, we have started $563 million of development in 12 markets with average stabilized cash yields of 9%. During this three-year period we also increased occupancy by 700 basis points, reduced our land holdings by almost 50% by selling non-core land which generated gains of $0.51 per share, and placing core land into service for new development. We sold $742 million of non-core, older assets at an average cap rate of 6.7%, retired $242 million of high coupon preferred stock, refinanced expensive debt and increased unencumbered NOI from 51% to 58%. Looking ahead in 2008, we expect to deliver $211 million of development. This includes RBC Plaza, the mixed use office, retail and residential project in downtown Raleigh. We also plan to sell $100 million -$250 million of non-core properties. While these properties targeted for sale are non-differentiating older assets, on average they are not as "leaning-curve" challenged as the properties sold over the last three years. We will continue to preen our non-core land holdings, generating cash proceeds. However, we expect future land sale gains to be nominal. Less than 25% of the 634 acres we own to date is non-core and our 493 core acres can support approximately $1 billion of development. This year we have budgeted to buy $10-20 million of land in strategic infill locations in a number of our markets. To date, we have not seen a drop in the pricing of premium infill land, but we are watching our markets closely. Finally, we expect to remain CAD positive for the full year 2008. While we have a lot of good news to report, and continue to see good leasing activity, we aren't looking at the world through rose-colored glasses. We recognize that the economy is experiencing turmoil and uncertainty abounds. However, we believe Highwoods is significantly better prepared to weather and take advantage of a slowdown today than we were 36 months ago. We have an experienced and highly energized management team, we have a significantly better portfolio, we have well-leased accretive developments delivering in virtually all of our markets and we have dry powder to take advantage of acquisitions and/or development opportunities that make sense for our shareholders. Mike.

[Mike Harris:]

Thanks Ed, and good morning everyone. As Ed mentioned, we had a very solid quarter leasing almost 2 million square feet of first and second generation space which helped increase our occupancy by 200 basis points year-over-year. Looking at occupancy for all of 2008, we do expect it to drop in the first quarter due to several industrial lease expirations. As we move through the year however, we expect occupancy to pick up and should finish the year in our forecasted 92-93% range. In my monthly call with all of our leasing routes they commented that our customers were generally satisfied with the size of their current space and in fact, some of our customers have hinted they would expand if they could get comfortable with the economy. Due to the uncertainty of the marketplace, deals are taking a little longer to sign, but they are still getting done, and we have not seen much of an increase in concessions. We were also very pleased that in December we renewed what was by far our largest 2009 lease expiration, 221,000 square feet in Atlanta, with AT&T. Average in-place cash rental rates across our total portfolio was 2.4% from a year ago, and were up 3.1% from the same period a year ago for our office portfolio. There is still a fairly wide spread in asking rental rates between first and second generation space in our markets and this should serve to sure up second gen. rates CapEx related to office leasing was $11.32 per square foot in the fourth quarter versus the five quarter average of $11.52 per square foot reflected in our supplemental. While I will go through our top five office markets, overall for 2008 we expect to see positive market absorption with flat to modest rent increases and no meaningful change in TIs and lease commissions. New construction was 3% of market at yearend and we don't anticipate a material increase in 2008. Turning to our top five markets and starting with Raleigh. In 2007 occupancy in our portfolio increased a healthy 540 basis points year-over-year to 91.5%. We also have $186 million of development underway that is 64% pre-leased. This includes RBC Plaza as well as GlenLake IV and VI, and Centre Green V. Market absorption was solid, just under 500,000 square feet in the quarter and 1.3 million square feet for the year. As we've discussed on previous calls, there is quite a bit of office development activity underway in Raleigh. About 4.8% of the market, or 1.9 million square feet. Taking a closer look, if you strip out Highwoods development, and development in outlying submarkets where we don't compete like Durham and Chapel Hill. The competitive landscape is not nearly as crowded. In fact, construction as a percent of market crossed to 2.4%. Pre-leasing in this competitive subset, excluding our development is 54%. Demand in Raleigh should remain relatively strong, buoyed by such growth in industries as clinical research organizations, pharmaceuticals and telecommunications. Occupancy of our Atlanta office portfolio continues to perform better than the overall market. 90.5% versus 87.2%. Net absorption was 3.3 million square feet last year. We have 23 million of development underway in Atlanta including a 50,000 square foot Build-to-Suit for the FAA and a 263,000 square foot industrial building, Newpoint V, that is now 88% pre-leased. In the fourth quarter of 2007, we placed our $21 million, 91,000 square foot Build-to-Suit for Department of Homeland Security into service. New office construction remains moderate in Atlanta, about 2.4% of the total market with most of this construction occurring in the Buckhead and Midtown submarkets where we do not directly compete. Market rents in our submarkets, specifically Central Perimeter and I85, are trending up by on average, 3-5%. Occupancy in our Tampa portfolio declined slightly from last quarter but is still a very respectable 95% and we continue to outperform the office market as a whole which was 87.4% occupied at the end of the fourth quarter. The Westshore Submarket, where over half of our Tampa assets are located, continues to demand the highest office rental rates in the area. We are seeing significant new spec office construction starts in this submarket. A few weeks ago we announced that we had signed a 25,000 square foot lease at Highwoods Bay Center I with a major software supplier. We started construction of this 208,000 square foot, $42 million, Class A office building as a 100% speculative project in 2006 and it is now 78% pre-leased. We are getting higher rents than pro-formant in our initial model and this project should be stabilized before the new product in Westshore delivers. Occupancy in our Richmond portfolio climbed to 92.5% at the end of December, a 70 basis point increase from the third quarter, and 270 basis points better than December 2006. For the year, the Richmond office market absorbed close to 800,000 square feet compared to negative absorption of 32,000 square feet in 2006. Stony Point IV, which is 96% leased, was placed in service in the fourth quarter. Leasing in our second developed project in Richmond, North Shore Commons II, started out slower than originally expected, but leasing activity has been picking up, and the project is now 46% pre-leased. This is a significant improvement from the third quarter, when pre-leasing stood at 17%. Our Nashville portfolio ended the year 95.1% occupied, up 350 basis points from December 2006. Net absorption of that market was 1.6 million square feet, compared to 908,000 square feet in 2006, and the healthcare industry continues to drive much of that market’s growth. We have placed two of our three development projects into service in the fourth quarter. Our 255,000 square foot Build-to-Suit for Health Ways and Cool Springs III, a 153,000 square foot totally spec office building that is now 100% leased. A third project, Cool Springs IV, is on the way and expected to deliver this fall. The Cool Springs submarket is one of the most vibrant and active submarkets within our system. Although new supply continues to be delivered, demand remains strong, largely from burgeoning health care companies such as Health Ways and CHS. Based on the level of activity we are presently seeing, we believe our markets will continue to enjoy healthy demand in 2008. However, we are mindful that prolonged economic uncertainty could slow activity. With higher portfolio occupancy and less spec development inventory, our leasing folks are highly incentivized to continue to take care of renewals, re-let vacant space, and pre-lease future developments.

[Terry Stevens:]

Thanks Mike and good morning everyone. As Ed noted in his opening remarks, we had a very solid year. FFO per share for the fourth quarter was $0.65, with no unusual charges or credits. FFO for the full year was $2.77, as adjusted to exclude $0.04 in preferred stock redemption charges in prior quarters, and $0.01 from a third quarter impairment charge. These results compare to $0.71 and $2.46 per share in the corresponding periods of 2006. FFO from core operations, which we define to exclude lease termination fees, land gains and any similar items was $0.64 this quarter, which compares to $0.56 for the fourth quarter of 2006, and $0.61 in the preceding third quarter of 2007. For the full year, FFO from core operations was $2.40, compared to $2.20 in 2006, a 9% increase. These improvements primarily reflect growth in same property NOI, and contribution from new development deliveries. Total revenues from continuing operations in the fourth quarter were up 8.6 million, or 8%, compared to the same period of 2006. 2.2 million of the increase relates to same properties and the remainder comes primarily from development properties delivered late 2006, and in 2007. The growth in same property revenues primarily reflects higher same property average occupancy, plus increases in average in-place rent per square foot. Total same property NOI, excluding, straight line rental income lease termination fees was up 2.4% for the quarter, compared to fourth quarter ’06, and up 4.2% for full year ’07, compared to 2006. We are pleased that our total NOI margin for all properties increased from 62% in the fourth quarter last year to 63.9% for this quarter, and for the full year increased from 63.2% to 64%. These improvements result from higher revenues and higher average occupancy, and in addition we are benefiting from the lower operating costs of a younger and higher quality portfolio and also from recent investments in such things as lighting and HVAC energy savings initiatives. We continue to work hard in controlling both fixed and variable operating expenses. G&A for the fourth quarter of 2007 was lower by about $1 million compared to the same quarter in 2006, just under $0.02 per share. The fourth quarter decrease was due in large part to lower expenses from marking to market deferred compensation liabilities and phantom stock. For the full year, G&A was up 4.2 million, or $0.07 per share, $0.03 of this increase was due to higher write-offs of predevelopment costs, including several GSA deals where we were short listed, but not the winner. $0.01 of the increase was from RBC residential condo marketing costs, which must be expensed under GAAP. And as we previously reported, all 139 condo units are now under contract with nonrefundable deposits, so future marketing costs will be minimal. Over $0.01 of the increase was from higher annual and long term incentive costs, offset by lower phantom stock expense on deferred compensation, and the net remainder of the increase is primarily from annual merit increases on salaries, increases in healthcare employer taxes, and other inflationary effects on our G&A activities. Interest expense and preferred dividends on a combined basis were up about $1 million or $0.02 per share in the quarter, compared to fourth quarter last year, primarily due to higher average balances quarter-over-quarter, offset by slightly lower average rates. For the full year, interest expense and preferred stock dividends combined were down $4 million or $0.07 per share, due to lower average debt and preferred stock balances year-over-year, and from higher capitalized interests from our growing development pipeline. Primarily as a result of our recent refinancing activities, and declining floating rates. The weighted average rate on all of our preferred stock and debt combined was 6.79% at year end, or 29 basis points lower compared to the end of 2006. We’ve mentioned the very strong land sale gains we had in 2007, mostly in the first quarter. Going forward we will still have more non-core land to sell, but the gain should be nominal. We do expect to generate gains beginning in late 2008, and into 2009 from sales of the residential condos being constructed in the RBC tower here in downtown Raleigh, and we will include those gains in FFO. On the building side during 2007, we sold wholly owned, non-core buildings for gross proceeds of $114 million, plus another $30 million representing our share of joint venture dispositions. All told, including our share of the JV gains, we recorded gains on building sales in 2007 of $46 million, or $0.75 per share, most of which is included in discontinued operations, and as you know building gains are not included in FFO. The FFO contribution from our unconsolidated joint ventures was 4.8 million for the quarter, and 19.4 million for the full year, up modestly from 4.5 million and 18.0 million for the corresponding periods in 2006. We’ve recently been advised that our joint ventures in Des Moines, which we do not manage, and which are not audited by our independent auditor, will be adjusting their 2007 financial statements to correct for the cumulative effect of using certain non-GAAP depreciation methods for buildings and tenant improvements in prior years. We record our share of their net income using information provided from our joint venture partner. After we received the revised information from our partner we will determine as part of the final completion of the audited financial statements whether any adjustments should be made to depreciation expense included in our share of income from the joint ventures. However because any such changes will relate to depreciation expense, there will be no impact to FFO. On the financing front in 2007, we paid off 92 million of secured debt, with a weighted average interest rate of 7.9%, which uncovered 202 million of assets based on un-depreciated book value, and we retired a total of 62 million of preferred stock. Since embarking on our strategic plan in early 2005, we have unencumbered approximately seven buildings, and today the portion of our total NOI that is not encumbered by secured loans is 58%, up from 51%. Just about two weeks ago we paid off at maturity 100 million of 7.125% of unsecured bonds. We used our credit facility to fund this pay down on a temporary basis. We are working on a 137.5 million three year bank term loan that is expected to have the same - covenants as our credit facility and bear interest at LIBOR or plus 1.1%. The rate would equate to 4.3% using today’s LIBOR. We have received signed commitments from eight banks, and expect to close this term loan on these terms before the end of the quarter, and use the net proceeds to pay down our revolving credit facility. Pro forma, after the term loan closing, we will have 263 million of borrowing capacity under our unsecured revolving credit facility, plus another 70 million of capacity under a new revolving construction facility that we closed in December. Given this 330 million in expected funding availability, combined with proceeds from additional planned dispositions, and other potential capital sources, we are well positioned to fund the approximate 190 million of development costs that remain to be funded as of year end ’07, and still have additional dry powder to take advantage of other investment opportunities that may arise. In 2007, our CAD ratio was 97%, the first time we have been CAD positive in several years. We had funded our CAD shortfall in prior years from land sale proceeds. Getting to CAD positive territory was a key initial goal in our strategic plan, and we are very pleased to have achieved it in 2007. We are projecting to remain CAD positive and to grow our free cash flow in future years that we can use to further grow our business. A few weeks ago we issued our 2008 FFO guidance of $2.56 to $2.72 per share. FFO from core operations for 2008 is projected to grow from $2.47 to $2.57 per share, which at the midpoint is up 5% from the $2.40 we earned in 2007 on the same basis. As we’ve discussed, 2007 was positively impacted from significant land sale gains, lease term fees, and a gain from the insurance claims settlement. Land and condo gains and lease term fees are expected to be lower in 2008, but FFO from core operations is expected to grow meaningfully as our development properties are placed in service and we reap the benefits of lower interest rates and higher average occupancy. These gains will be offset in part by some dilution from the expected dispositions in 2008. Other assumptions underlying our 2008 guidance were included in yesterday’s press release. Now I’ll turn the call back to Ed for his final comments.

[Ed Fritsch:]

Thanks Terry. In closing our script remarks I want to spend two minutes talking about how we at Highwoods are looking at the future of our company. We recognize we’ve run a good race these last three years in meeting, and in most cases exceeding, the initial three year goals of our strategic plan. However, as the old saying goes, if you find yourself enthused over yesterday you aren’t doing enough today. The fact is that at Highwoods our enthusiasm about tomorrow couldn’t be higher. We know there is no finish line in business, so as we launch into a new year we are setting our sights on continuing to raise the bar on many fronts. This means working even smarter and staying energized. It means continuing to improve the quality of our portfolio, seizing opportunities, securing anchor tenant, and Build-to-Suit development projects and being prepared to tackle whatever challenges may face us. Our strategic plan continues to serve as the framework for our future. It is a living plan that is routinely reviewed and updated by our management team and board. We will remain true to the key tenets of this plan in all that we do. This includes enhancing long term shareholder value through the establishment of ongoing defined goals with quantifiable results, owning a portfolio of high quality differentiated assets, maintaining a strong and flexible balance sheet, continuing to communicate consistently and transparently with shareholders, customers, directors, co-workers, and vendors, and being deliberate stewards of our shareholders money. Expanding on that last point about being “deliberate stewards of our shareholders money”, we take that responsibility very seriously. We have worked hard towards building a strong platform to deliver significant long term value for our shareholders, and I assure you we will continue to be entrepreneurial, while taking deliberate and measured approach to all investment decisions we make, the same approach we’ve been taking over the past three years. Finally, I thank and applaud all my co-workers for their continued dedication, fortitude, and hard work. Thanks also to our board for their active involvement and ongoing support of the strategic plan, and of course to our shareholders, whose belief in our plan and in this management team has been extremely gratifying, and energizing. Operator, we will now open up the call for questions.

[Operator:]

(Operator instructions) Your first question comes from the line of Jamie Feldman from UBS.

[Jamie Feldman:]

Hi, thank you very much. I noticed on your NAV estimate you raised the cap rate 50 basis points, is that a view to the future or is that what you are seeing already in the market?

[Ed Fritsch:]

Hi Jamie, it's Ed. That’s what we are seeing in the markets. We look at a lot of transactions that we consider for acquisitions. We try to monitor what happens within our core markets. We subscribe to real capital analytics for that data and we have seen about a fifty bp move.

[Jamie Feldman:]

Ok. Then if you were to give a view towards the future, do you think they go up higher from here or is that about as bad as it looks?

[Ed Fritsch:]

I think there is the potential for it to move from here. We are going to have to wait and see what data points are out there. But as you know, the volume of transactions is off dramatically from what it was a year ago, less then half in the fourth quarter of '07 than in the fourth quarter of '06. We participated in some, so we have been able to see, from what we have sold, Columbia being an example which was a very attractive cap rate. We've looked at potential acquisitions and we have watched what others have done in the market and talked with a lot of investment brokers. So, from those four different sources, I think that the information we have is fairly accurate and time will tell what will happen in 2008. The important thing to remember with regard to our NAV page is that we provide all the statistical data for anyone to draw their own conclusions on what they think NAV should be. We give a range of rates based on product types, but certainly all of the data is there. So if someone believes that the cap rates are actually lower, they can compute that.

[Jamie Feldman:]

Ok, great. And can you just give a little bit more color on your development outlook, as the economy slows. I think last quarter you had mentioned that the competition for GSA development has probably increased, which means that margins come down. As we look out to '09 and 2010, where do you think that you will be able to compete effectively and where do you think margins go?

[Ed Fritsch:]

Of all that we've started in the past three years, our blended, stabilized, cash return in year one is right at 9.1% and the gap is at about 10%. We don’t think that we will stray far from that in the next twelve to eighteen months. I think a lot is dependent upon what the mix is, Build-to-Suits versus buildings that we have built with an anchor tenant but have some speculative component to it. With regard to markets, I feel good about it, almost across the board. Of course, we still have an interest in exiting Winston Salem. We have said a number of times that we are keeping a watchful eye on Greenville, South Carolina. We are out of Columbia, but of the other markets, we have land inventory and we will continue to pursue strategic infill locations in those locations that we think would be the last to turn down and the first to turn up, in tough times.

[Jamie Feldman:]

Ok, all right. Thank you.

[Ed Fritsch:]

Thank you, Jamie.

[Operator:]

Your next question comes from the line of John Guinee.

[John Guinee:]

Hi Ed. Did Virginia beat Carolina last night?

[Ed Fritsch:]

They did not; it was a good effort though.

[John Guinee:]

One quick question and I have to ask this, everything else looks good, trending in the right direction, except the dividend. You guys are CAD positive, what's your plan for that?

[Ed Fritsch:]

We feel, with regard to dividend, that we will hold tight to where we are with $1.70 per year. We expect to be cash positive again in 2008, and if our forecast models work, that free cash flow will grow, as we get into '09 and 2010. For right now, I think that holding the dividend at $1.70 is the appropriate thing to do. Obviously, like everybody says, and we certainly do, this is a topic to discuss with our board. I think it is important for us to have some flexibility right now, to take advantage of some opportunities that may come our way.

[John Guinee:]

Okay. And then the second question. In terms of land inventory, you clearly need to have some in order to fund your development pipeline and Build-to-Suit and be available for the right opportunities. What is your overall strategy as a percentage of total assets, or in terms of ability to carry it, and how do you look at that? And then, how much of your land are you expensing the cost and how much are you capitalizing right now?

[Ed Fritsch:]

Terry, let me say something generic on that and you can be more specific on the accounting aspect. John, with regards to the land, we've called a lot of it out, we still have some more to go, with regard to what we want to sell, with regard to the non-core versus core. We break that out in the supplemental, what we feel is core. We think that having good land positions that enable us to have a competitive advantage when there are Build-to-Suit opportunities or anchor tenant opportunities, or even the better spec product that you can put on-line, is important. So we will have some of that but we certainly won't bloat to where we were in the past, by any means.

[Terry Stevens:]

And I would think that as a percent of our total market value of our total company, having a land inventory somewhere, maybe in the 2% to 3% range makes sense. And I think right now we are right in that sweet spot.

[John Guinee:]

And then of your 150 million, plus or minus, in land, which I think you quote at market, how much of that are you capitalizing the carry and how much are you expensing?

[Mike Harris:]

We don’t capitalize any carry costs, John, the carry cost would be primarily property taxes, so that is all charged to expense, currently.

[Terry Stevens:]

Mike, I don’t have that exact, but I'm thinking it is somewhere around $1.5 million to $2 million dollars a year.

[John Guinee:]

How about your interests carry?

[Terry Stevens:]

The interest carry is also expense. We do not capitalize interest on land until it's placed in service for a development project, and then once that starts, we capitalize interest on the land and any other building costs until complete.

[John Guinee:]

So if you are actively marketing, which is sort of a nebulous term, your expensing your interest on your land?

[Terry Stevens:]

Yes, even if we are marketing, we are not capitalizing any imputed interest carry. And none of the raw land is covered by a secured loan. It's all unencumbered land, so there is no direct interest in any event. Even the imputed interest is not being capitalized.

[John Guinee:]

Very conservative, thank you.

[Ed Fritsch:]

John, one other footnote with regard to land. You may see the market value move from time to time. We periodically evaluate the value of our land, but the movement in value quarter-over-quarter or year-over-year is more driven - because we take a pretty conservative tack, I think, with regard to how we evaluate it - but it's more driven by where we are in the site planning phases. If we are able to garner a better site plan that generates a higher density that we think suits the land better, that could drive the land value. Or, if we put infrastructure in place, like at the base center in Tampa. We have infrastructure in place for Phase Two that enhances the land value. So I wouldn’t want you to interpret that we are growing land values based on square footage market caps. We are not changing the value of FARs, we are just modifying density and infrastructure.

[John Guinee:]

Great, thank you.

[Operator:]

The next question comes from the line of Michael Billerman from Citi.

[Michael Billerman:]

Looking at the portfolio in the asset sales, you have done a tremendous amount, 750 million over the last few years. You set a goal of another 300 to 600 million for the next two to three years with 150 to 200 this year. Then again, in your opening comments you said that these are not as "curved challenged" as the previous ones you sold. What does the portfolio get to in terms of average age? What characteristics does it have once you are done with this next 300 to 600, in terms of what you are left with?

[Ed Fritsch:]

Well, first of all, congratulations Michael on you announcement, from everybody here at Highwoods.

[Michael Billerman:]

Thank you.

[Ed Fritsch:]

You're welcome. It's well deserved. Second, with regard to - it's a fairly broad question and I don’t want to give you too limp an answer on that with regard to it really depends on the asset. If we are in the best submarket and we have one of the best assets in that submarket and it will perform well over time and the age doesn’t worry me that well because it has certain insulations given where it is and what it is. But what we've sold, clearly the average being 21, 22 years of age, we started to get into a lot of CapEx needs and they were aspects of the buildings that were functionally obsolete, but we also sold off a fair amount of flex space so I think the largest component of that pie would be flex. We made a very defined decision that we wanted to be out of flex and that certainly was a significant component, the $750 million. Once we get through this next trance of 3 to 600 I think that - and we’ve said this a number of times - as long as we own ten buildings we ought to look at number ten and figure out is it something that we ought to keep or should we try and exchange it for a one, two or three?

[Michael Billerman:]

And when you think about it are you going to lower the industrial or the retail when you’re thinking about the 3 to 600?

[Ed Fritsch:]

I would think that this is a prospect for us to call out some of the non-Plaza retail potentially and the industrial we really pulled back to two markets now and have Greensboro, North Carolina and Atlanta. I think that as a percentage it would stay in proportion to where we are right now with overall holdings within the portfolio move.

[Michael Billerman:]

Right, Terry maybe you could talk a little bit on the balance sheet by swapping the fixed rate for a floating rate piece, your floating rate debt will rise further given your rates are not a bad thing from an accretion standpoint. But can you just talk through what your plans are on the balance sheet through this year in terms of perhaps doing more fixed rate debt.

[Terry Stevens:]

Sure Michael at this point with those bonds paid off there really are no additional debt maturities to deal with in 2008. And in 2009 looking out two years we have 50 million of bonds coming due in early ’09 and they’re currently at 8.125% so at a fairly high rate. I’m looking forward to getting those paid off. And then in late ’09 we have some secure debt coming due, which carries array of 7.9% also well above market. So the next two pieces of debt we have to deal with are both in ’09 and both of them have above market rate so it would be good to get those both refinanced in some way. We do have a little bit more floating rate debt as you point out. We have entered into a few small swap agreements to fix the LIBOR on just a piece of that. But we’re comfortable with the floating rate exposure we have right now given where we see interest rates going and the indications of that from the swap markets. So right now we’re quite comfortable with that and really have not much to do until we get to next year.

[Michael Billerman:]

Right, so now you not going to plan to try to fix out the debt further in terms of reducing the credit line further, because you’re probably at low 20s percent floating rate debt.

[Terry Stevens:]

We will consider those things, Michael we haven’t made any decision, but we could enter into additional swaps to basically fix the floating rate but that’s certainly an option for us.

[Michael Billerman:]

Right. Just a quick question on the NAV page which is extraordinarily helpful there’s a line in the other assets, assets not fairly valued by NOI capitalization, about 205 million. What’s embedded in that?

[Terry Stevens:]

What that is, our methodology is to take the cash NOI projected for next year as a starting point but some of the buildings the cash NOI for the next year is really not reflective of what the annualized cash NOI would be, there might be some free rent next year or some pre-lease, maybe its pre-lease, but the leases aren’t scheduled to start until maybe half way through the year. So just taking the projected cash NOI for ’08 doesn’t give you the appropriate value. And we go through portfolio, property by property, and where we have a situation where the numbers don’t make sense we take a look at that, maybe we’ll put in a pro-forma or utilize a discounted cash flow approach to come up with a number that we feel is more representative of what the value is rather than just taking the cash NOI from the budget and just applying the cap rate to it.

[Ed Fritsch:]

And Michael we won’t do that on a 2500 sq. foot lease, there’s probably less than a handful of buildings that comprise this and the component has to be very significant in order for us to do this. So I don’t want you to think we go sweep by sweep, building by building.

[Michael Billerman:]

Do you have a sense of how much cash NOI that $200 million of that represents and what square footage is just so we get a sense of what’s being stripped out?

[Terry Stevens:]

I think its 5 to 10 buildings all together. I don’t have the exact number Michael, but it’s not a significant part of the overall portfolio.

[Michael Billerman:]

Okay.

[Ed Fritsch:]

And one other point worth making is that it does have to be where a contract is in place. This isn’t hypothetical lease up. There has to be a fixed firm agreement in place in order to make that happen.

[Michael Billerman:]

And my final question just on the development that was delivered in the fourth quarter. Does that average at 9% cash, 10% GAAP for the ones that actually got delivered in the fourth quarter?

[Ed Fritsch:]

I’m quick looking at our deliveries. Yes, they were in-line. I would agree.

[Michael Billerman:]

Okay, thank you very much.

[Ed Fritsch:]

Thank you Michael.

[Operator:]

Your next question comes from the line of David Cohen with Morgan Stanley

[David Cohen:]

Just wanted to go back to the asset sales on the 3-600 million. How are you guys thinking about potential dilution from those sales and how you’re thinking about relative to your dividends, how are you going to go about thinking about whether or not to go through with selling those assets?

[Ed Fritsch:]

Hey David, it’s Ed. We’ve taken the potential dilutive effect into consideration when we gave 2008 guidance. We’re trying to make these decisions in keeping with our - the key tenets of the strategic plan with regards to these being strategic decisions and not financial decisions. So like Winston, which we talked about a fair amount, the assets that we have there aren’t necessarily terribly bad but there hasn’t been a four-lease building built by us or any other landlord in that market since 2000 - 2001, which to me is representative of a market that doesn’t have a lot of future rent or development opportunity growths. So, we’re looking at these as strategic decisions. We’ll deploy the proceeds in an accretive manner. I think that based on what we talked about with the changing cap rates what everybody's seeing, we may not get as aggressive a pricing as we received in the past, but I think the deployment of the monies will be appropriate with regard to a balance of development, maybe acquisitions. And we still have some things we can do on the balance sheet with regard to preferred stock. And then from a pure CapEx perspective these older assets are typically maybe slightly FFO dilutive, but they’re CAD accretive.

[David Cohen:]

Okay that may not be the case - I guess my question is - that may not be the case six months from now or a year from now, how will you take that into consideration? It sounds like you’ve wanted to get out of a lot of these markets, I wouldn’t say regardless of the FFO impact, and I just wanted to get a sense of whether you’d be willing to accept that cash dilution as well.

[Ed Fritsch:]

I think that we do take a little bit of gas in order to get strategically where we want to be.

[David Cohen:]

Okay, you talked about you’ve been bidding on a bunch of deals so how are you evaluating the IRRs? Have you changed your hurdle rates at all?

[Mike Harris:]

We haven’t changed our hurdle rates and just, sorry semantics, not necessarily bidding on a lot, but looking at a lot, but some of that, which a majority of what we’ve looked at we’ve chosen not to bid on. But, we have bid in certain instances. We make sure that when we do decide to bid that there’s a careful balance of it being a strategic play, it being accretive and we we’re being guided by the listing brokers with regards to replacement costs versus pricing

[David Cohen:]

So, what type of unleveled returns are you guys trying to sell for?

[Terry Stevens:]

We don’t look at IRRs in maybe the same way an investor does, but typically when we buy or build we’re looking for the long haul and we’re not thinking about what will be our exit cap rate in 10 years and so forth. We tend to look at what the returns will be relative to our cost of capital. We want to make sure that whatever we do is going to be accretive for us going forward in generating long-term value

[David Cohen:]

Okay.

[Mike Harris:]

I just wanted to clarify. In that we are bidding on some of these things. We are a little bit reluctant to give out too many statistics on Willow B because we’re in a competitive environment right now with other bidders. For example, if we say we wouldn’t do anything less than a 7-5, that could work against us in a couple shots right now when we’re looking at some one-off assets.

[David Cohen:]

Okay and just a quick question on the CAD payout, for 2008 does that include RBC, meaning are you going to be able to cover CAD through just your core properties?

[Mike Harris:]

We expect to David, yes. Now the RBC condos should be about $3 million or so at the mid-range, 3.5 in 2008 with those gains obviously as more of a cushion. Without, we still expect to be CAD positive, but the cushion will be more narrow.

[David Cohen:]

Okay and just in terms of how you’re accounting for those condos that’s not a percentage of completion that will just be as you sell the units?

[Terry Stevens:]

Yes, we’ve looked into that and because of the size of the down payments and so forth under gap we would be using the completed contract methodology so those gains won’t get recorded until closing start, which are scheduled in the fourth quarter of ’08 and then will continue on into the first part of ’09.

[Ed Fritsch:]

And David as we’ve said - I think Michael said in his script, I think we’re 100% under contract with those. The earnest money is hard, it’s 5% on those who attested that they would be residents and 10% on those who attested that they would be investors. And only 27% are under contract with those who attested investor. So, we have about $3.5 million non-refundable deposits and then we have another about $400,000 in non-refundable money that people have given for upgrades to their units and we were 100% under contract in third quarter ’07 and we’re 100% under contract today.

[David Cohen:]

Alright, thanks a lot.

[Operator:]

Your next question comes from the line of Lou Taylor with Deutsche Bank

[Louis Taylor:]

Good morning guys. Mike or Ed, could you give us a sense for what the development yields were on the Q4 deliveries and what do you expect on the average on the pipeline?

[Mike Harris:]

They were pretty much in sync with the 9% stabilized cash yield load.

[Louis Taylor:]

Okay great and that’s for the pipeline as well?

[Mike Harris:]

Yeah, the overall pipeline, that’s exactly right. There is some lumpiness there, in the Build-to-Suit less than the multi-tenants.

[Louis Taylor:]

Right. And then just the second question pertains to the deposits on the RBC Plaza condos. I mean, how big are those deposits, what would people be walking away from? And if that were to occur what would you have for a waiting list?

[Ed Fritsch:]

It’s about $3.5 million right now. Those who attested that they would be residents were as for 5% and those who attested that they would be investors we asked for 10% and the mix is 27% investors and then there’s another $400,000 plus or minus monies that we’ve received that’s non-refundable for upgrades that people have asked to be made to the finishes in their units. So in total about $3.5-4.5 million.

[Mike Harris:]

The average price unit was just a shade over $4.5 million bucks so even deposits that are 20,000 lets say on the low side and the higher price units could be up to 70,000 bucks in terms of the average earnest money deposits.

[Louis Taylor:]

Great and then last question for you, Mike, in terms of Raleigh you did gain 550 basis points of occupancy, yet you were - same story - I don’t know why you only grew by 200 bps. Can you reconcile the difference there?

[Mike Harris:]

Yeah, Lou, hang on one second. Primarily if you look at it year over year back in ’06, Lou, we had an extraordinary transaction that was actually a bankruptcy settlement from a former tenant in the fourth quarter, and that was significant. That was not there in ’07. So that was the big, big spread between NOI year-over-year.

[Louis Taylor:]

Great, thank you.

[Operator:]

Thank you, your next question comes from the line of Chris Haley with Wachovia

[Chris Haley:]

Good morning. Couple of questions. First in the fourth quarter, the volume of leasing commissions was down significantly, and the year-over-year full year leasing commissions paid were down about two to three times the amount of leasing was actually executed in ’07 versus ’06. So I’d like your view on why the fourth quarter commissions were so low, and the full year, and kind of get your look into ’08. That’d seem to be the major variance in terms of helping the FAD numbers get up to where they were.

[Ed Fritsch:]

Chris, the leasing commissions really don’t vary as far as what we pay in the market from market to market. Atlanta’s the only one that’s a bit unusual in that they still had that pro fee. What really drives this number is how much we do in-house with our people versus how much we have to work through co-brokers, tenant rep brokers. So if we have renewals where we can manage it in-house then we do that, and where we interact with the brokerage community we do that as well. Now the deal that Mike talked about with regard to the AT&T renewal, half that commission was paid in ’07 and half will be paid in ’08.

[Chris Haley:]

Okay, so by our calculations aggregate commissions paid were down by about 30% in ’07 versus ’06, yet aggregate leasing volume was only down about 10-12%, which would imply a much greater percentage of either renewals and/or in house deals. Could you provide any commentary in terms of ’08?

[Ed Fritsch:]

It’s tough to say, we forecasted that we would use brokers more often than not. Time will tell. It’s difficult to project when a customer will come back and say. We’ve engaged on a national basis, ABC Brokerage House out of x-ville, and we sign up and we deal with that. I think that a lot of it’s dependent on how the customers do it, but we haven’t changed anything with regard to our customer relations that would cause it to be different, dramatically different in ’08 versus it was in ’07 or ’06, which I know you said was higher. But our people, our leasing folks make more money when there’s not an outside broker involved.

[Mike Harris:]

Of course, also, there’s clearly been a trend of the national brokerage firms that have tried to push for higher commissions, particularly on renewals, that in most of our markets it was lets call it 4% on a new deal 2% on a renewal, and you’re seeing a big push by many of the firms to try to go to a full four. We’ve resisted, and tried to hold the line with that, but given the size of the transaction and the tenant and if they’re pushing hard as well then we’ll occasionally cave.

[Chris Haley:]

Is there anything, one of the risks, firstly this obviously can be viewed as a positive in terms of a greater number of direct deals versus broker deals, yet we’ve run across the situations where relationship between brokers and landlords can sour, based upon activities at certain companies and their friendliness to brokers. Should we expect to see a lesser increase in leasing commissions paid versus volume of leases?

[Mike Harris:]

I don’t think so, I think that there’s two things. One, we really do encourage our leasing folks to get out to our customers early and often, and stay in touch with them throughout the term. And in that case if we’ve got a good relationship oftentimes the tenant will like to go direct with us and not feel the necessity of going to a broker. National tenants on the other hand, most of them have affiliations with national firms, and irrespective of that relationship, they’re going to be involved, may or may not add a lot to the transaction, but would still be obligated to pay that commission if the tenant does suggest it.

[Ed Fritsch:]

Chris, we’ve tried to foster a broker friendly environment where we have programs and we’ve put them in place. Some time ago where we want, we call it signed, sealed, and delivered where we’ll pay a broker their commission that’s due long before it’s due. We try to tie it as close to the lease signing and the commencement of the lease as possible. We certainly host more than our fair share of broker functions, and our brokers spend a significant amount of time interacting with the brokerage community, so the tone from the division head is broker friendly.

[Mike Harris:]

We also send out annually a broker survey. So we listen to then, we get their response back, we have an idea where we may have issues with brokers and we do reach out to them and try, as Ed said to foster good relationships there.

[Chris Haley:]

That’s very helpful, and maybe we could do this offline, but I’d also like to reconcile the capital expenditure page in terms of those leasing commissions paid versus a committed numbers, because the commissions targeted to be paid on a per foot basis in the fourth quarter were up well over the trend, maybe we could do that offline as well.

[Terry Stevens:]

Chris this is Terry. The leasing commissions that show on page two, which is the components of how you get to CAD are based on actual cash payments, not on the leases actually committed in that period, and you do have timing effects, and I think that’s what we’re dealing with here is just timing. Ed and Mike have both said that the actual trends per foot on commitments haven’t really changed much, but the timing of when you make those payments can vary, and if you did some single large deals, the commission on a multi-year large deal can be very substantial. And you can have one of those in one quarter and not the other, and so that number can get a little bit lumpy quarter-to-quarter, but over the long term should stay relatively consistent with the volume of leasing that’s being done.

[Mike Harris:]

And in the fourth quarter, as Ed mentioned that the AT&T transaction Atlanta was the driver of commissions being up in that quarter, that was a 220,000 square foot transaction multi-year, so that was the big number there.

[Chris Haley:]

Thank you. Terry to keep you on the seat, the core number you mentioned was $2.47 to $2.57, up 5%, which is consistent with what you outlined a couple of weeks ago. If you could help me understand where we were versus 2007 on the core numbers, in terms of looking at it, and we’re looking a the fourth quarter run rate, annualizing that with a little bit of earnings growth, plus development, plus the potential upside from this refinancing, can you give me a sense as to what type of items would bring you down to the lower end of your range, which we’re having a very difficult time to get to?

[Terry Stevens:]

We did put in for the core FFO next year impacts for dilution, because we do expect to have sales, and I don’t know whether you factored that in or not, and I think that might be the one thing that could be the difference.

[Chris Haley:]

Will the developments be offset by sales?

[Terry Stevens:]

Not entirely, obviously, because we’re still having positive core growth year over year, but if it weren’t for dispositions, there would be even a greater growth in what we've projected, obviously.

[Chris Haley:]

Alright, thank you.

[Terry Stevens:]

Thanks Chris.

[Operator:]

Your next question comes from the line of Cedric Lechance from Green Street

[Cedric Lechance:]

Ed, in selecting the CAP rates you used for your NAV page, how did you think about some of the transactions that have not closed? And in particular, if you think of your Winston-Salem portfolio where you did not get the kind of pricing you were expecting, what’s that telling us about where market prices are going at this point?

[Ed Fritsch:]

We did take that into consideration, and what we tried to come up here was a fair blend of our best assets and some of our worst assets. So the numbers on that wasn’t so much the numbers that we saw coming in, it was the contingencies tied to it because there was such turmoil in the capital markets is more what gave us pause from the lender side. So we felt that until prospective buyers can get more clarity on where their debt was coming from that we shouldn’t participate in that scrum for now, let’s just back up and wait and see what happens. So Winston-Salem clearly a tertiary market, we knew it would be more of a struggle than some of the other assets that we’ve sold because of the blend, there’s some very good product in it and then there’s some lower end product in it, we didn’t want to (buy out). But we took into consideration what we are seeing, inclusive of what we closed on fourth quarter and inclusive of some other things that we have under contract. Aside from Winston-Salem that we would expect to close in the first half of 2008.

[Cedric Lechance:]

In regards to Winston-Salem, is it fair to assume that the cap rate that would have been on that transaction is well in excess of the high end cap rate you use in you NAV?

[Ed Fritsch:]

I would say that we need to stick to what we have said in the past about us not putting out too much information, because when we do, we end up negotiating against ourselves. So I answer your question, a perspective buyer, here is my answer, and then I am in the negotiation room and I hear my answer again. I know that is not the answer that you are looking for but that is the hard lesson that we have learned in the past.

[Cedric Lechance:]

Okay. So your NAV range, the low end is $42 a share, your stock trade is $29 - $30 a share. Isn’t buy back the best option for your capital right now?

[Terry Stevens:]

Cedric, this is Terry. We continue to run those numbers and we still believe that building, or using our capital that we have, when we have the development opportunities that we do, is probably for us the best source of our capital. We have bought, as we said many times in the past, we have brought in some operating partnership units for cash, which is a little bit of a stealth equity buy back, it doesn’t get the publicity that we have pulled in a little bit that way over the last two years or so. But at this point, given what we still believe are some decent development opportunities in the GSA initiative, we feel that that is probably the best use of our capital at this time. It's not something that we don’t ignore, we do think about it, but we are comfortable with where we are today.

[Ed Fritsch:]

And in 2007 we redeemed about, between '07, what we have done here today, almost a million operating partnership units.

[Cedric Lechance:]

Looking at your guidance for the next year, you expect to acquire as much as $200 million worth of buildings. Would you still consider acquiring assets instead of your shares?

[Ed Fritsch:]

Yeah. I think its important that we be very- as I mentioned in my post scripts remarks - that we would be very good stewards with this money that we have built in the way of dry powder. And if there are opportunities coming our way, then we need to be in a position to take advantage of those for strategic and long term shareholder investment enhancement opportunities. To buy back the stock today, it's very expensive to go out and raise that equity again. So I think that we need to be selective and strategic and be additive to the franchise with how we deploy these dollars.

[Cedric Lechance:]

It seems to me, with your stock trading and an implied yield of 8.8 %, you will be hard pressed to find anything else on the market with a higher yield then that. You mention that land prices haven’t really moved yet, but of course your perspective on cap rates is that they have moved up about 50 basis points. How is it that land prices have yet to move? Is there a lot of reluctance on land fillers or is there just not that many transactions?

[Ed Fritsch:]

Well, I think that there has been movement on land, and I'm kind of speaking a little bit out of school here, but from our perspective the land prices that have moved have been the large single family tract sites that are not of interest to us for our product. The core infill locations that we are seeking, that we consider to be premium sites have held their value, if not inflated. And one of the reasons for that is, of all the recent transactions the have occurred, where land was bought and then improvements were made upon that land and then the tax assessors came in and used all the sales comps to value those parcels. As a result, those family entities, or other entities that hold land now have a very high value in their minds what that land's worth. So we haven’t seen that come in our direction whatsoever.

[Mike Harris:]

Particularly for the infill pieces that we would be interested in.

[Ed Fritsch:]

Specifically for that. Because we're really not looking to go all the way to the end of the existing market and buy the next 100 acres of land and build it and hope they'll come to it.

[Cedric Lechance:]

Okay, final question is on your retail leases that rolled over in the past quarter. You had the decline in rent. Can you help me understand if there's anything specific about those leases that would explain that performance?

[Mike Harris:]

I think that, if you look at these transactions, most of which were on the Plaza, you're sitting here at north of 96% leased. These are smaller transactions, number one. A little bit of the Cinderella slipper where they're going in and the amount of TI dollars that's required and then the rates. You're basically trying to backfill a space, probably not with a national tenant where you can command that. So we don’t think it's certainly anything that's indicative of a trend there that we've seen but again, the size of the transactions that we did there were pretty small.

[Cedric Lechance:]

What is your best guess of the embedded NOI of your retail portfolio, the embedded NOI growth if you were to lease all the space at today's market rent?

[Ed Fritsch:]

We have to do that math. We can do that and give you a call back offline.

[Cedric Lechance:]

Okay, sounds good. Thank you very much.

[Operator:]

Your next question comes from the line of Wilkes Graham from FBR.

[Wilkes Graham:]

Hi guys. Just looking at the occupancy gains in the fourth quarter, they were pretty impressive. It looks like they 100% of those gains came in Raleigh, Nashville and the Triad. I was just wondering if you have any visibility into where you see, if we hit the high end of your guidance of 100 basis points increase in occupancy in '08, what markets those might come in.

[Ed Fritsch:]

Well, obviously in Greenville we're up 10% from a year ago in Greenville, but still it's mid 80s so there's clearly room in Greenville, Kansas City, although it's probably one of the tougher office markets overall that we're in. So, I wouldn't expect a significant amount there. Raleigh, we do have opportunity, we've got some rollovers that we need to take care of with very good prospects. But hopefully there's some upside there.

[Mike Harris:]

And we took care of, for example, in Atlanta, where we had our biggest expirations come up in '08, we took care of substantial amount of that already with the Nortel backed build. So in terms of pickup, I think Ed mentioned, Raleigh probably has in terms of just rollouts this year, a pretty good bit of that and we’re already seeing good activity on a portion of that. So, I think that's probably the one market where you'd see, going down earlier in the year with pickup toward the end of the year.

[Wilkes Graham:]

Okay. That's helpful. There was some, you guys talked about leading commissions for a while earlier. I'm looking at second generation TIs were down about half. In fourth quarter they were about half what they were the previous two quarters. And I think given that they were in that $11-12 million range in the second and third quarter was a big factor in AFFO not covering the dividend. Do you have any visibility into what the second generation TIs, what those levels could be if you saw, like you've been seeing, increased 100 basis points in '08? They ran 38 million in '06 and 36 million in '07 but we're only 5.5 million in the fourth quarter.

[Terry Stevens:]

This is Terry. We have always felt that for every 100 basis points in occupancy growth, which is about close to 300,000 square feet, that we would need somewhere in the range of $6-7 million in leasing CapEx to generate that additional occupied space, because, by definition it all has to be new leases because we're increasing our occupancy. And on newer deals, the CapEx is closer to $20 a foot for office all-in. So 20 times 300,000 is about that $6 million for every 100 basis points of occupancy.

[Wilkes Graham:]

Okay and I guess if I just add to that everything that expires this year and assume you resign it all, figure out that number of square feet and (inaudible) at that end.

[Terry Stevens:]

Yes and that obviously depends on the mix of renewals versus re-lets because obviously the newer tenants are more expensive and that's somewhat hard to predict. But you could probably look at the average that we've had and we report in the supplemental to give you a reasonable run rate on that.

[Wilkes Graham:]

Sure. Okay, thank you.

[Operator:]

(Operator Instructions) At this time we have no further questions.

[Ed Fritsch:]

Okay, thank you Stephanie. I thank everybody for calling in. Please feel free to call us if there are any follow-up questions. And those of you who we committed to do some math on we will certainly do that and give you a call back. Thank you.

[Operator:]

This concludes today's Highwoods Properties fourth quarter yearend conference call. You may now disconnect.