Highwoods Properties, Inc.
Q2 2013 Earnings Call Transcript

Published: 26 Jul 2013

[Operator:]

Thank you for standing by. Welcome to the Highwoods Properties second quarter conference call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions). As a reminder this conference is being recorded today, Friday, July 26, 2013. I would now like to turn the conference over to Ms. Tabitha Zane. Please go ahead.

[Tabitha Zane:]

Thank you and good morning. On the call today are Ed Fritsch, President and Chief Executive Officer; Mike Harris, Chief Operating Officer and Terry Stevens, Chief Financial Officer. If anyone has not received a copy of yesterday's press release or the supplemental, please visit our website at www.highwoods.com or call 919-431-1529 and we will e-mail copies to you. Please note in yesterday's press release we have announced the planned date for our third quarter release and conference call. Also following the conclusion of today's conference call, we will post senior management's formal remarks on the Investor Relations section of our website under the presentation section. 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 and acquisitions; the cost and timing of development projects, the terms and timing of anticipated financings, joint ventures, rollover rents, occupancy, revenue and expense 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 2012 Annual Report on Form 10-K and subsequent SEC reports. The company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events. During the 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 towards the bottom of yesterday's release and are also available on the Investor Relations section of the web at highwoods.com. I'll now turn the call over to Ed Fritsch.

[Ed Fritsch:]

Good morning, everyone. And if you look back over the past 90 days, we think of headlines such as sequester, what sequester, the Bernanke shouts, tapering is coming, housing industry rebuilding itself, increasing employment is hard work, auto industry hit the gas, Detroit runs out of gas and REIT remain active. All in all, we see the economy chugging along in the right direction and our customers continue to grow more confident. 2013 continues to be a strong and productive year for Highwoods Properties. Given solid leasing, efficient operations, lower capital cost and investment activity year-to-date, we are pleased to raise our 2013 FFO outlook to $2.76 and $2.84 per share, a $0.05 increase at the midpoint. During the second quarter, we delivered FFO of $0.70 per share and leased over 1 million square feet of second generation office. This leasing performance was accompanied by year-over-year same-store cash NOI growth of 2.8%, excluding term fees. We also acquired our second trophy asset in Buckhead. We sold 36% of our Atlanta industrial assets based on a square footage basis and ended the quarter with leverage at 43.4%. Another highlight of the quarter was Moody's upgrade of our senior debt rating to Baa2 with a stable outlook. As you know we have been very focused on improving our conservative and flexible balance sheet to position us for lower capital costs and to capitalize on favorable growth opportunities. We appreciate Moody's recognition of the success of these efforts. Turning to investment activity, in June we acquired One Alliance Center, the sister building to Two Alliance Center which we acquired last September. We now wholly own over 1 million square feet of contiguous Class A space in one of the most competitively advantage sites within Buckhead where available Class A office space is rapidly shrinking and no development is currently in process. At One Alliance with 67% occupancy in below market rents and operating synergies with Two Alliance, we have tremendous opportunity to grow NOI and we project occupancy at One Alliance to exceed 93% within three years' time. As a reminder our combined basis for both of the Alliance Center towers is $278 per square foot, which is 15% below replacement cost. Earlier this week, we announced the acquisition of our joint venture partner 60% interest in five CBD Orlando office buildings encompassing 1.3 million square feet for an incremental investment of a $170.5 million. We garnered these assets at an attractive a $153 per square foot of 40% discount replacement cost. On average these buildings are 82% occupied and with Orlando in the early stage of recovery, they present a great opportunity to grow NOI as we increase occupancy. In addition owning a 100% of these five buildings materially streamlines our leasing process, strengthens the Highwoods brand and simplifies our overall business. Including these two acquisitions we have now completed $350 million of acquisitions in 2013, which exceeds the former high end of our full year acquisition guidance. We continue discussions with owners and brokers with respect to opportunities and therefore have increased our acquisition outlook for the year to a range of $400 million to $550 million. Our $129 million development pipeline includes 501,000 square feet of office in the retail that is presently 93% pre-leased, including the $60 million announcement thus far this year. We're very encouraged by discussions we're having for potential development starts with the number of prospects and have therefore raised our outlook for development announcements to a range of $125 million to $235 million. Turning to our disposition pipeline, we sold $68 million of non-core properties year-to-date. For the full year, we now project selling an increased volume and therefore have increased our guidance to a range of $190 million to $225 million of non-core assets. This includes the planned sales of bulk of our remaining industrial assets in Atlanta, consisting of 1.7 million square feet across 16 buildings which we expect to close this quarter. As we mentioned during our last call, we're finding it to be an opportune time to exit our Atlanta industrial assets given the very strong pricing environment and our portfolio's healthy rent role. Before turning the call over to Mike so that he can cover markets, I must say that I am really proud of our team for having delivered on an active and highly successful first half of the year. In addition based on the earns we currently have under fire, the second half should be at least as successful and productive. Mike?

[Mike Harris:]

Thanks, Ed, and good morning. I would like to echo Ed's comments that we had a solid second quarter with strong leasing, modest leasing CapEx and good net effective rents. Modest but steadily positive employment growth coupled with dwindling levels of large blocks available Class A office space is leading to fewer concessions and in a number of our markets increases in asking rents. We ended the quarter with occupancy at 90%, our acquisition of One Alliance Center which is 553,000 square feet and 67% leased and PWC's move out of 244,000 square feet in Tampa negatively impacted occupancy by 100 basis points. However, the impact of these previously disclosed transactions was offset by net leasing activity within our portfolio which added 40 basis points to quarter end occupancy. On a same-store basis, office occupancy declined 40 basis points. Excluding the impact of the PWC move out, same-store office occupancy increased 70 basis points from the first quarter to 89.9%. Looking ahead, we have reduced the low and high end of our year end occupancy outlook by 50 basis points due to the One Alliance and Orlando CBD acquisitions combined 1.8 million square feet collectively having a 60 basis points negative impact on the year end occupancy. At quarter end average in place cash rental rate across our total portfolio rose 7.9% from a year ago. Cash rent growth to lease assigned during the second quarter declined 6.1% while GAAP rents increased by 2.3%. CapEx related to office leasing in the second quarter was a modest $13.12 per square foot even with 34% of leasing consisting of new deals. Turning to our markets, I'll start with Tampa where unemployment fell to 6.7%, a 23% year-over-year decline. Our Tampa division had a very strong quarter, leasing over 300,000 square feet the majority of which related to two large renewals. We have begun construction of the improvements to transform LifePoint 1 and 2 into a more urban environment. This renovation should be completed by year-end and we reaffirm our expectations that we will have 100,000 square foot lease by year end. Pittsburgh's economy continues to improve posting 36 consecutive months of year-over-year job growth. Occupancy in our Pittsburgh portfolio grew 240 basis points from the first quarter. Second quarter NOI from this division grew 71% compared to second quarter of 2012, this increase was fuelled not only by the December 2012 acquisition of EQT Plaza, but also from the increase in PPG's NOI driven by year-over-year occupancy increase of 83.6% to 92.3% and significant operating expense efficiencies. Job growth in Atlanta has led almost 5 million square feet of office in short-term in the two years. Much of this recovery has been in bucket, where we now wholly own over 1 million square feet that is 78.9% occupied. There have been several forces driving the bucket recovery, corporate relocations from out of state, organic growth and relocations from other Atlanta submarkets. Effective rental buckets are increasing due to this rapidly tightening submarket. We have 223,000 square feet of space at our One Ward Parkway building that AT&T has expected to vacate in October. We have then showings with several users interested in taking a substantial portion of the space or the entire building and a couple are already running to test that. This building is in a good location with numerous walkable amenities, has good bonds, a generous parking ratio and attractive sizes. Our repositioning improvements are underway and we are expected to be completed by year end. Raleigh remained a strong market; it is also experiencing a rapidly shrinking count of larger box of space in the BBDs. Companies are continuing to move into the area and others are expanding evidence by 98,000 square foot order renewal we signed with a strong credit customer just last week. They added seven years to their original lease term but positive cash rent growth and low TIs. Excluding our properties in [RTB] submarket which we plan to exit, our Valley occupancy is 92.9% indicative of the strength and quality of our core portfolio in that market. Our Nashville portfolio continues to boost our highest office occupancy at 95.5%. The entire office market is tight with direct vacancy at 9.2% and limited new supply. We expect to complete the new corporate headquarters building for LifePoint Hospital Systems by year end and we're having good traction on the 39,000 square feet of standalone amenity retail which amounts nearly 60% committed under leases or LOIs. Overall, we had a productive quarter and the team leads are suggesting that the second half for this year should be even better. Terry?

[Terry Stevens:]

Thanks Mike. Total FFO available for common shareholders this quarter was $61.1 million, up $5.8 million from second quarter of 2012. This increase primarily reflects $4.3 million higher NOI from acquisitions net of dispositions, $1.2 million in lower interest expense from lower average interest rates and more capitalized interest and $0.8 million in lower G&A partly offset by lower interest income. As a reminder, FFO and G&A amounts in my comments exclude property acquisition and debt extinguishment costs which are disclosed in a table in our press release. Weighted average shares outstanding this quarter were $86.6 million, up $8.1 million from second quarter of 2012. On per share basis, FFO for the quarter was $0.70 the same as second quarter of 2012 and $0.02 better than first quarter of 2013. Second quarter 2012 FFO benefited by approximately 0.05 per share because average leverage that quarter was still over 46% from the PPG Place and Riverwood acquisitions we did in September 2011. As you recall in 2012, we reduced leverage through equity issuances and non-core dispositions, and by July 2012 we are back under 45% to the level we had prior to the 2011 acquisitions. Same property cash NOI without lease termination fees was up $2.1 million or 2.8% in the quarter compared to the second quarter of 2012 even with a four-tenth of percent drop in average same property occupancy due to PWCs move out on May 1. The cash NOI increase was driven by the conversion of straight line rents into cash rents and from lower operating expenses. Same property GAAP NOI was essentially flat as our cash NOI growth was offset by lower straight line rents. Straight line rental income in the same property pool is expected to be approximately $7 million lower for full year 2013 compared to 2012. G&A this quarter was $8 million or $800,000 lower than second quarter 2012. The net decrease was driven mostly by lower annual incentive and long-term equity based compensation offset by modest non-officer salary merit increases and higher healthcare premiums. As [Ed] mentioned, we are pleased to have just acquired our partner's 60% interest in our HIW-KC Orlando, LLC joint venture, which owns the Orlando CBD portfolio. Our incremental investment will be $117.5 million, inclusive of planned building improvements. The balance sheet impact is somewhat different because we will obviously now consolidate 100% of the assets and liabilities of the LLC in our financial statements. Those assets are $188.9 million of real estate assets and a $127.9 million of secured debt with an effective interest rate of 3.11%. This debt matures in July 2014 and is pre-payable without penalties starting in April 2014. Previously, we accounted for our 40% interest using the equity method of accounting and accordingly, we will make a related reduction in investment and unconsolidated affiliates. Our 2013 FFO outlook includes $1.1 million of deferred leasing commission income that will be recognized in the third quarter in connection with the Orlando transaction. This amount relates to leasing fees that were scheduled to have been paid to us by the joint venture over the term of leases signed before the acquisition. These one-time deferred fees were trued up and paid out to us upon closing of the deal. Turning to balance sheet, on a pro forma basis inclusive of the Orlando deal and ATM activity in early July, our leverage is under 45%. We're very pleased to have received in late June an upgrade in our senior unsecured debt ratings from Moody's from BAA three stable to BAA two stable. This upgrade immediately reduced the LIBOR spread and facility fee of our unsecured revolving credit facility and bank term loans, which lower annualized interest by approximately $1.8 million, assuming $150 million average usage on our credit facility. Moody's also upgraded our preferred stock rating to investment grade at BAA 3 stable. We still plan to pay off two unsecured loans later this year, a $115.3 million, 5.75% loan and the $67.5 million, 5.2% loan which become pre-payable at par on September 1 and October 1 respectively. Since the end of the first quarter we've issued $2.3 million common shares under our ATM program for $84.2 million in net proceeds which include $17.9 million raised early in the third quarter. We are pleased to have a variety of equity raising alternatives including non-core dispositions such as the second large tranche of our Atlanta Industrial to grow on at least a leverage neutral basis. Lastly, we increased the midpoint and narrowed the range of our 2013 FFO outlook to $2.76 to $2.84 per share from the prior guidance of $2.68 to $2.81 per share. As a reminder and consistent with past practice our FFO guidance excludes the impact of any acquisitions, dispositions or equity issuances that may occur after the date of the release. Operator, we are now ready for questions.

[Operator:]

(Operator Instructions) Our first question comes from the line of Jamie Feldman with Bank of America/Merrill Lynch. Please go ahead with your question.

[Jamie Feldman:]

Great thank, you. I was hoping we could talk a little bit about rent growth, I think Mike had mentioned, you've seen effective rents starting to rise in your markets, can you talk a little bit about the pace of rent growth you're seeing and then also as you think about the back half of the year, anywhere in the next year, like when do you think to start to see leasing spreads either turn neutral or positive?

[Ed Fritsch:]

Good morning, Jamie, this is Ed. We're seeing asking rates year-over-year improve in most of our markets on an average of 2% to 5%. As far as rent growth, we have seen our statistics quarter-over-quarter are improved and in fact 7.7% negative that we have this quarter was heavily driven by two deals that totalled 162,000 square feet, where we have less than $4.50 in total TI for both of them. A lot of it depends on, what space it is, what market it's in, what building it's in, but we're seeing a trend towards improvement, when we'll from red to black on that, is tough to predict, but the regression now since it's going in the right direction. Just as a reminder, when we calculate that we do include prior TAMs and full escalators, when we compare old rent to new rent and in the escalators have been stout throughout the downturn as far as their compounding effect we've average about 2.75% compounded annually on the deals that we have in place.

[Jamie Feldman:]

Okay. Great and then I guess just on a macros picture, when you like do you think about across your markets, would you say most tenants are neutral, expanding, maybe shrinking like how would you say where were we in that part of the cycle?

[Ed Fritsch:]

I would say, if 12 o'clock is neutral and 10 o'clock is contracting, I'd say we're about 1 o'clock slightly tough for the expansion.

[Jamie Feldman:]

Okay. And then Terry two questions here on the guidance. One is have you updated your SAD guidance, your thoughts on where you'll be?

[Terry Stevens:]

We haven't updated that in the press release Jamie. But we're thinking we're going be slightly positive for the year.

[Jamie Feldman:]

Okay. And then can you just--

[Terry Stevens:]

And just to confirm we were slightly negative last year. So again, the trend line on that is going in the right direction.

[Mike Harris:]

Jamie just a quick add on the rent growth. What you'll see is before you start seeing top line rent growth, because most deals go ahead some level of concession, those will start to contract first, before we start seeing the rent growth turnaround. So that -

[Ed Fritsch:]

Which we've already seen.

[Mike Harris:]

Which we've seen.

[Jamie Feldman:]

So you said asking rates 2.5%, 2% to 5% year over year. Do you have a sense of net effective rent?

[Mike Harris:]

Net effective rents are basically flat. But we are seeing that continue to improve, GAAP rent has been positive.

[Jamie Feldman:]

Okay. And then finally Terry, just can you just walk us through the moving biggest pieces of the guidance change, I think you said something about getting a gain from or a payback from the JV purchase. I just want to make sure, we understand any consumer --

[Terry Stevens:]

Sure. The biggest part of the increase from where we were last time relates to the acquisitions and there it's primarily Orlando probably around and total around $0.04 of FFO growth from the acquisitions, net of the dispositions. And part of that $0.04 little over a penny was the differed leasing commission income that we were able to recognize in full upon the closing of the deal, here in the third quarter. So that $0.04, little over $0.01, where our prior commissions had it not been yet recognized that we were able to bring in. And we picked up about eight tenths of the $0.01 in lower interest expense upon the Moody's upgrade, I mentioned that in my comments about how we upgrade lowers the spread on all of our bank debt, and those were the big positives on -- the last positive, I am sorry, was just about another penny and half in just regular GAAP NOI growth existing portfolio. Because you saw that we updated and increased the cash NOI growth range and the guidance as well, so that had a corresponding impact on FFO, and then we did take G&A up a little bit which lowers the overall increase and part of that increase in G&A was just from slightly higher, short term incentive comp which tends to follow the change in the overall FFO in operations.

[Jamie Feldman:]

Okay, great. Thank you very much.

[Operator:]

Our next question comes from the line of Vance Edelson with Morgan Stanley. Please go ahead with your question.

[Vance Edelson:]

Hi, good morning, and thanks for taking the questions. Could you provide a little more color on what can you do differentially to improve occupancy across each of One Alliance, Meridian and the CBD Orlando assets. I think the Orlando upside is pretty clear but just given the relatively modest collective occupancy across those assets, if you could elaborate somewhat on what the plan is?

[Ed Fritsch:]

Sure, Vance, this is Ed. Two different situations there, one with the assets that we just bought out our partner on, in Orlando which is 1.3 million square feet, we think that there is two things happening there. One is that the market is improving and there is, there are clear signs of that and two is I think anybody would attest to this that being able to operate a wholly-owned building without having to negotiate with a investment partner, makes us so that we can be more streamlined when marketing the space, investing dollars for BI, capital improvement. So even though we've been involved in these buildings, we have committed $7 million towards advertising them and I think that we'll be, there is no doubt we'll be able to be more [stealth] and more responsive in the way that we act with our prospective, customers and existing customers. On One Alliance, which we just recently closed, we already have had showings that totaled 232,000 square feet. I would call these more of suspects than prospects, and so we've just recently gotten into the building but just in our short tenure of ownership, we've added significant number of showings.

[Vance Edelson:]

Okay, that's very helpful and then any field you can provide for the pace of leasing activity in your markets, not necessarily your own leasing but kind of market wide during the quarter. Was that accelerating or pretty flattish and if you can discern a trend there, would you say it largely continued in to July?

[Mike Harris:]

Yes. I would say that leasing velocity has remained attractive. Having leased over 1 million square feet of office in the first quarter, the number of prospects that we already have that we just talked about for One Alliance, I would say across the board that the volumes of prospecting and RFPs and showings and test beds is attractive for seven months.

[Ed Fritsch:]

Generally we start seeing first of June to the end of the summer doldrums when things start to slow down, but this one we just kind of went right through it. It's been good, surprisingly good for this time of the year.

[Operator:]

Our next question comes from the line of Brendan Maiorana with Wells Fargo.

[Brendan Maiorana:]

Mike, you mentioned Tampa 300,000 square feet of renewals. I imagine there is a portion of that that was T-Mobile it looks like, can you elaborate on how much of that was T-Mobile, which of the two expirations that related to and then the other largely spent, the other largely one that you did as well?

[Mike Harris:]

Sure. Brendan the renewal was the T-Mobile at how it's preserved, the 115,000 square feet slightly early renewal, so that was the one that we took care of the 92,000 square foot lease and with T-Mobile in Lake Side which is the tip of a park is likely not to renew and we've already started working on plans for that project in terms of improvements which will be needed expanding the garage down there to provide for more parking given that that submarket has a large back-office component to it. So that's already in place and both toward that building with Dan Woodward and his team, they already have a good plan in place for repositioning that building when T-mobile eventually moves out. The other large renewal was also in Tampa Bay Park which was AT&T in the Pavilion Building 127,000 square feet.

[Brendan Maiorana:]

Okay, great. And then, the T-Mobile one at Tampa Bay Park, that's late '14 is the expiration?

[Mike Harris:]

No, excuse me, that's 1st of ‘14.

[Brendan Maiorana:]

Beginning of 14, okay got it, okay. Thank you. Couple of questions for Terry. Is there any impact on fee income and you guys typically recognize from taking from Orlando acquisition bring that as a consolidated wholly owned portfolio now?

[Terry Stevens:]

Well, there are two things. One, we had always been managing and leasing those assets on behalf of the joint venture, so there was always some amount of fee income coming through from our leasing efforts, but the results of deferred fees that would have been paid in future quarters, which upon us buying out our partners interest, it was all trued up at closing paid in cash and then we fully recognize that. So that one-time impact from that I mentioned on the call and in response to Jamie's question. When I talked about the overall increase in FFO guidance for this quarter versus what we have last time, we've factored in any impact of us not getting 100% of the fees and only having 40% of the interest that was factored in to the overall change in FFO guidance.

[Brendan Maiorana:]

Yeah. I am just thinking more, longer term if I not for 2013 necessarily, but if I look at roughly $4 million of income from fees and leasing that you can get annually, is there a $1 million of that, that sort of goes away with this JV being bought in?

[Terry Stevens:]

That might be a little bit on the high side, but it's probably not too far on annualized basis.

[Brendan Maiorana:]

Sure. That's helpful. And then you talked about some of the long payoffs at the end of the year, your line of credit either it's not high relative to your -- the balance isn't high relative to the total $400 million, but it's $135 million. What's the plan to pay off the mortgages that you have coming and what's your longer-term outlook for balance that you'd like on the line of credit or credit facility?

[Terry Stevens:]

On the credit facility, the total amount that we have available -- the total line is 475, not 400, so a little bit more capacity than you mentioned, but it is up around a 130 as you say today. On terms of those two secured loans, we haven't made a final decision on how we might pay them off, but we do plan to pay them off when we can because of the interest rate savings that will garner upon prepayment. Long term, we again like to maintain our availability on the line a fairly robust, so generally not trying to run that line at over 50% of total capacity.

[Operator:]

Our next question comes from the line of Dave Rogers with Robert W. Baird. Please go ahead with your question.

[Dave Rogers:]

Ed, one of the follow-up on both the acquisition and the development guidance that you kind of talked about earlier in the call, but maybe first on the acquisition side. Clearly a better run rate going into the middle of the year and resulted in the guidance increase, but can you talk maybe in more detail about what you're seeing more transactions like One Alliance where you can step in maybe into a broken debt situation, are you seeing more and more of those and more ability to put money to work even subsequent to the end of the first half?

[Ed Fritsch:]

Good question Dave, we haven't seen more One Alliance troop yes that's coming to market where there is broker situations used. We have seen more offering them more items come out in the last 9000 days than we had earlier in the year. It's been a bit of the mix bag, some of the assets that we would be understood with more assets that are of a lower quality than we would like to pursue. Yeah, we beat the top end of our year guidance already and I think that what we have put out for the remainder of the year, more hopeful but we've got to get some more time down the road, but certainly at least we are hoping a couple of $100 million of assets that we would be proud to own.

[Dave Rogers:]

And it's hard to comparison times, but maybe on the apples to apples basis what do you see happening with pricing of assets that are coming to market in the areas in which you operate?

[Ed Fritsch:]

Well, they are still very competitive and as we mentioned with the One Alliance Center that was hardly sought after asset and I think that what helped us there was being able to garner the synergies of owning both building side by side and the benefits that we will capture by having over 1 million square feet contiguous to one another. I think that going forward that we have seen a pretty widening spread between cap rates and interest rates, it's likely to narrow at some point, but we don't see any impact that it's had on cap rates today. As that narrowing starts to occur the leverage buy will be more negatively impact than we will be.

[Dave Rogers:]

Fair enough. And I guess on the development side, you are seeing more and more activity to due development on something your land parcels and those negotiations heating up once again with big lots of space starting to be either absorbed or just people looking for different types of space?

[Ed Fritsch:]

We're Dave. Part of it is the latter part of what you say that the larger blocks of higher quality, better located space have been absorbed. In the absence of any new development and so NFC is looking to consolidate or reposition their image or take advantage of their own growth are having to turn more towards build the suites given that there is large blocks of quality space are evaporating and the clientele that we're working with is pretty eclectic in their SIC codes. It's advertising, medical, healthcare, professional services, technology, insurance, you name it. It's been pretty much across the board. So we're pleased with the volume of conversations we're having still is a protracted process, but they seem to be more earnish than what they've been in the past and that's what's given us comfort to raise the guidance and we feel quite confident on the guidance that we've raised.

[Operator:]

Our next question comes from the line of [David Jamings] with Jefferies. Please go ahead with your question.

[Unidentified Analyst:]

Just turning back to the acquisitions, for the additional $50 million to $200 million of acquisitions that you are hoping to achieve this year, just wondering how much of that has been identified so far and where you are in the process. So at what markets are you looking at? Are there any other Pittsburgh type of markets out there where we could be surprised.

[Mike Harris:]

A, we don't like the surprise you know. B, we hope that was a pleasant surprise. It's turned out quite well. So we prefer not to give the street address so that we open up a feeding frenzy on some of the stuff but suffice it to say that yes we've identified the opportunities and they are in existing markets.

[Unidentified Analyst:]

And are there any additional opportunities to buy out any other JV partners like you did in Orlando?

[Mike Harris:]

Well, you know JV it's a great topic, when we rolled out and I won't go back to beginning the time on this but just briefly when we rolled out our strategic plan in January of '05, we included words like war and complexity and simplification and our goal has been to reduce our exposure in JVs. Now having a good partner and having good assets you know they certainly have their merit but our overall goal is to reduce the amount of JVs that we are involved in and it's the point to roll out of the strategic plan we had run at $1 billion worth of assets in joint ventures and we've now slashed that in half. We've reduced the number of entities and JVs by a third. We've reduced the number of assets by two-thirds. We've reduced the square footage by half and the asset value by about half. So I think that it's fair to say that we would continue to look at consolidating those into the most productive JVs that we can have. So we have some excellent partners where we like to grow those JVs, where they have skin in the game with us and others where the JV is really haven't grown and don't have a prospect of growing, we are more likely to try to work towards unwinding.

[Unidentified Analyst:]

Great and then just on the dispositions, is there anything else that's honestly other than the Atlanta industrial assets, are there any office market fee you would look to exit at this point?

[Mike Harris:]

Well, there are a number of worn-off assets that we would like to get, as in addition to this second large tranch of Atlanta industrial assets, so there are more worn-offs the only exception that would be our continued interest to exit Greensboro, South Carolina and we are still working on the leasing on that. And we do have a package out in the market to see how the reaction. It's still very early in the process, but with that exception it's mostly worn-offs in addition to the Atlanta industrial which we, as we said, we hope to close that by the end of this quarter.

[Unidentified Analyst:]

And then just back to developments, what kind of yield are you underwriting for those?

[Mike Harris:]

Well, what we like to do David is not say, here is the specific number, because and this sounds a little bit like a political answer, but there are always different circumstances with regard to Highwoods only and what's the credit quality, what's the length of the lease, how specialized is the building etcetera, but all of the development that we've done, since the deployment of this strategic plan, we've been all over a 9% cash return and so we continue to work towards that, but if have an opportunity to do build-to-suit with much higher credit then we would be a little bit more leaning on that and if can get longer term, we would be more leaning on that. Then visa-e-versa if it's the other way than we are going to go higher than that.

[Unidentified Analyst:]

Great, thanks Mike.

[Mike Harris:]

We are obviously in the process of negotiating in a number of those things, so I don't want to put a number out there that a competitor could listen to and say well I understand, Highwoods is only going to do, build-to-suit you guys if they can get a 16% cash-on-cash return year one. So we're going to under bid them.

[Operator:]

Our next question comes from the line of Michael Salinsky with RBC Capital Markets. Please go ahead with your question.

[Michael Salinsky:]

Just go back to the rent topic there, as we look at the second half of the year, what kind of roll downs are we expecting there, just given the comments on positive rents and also if you look at the portfolio, where rents are today. How does that compared to market?

[Mike Harris:]

Our cash roll down to; we anticipate them to be slightly negative to what we experienced this quarter. Again, we've been very successful in the brokerage community is helpless with this in garnering stout annual escalators in 99% of the leases that we have in place. So the escalators plus the fact that we include the fully escalated base trend past they came and comparison to prior rent is typically what compounds that outruns the market growth. And then the GAAP side evidence is that we recapture that within the first year or two, where at least we're positive on the GAAP side. A lot of it depends on the quality of the customers etcetera, but we're moving in the right direction, the volume of deals that we continue to do where we can garner at 2.75% or 3% annual compounding escalator, and we're continuing to go for those. We can fix this cash rent by doing with those escalators. If we get away with them, we would certainly show you difference, but also as I mentioned earlier, I think when Jamie was on that we have seen asking rents going up in most of our markets in the 2% to 5% range.

[Terry Stevens:]

And I would say Michael, we also recent folks are clearly focused on top side rent growth and escalations, but they are also keenly focused on net effective rents as well. So it's the whole model not just top sided keeping the original CapEx not just having to spin a tremendous amount to get these deals and we don't have and concession levels as well.

[Mike Harris:]

Like one more foot note, if you look at page 17, in our supplement you will see that the average cash rental rates in place that those rents are continuing to go up. So we are now at the end of this quarter we were 21 and 25 average cash rental rates in place versus the last year at this time we were $0.75 a square foot less than that.

[Michael Salinsky:]

Okay, that is helpful. Do you have the mark-to-market statistic on in place rents versus [Mark] today just given the rent comments or?

[Mike Harris:]

We don't go through the exercise of taking our entire portfolio and comparing it to market. So much of it like right now 80 whatever percent of it won't even roll within the next 18 months, so we don't go through that exercise, sorry.

[Michael Salinsky:]

Okay, that is fair. I think you talked a little bit about the next six to 12 months, but any large vacates on the horizon that are known at this point?

[Ed Fritsch:]

Yeah, the looking forward the largest we have in between now and the end of ‘14 is LifePoint Hospital Systems. We move out at about 147,000 square feet, the first of 2014, that's a customer that we are building a 203,000 square build-to-suit for their headquarters. So that's the largest but that's in our market where the submarket itself is running around 5 million square feet and less than 5% vacant and we own little more than 20% of that market and we're also less than 5% vacant and we have about 100,000 square feet of prospects. So we're comfortable with the largest vacancy that we will have in 2014 based on the statistics I just provided you. The next would be the one that Mike alluded to earlier with T-Mobile at Lake Side and Tampa which expires in January of ‘14 which is about 91,000 square feet.

[Mike Harris:]

And we did scout the AT&T and the T-Mobile and (inaudible) 25, 0

[Michael Salinsky:]

That's helpful. Third question with the Orlando purchase leverage ticked up close to 45% close quarter. What's kind of the plan long-term financing for that and where do you see leverage kind of the end of the year just given your investment plans currently?

[Terry Stevens:]

Michael, this is Terry. As I said in my call script, we have lots of options to raise equity to keep our leverage in line and to grow leverage neutral and we do have is, we've mentioned as well, the Atlanta industrial portfolio out in the market. So we have some dispositions coming which will help a lot on that leverage. So we did spike up just a little bit as a result of that late, recent acquisition of Orlando but we're not that much above the range we like to operate on a leverage basis.

[Michael Salinsky:]

And just final question, you talked about increased build-to-suit demand. How comfortable are you with at this point, and in fact where you feel comfortable, you've got enough land at this point?

[Ed Fritsch:]

Yeah we feel comfortable with the land that we have. We did make an acquisition in December of last year, got just shy of 70 acres in Nashville's Cool Springs submarket but we feel comfortable with what we have with support over $1 billion of development. We still have a little bit of land that's even non-core. We sold the tract of that last quarter and we will continue to work a way out of that as demand comes around. But we don't have any significant expenditures for the acquisition of land on the near term horizon.

[Operator:]

Our next question comes from the line of Michael Knott with Greenstreet Advisors.

[Michael Knott:]

Question on the investment environment, I was curious if you are seeing any impact on cap rates or investment demand from higher interest rates able to give yourself any discount on the Orlando pricing because of higher rates or does that not factor in.

[Ed Fritsch:]

It didn't factor in. you know there was a significant piece of debt on those assets and I think it was a bit of a unique situation. Those folks have been a terrific partner of ours. We've been in partnership with them long term. Their fiduciary out of New York has been a very good partner of ours and we've had I think a good friendship with them for a long time. We still own assets with them but the organization in Germany was restructuring so that they could go public in having fewer US owned assets which was better for them so they were motivated seller. So I think that was more of two parties working out the deals as opposed it being fully [invaded] OM that went out into the market.

[Michael Knott:]

Okay. And more broadly are you seeing any impact in the market in terms of pricing, or is it too early to tell?

[Ed Fritsch:]

I think it's too early to tell. And I think Michael, if you're going to identify anything or we are going to identify anything as just leverage buyers are less able to compete that's the biggest difference, but I think the move has been nominal and given the percent of debt that goes towards these debt, we really haven't seen the change in cap rates.

[Michael Knott:]

Okay and then on the balance sheet appreciate that you guys have done some ATM issuance to at least keep the leverage, first to where it is, but just curious why, conceptually why 45 is the right leverage level for your company as opposed to may be 40 or something, just curious you must think your cost of capital would be higher if you had slightly lower leverage levels?

[Terry Stevens:]

Michael, this is Terry. I don't mean to imply necessary that 45 is our desired level, we have a range and we like to operate and as we said on some occasions to our buyers that talk right more into the lower end that range than in the upper end of the range. So we are in the range now over time we would like to bring it down and we have the dispositions that I mentioned, we've hit the ATM in the past as you pointed out and have other ways regular way deals if we had the need for larger amounts of capital. So just lots of options that we have to keep our leverage inline going forward.

[Michael Knott:]

Okay. And then just a question on Tampa in Atlanta, I know there's been some comments on this throughout the call, so sorry to re-ask for clarification, but typically you guys give quantifiable update on how much of the vacancies are put to bad, did you guys prepare that this time?

[Ed Fritsch:]

Yes. We just expected you'd be earlier in the queue. So on 2,800 Century Center, we are right now link for 75%, 74% of that is re-leased than we have letters of intent out that would get us to North of the 92% by year end. So that there has been LOI is basically one customer that is LOI all to get to see a north of 92% by the end of the year. And then at LifePoint, at LifePoint, we that PWC ended up keeping the 75,000 square feet which is about 23%, 24%. We have strong prospects for well over another 100,000 square feet and we have there is one large prospect for 180,000 plus square feet, but we don't know how many office are blind prospects. So we don't know how many options they are looking at, as far as cities, but we know that were the only option for that market. And then at Vinewood, we have already had a couple of showings and we're running right now at two prospect touch pads, one for about half of the building and one for about 90,000 square feet.

[Michael Knott:]

Okay. Thanks. I guess you did have that prepared though, it's very helpful.

[Ed Fritsch:]

Thanks, Michael.

[Michael Knott:]

Last question if I could were just the you mentioned you're seeing some expansion you feel like we are getting to a point where the cycle for office demand is about to pick up that tenants are going to start leasing space more for growth than growing the business or do you still feel like we're in kind of that 2% type of economy that you described before which is just okay for office?

[Ed Fritsch:]

Yeah, good memory on the 2%, I think the 2% is true, but biasedly, selfishly and supported by some actual forensics, I think that we're in the footprint that would do better than the 2%, in other words there is parts of the country that bring down the average in parts that bring up and I think we're and part of the country that brings it up to the 2% and making up for some other weaker area. So we do see a higher level of confidence, I think that some of that's the fact that we're away from so many of those economic crisis of (inaudible), from the sequester in the fiscal cliff et cetera and so I think as long as that noise stays quiet, I think it's helpful for the business community and we're certainly seeing customers that have a desire for growth, for example we have one office park, where we have roughly over a 0.5 million square feet and we're 100% leased there and customers needing more space. So we are seeing not everywhere but we certainly are seeing a considerable volume of conversations where customers are talking and serious tones about expansion.

[Michael Knott:]

Thank you.

[Ed Fritsch:]

Okay, Michael, thank you.

[Operator:]

Our last question comes from the line of Josh (inaudible) with Citi. Please go ahead with your question.

[Unidentified Analyst:]

Thanks and good morning. Can you talk about where the better NOI growth is coming from that drove the higher guidance, was it broad-based across the portfolio? Or whether it's one market or a couple of leases that you got done? Maybe just, where was the source of strength that caused you to raise the NOI guidance?

[Ed Fritsch:]

Well, there's no doubt that we've had tremendous NOI growth in Pittsburgh even though someone referred to it earlier is a surprise which that was a fair comment but we've had, Andy and his team have done a phenomenal job with increasing NOI both by improving the way that operating expenses were spent or are spent. So we're providing better service at a lower OpEx and certainly has bolstered occupancy on the top end. We're able to have better discussions with prospects in some of our stronger markets like Richmond, Nashville, Tampa certainly come along and better parts of Atlanta. Terry you have anything to add?

[Mike Harris:]

I would add, Josh. We have a good NOI margin in the second quarter. Just OpEx are running well. Bad debts are down little bit as well and that's going to carry over in to the full-year guidance on our NOI growth. So just partly reflecting in the full-year guidance, some favorable guidance results here in the second quarter along with some leasing in Pittsburgh, and other markets as I had just mentioned.

[Ed Fritsch:]

I would also add one more small foot note to that, Josh, that the sales per square foot and percentage rents in our retail and Kansas City, just year-after-year, quarter-after-quarter continued to just, with those numbers are (inaudible). So that asset continues to really perform, big good ballots for the company and we continue to see very good growth there and Glenn and his team have done a phenomenal job with tenanting and operating that.

[Unidentified Analyst:]

And just one last question on the development pipeline, how big is the pipeline of potential deals? I know that you gave kind of guidance for what you think starts looking to be in the pipelines around $100 million today. But if you can give us some sense for what's the opportunity set that you are looking at and also maybe what are some of the characteristics, are they mainly Highwoods existing tenants or are they tenants that would be new to Highwoods and which markets are you kind of seeing more or less activity?

[Ed Fritsch:]

Okay, I'm going to answer that question, but at the Citigroup conference. Now you have to be sure you get everybody agreed not to ask us this number deal by deal going forward every quarter from now on, but just and what we are talking to Josh, so talking to means that we could be pretty far down the road or these could be in the infant stages and they can be considering multiple markets and multiple states, okay. So do you understand the setting?

[Unidentified Analyst:]

Yes.

[Ed Fritsch:]

Okay, so it's broad from -- we are working on it and it's preliminary too, we are working on it and you know we are hopeful, but we haven't quite ordered the champagne yet. And so if you add all it up, it's about $700 million, but you know there are a lot of -- you know if you and I ran a car dealership we can't say that you know we had 20 people come out and look at cars today because that doesn't mean you got the potential for 20 sales, but I'm not sure you are going to say you are going to about a 1000 on that, but we feel quite confident enough on this to you know raise our guidance twice now during the year and it's only July. So we feel quite good about what we put out in a way of guidance and we feel quite comfortable actually with the high end of that. Are there others out that that could materialize yet within the year, yes, but I wouldn't want to bank on that which is why we excluded it from guidance.

[Unidentified Analyst:]

And how big would you feel comfortable growing the pipeline to for 500 million or for 700 million if you looked out one or two years as lot of these deals you are able to get just from a development risk perspective. I know a lot of it depends on how much of it is pre-leased but assume you can get a reasonable degree of pre-leasing, what size would you like to see the development pipeline at?

[Ed Fritsch:]

Yeah. I think that there is a well machine here. I think that Josh there, we have the capacity from a balance sheet perspective, from a personnel perspective, resources, vendor relationships, community, municipal relationships to do, to grow it to a fairly large size in the development risk, some of these projects or a number of projects are done open book. So if we are significantly pre-leased and we are open book, there is not a significant amount of risk there has been interest rate movement. I don't see a whole lot of risk in growing this pipeline from a investment side. And I see significant upside, I mean we've been core developers from beginning and it's one of the things that we have a good discipline, a good skill at. So we are not shy about chasing development projects as long as the credits there and that the economic terms will support it.

[Terry Stevens:]

I was just going to add Josh that I think that when you get around maybe 10% of our market cap that would be kind of maybe enough for them, but that gets you close to $500 million, $400 million or $500 million at any one-time that would be in the pipeline. And most of the things we're chasing are build-to-suit deals right now and that really lowers the risk dramatically. If that were, that much inspect, I think we won't be comfortable nearly at that level. So I hope that gives you some perspective on what we would be comfortable with. But I just like to think roundly around 10%, plus or minus is kind of maybe the upper limit on development that we might have at any one point of time.

[Ed Fritsch:]

And there is benefit to us being the developer, obviously in most cases we're putting land into use that's coming out of our inventories or the incremental spend isn't as high. And in addition of that, when we develop it, we're specking all other things from lock sets to roof type to parking lots, all of it. So we are doing that and then we have basically have cash flow, because you have no real CapEx exposure, because you are at 0 days to top of life expectancy of all the components of the property.

[Terry Stevens:]

And Josh also looking at the logical source of our pipeline, I mean you mentioned our existing customers look at international type of the deal we're doing in Memphis, LifePoint Hospital, those are existing customers. So I think we've evidenced to the market to our customers that we like to grow with them. And so we have a good customer base and when they come to us, and say look we're growing, we need help, we are the first developer resort they come to. So, I think they are the best source feeding this pipeline as we go forward.

[Ed Fritsch:]

And the number I gave you more are not because existing customers and customers.

[Operator:]

Mr. Fritsch, there are no further questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.

[Ed Fritsch:]

Thanks, operator, appreciate your work and thanks everybody for dialing in, if you have any more questions then never hesitate to call us, thanks, bye.

[Operator:]

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.