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Parkway Properties, Inc. (NYSE:PKY)

2009 Earnings Outlook Call

December 11, 2008 11:00 am ET

Executives

J. Mitchell Collins - Chief Financial Officer, Executive Vice President, Secretary

Steven G. Rogers - President, Chief Executive Officer, Director

William R. Flatt - Chief Operating Officer, Executive Vice President

James M. Ingram - Executive Vice President, Chief Investment Officer

Analysts

Jordan Sadler - KeyBanc Capital Markets

Stephanie M. Krewson - Janney Montgomery Scott

David AuBuchon - R.W. Baird

Analyst for Christopher Haley - Wachovia Securities

Irwin Guzman - Citigroup

[Bruce Garrison - Saley & Trow]

Nap Overton - Morgan Keegan

Operator

Welcome to the Parkway Properties 2009 earnings guidance call. Today’s call is being recorded. With us today are the Chief Executive Officer Mr. Steve Rogers, Chief Financial Officer Mr. Mitch Collins, Chief Operating Officer Mr. Will Flatt, and Chief Investment Officer Mr. Jim Ingram. At this time I would like to turn the call over to Mr. Collins.

J. Mitchell Collins

Welcome to Parkway’s 2009 earnings outlook conference call. Before we get started with this morning’s presentation I’d like to point out that there is no web presentation that accompanies our call today but you can find a copy of this morning’s press release on our website at www.pky.com.

Certain statements contained in this presentation that are not in the present tense or that discuss the company’s expectations are forward-looking statements within the meaning of the federal securities laws. Although the company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, it can give no assurance that its expectations will be achieved. Please see the forward-looking statement disclaimer in Parkway’s press release for factors that could cause material differences between forward-looking statements and actual results.

I would like to now turn the call over to Steve.

Steven G. Roger

As many of you already know, [Sara Clark] is currently out recovering after surgery and will be back with us to help out on our next conference call and we wish her a speedy recovery.

Before we present our 2009 earnings outlook and assumptions, I’d like to briefly address the environment that faces our industry and ones which we have taken into account when preparing our 2009 budget. Recently at the NAREIT annual conference we held over 30 meetings with analysts, investors, bankers, partners and others and about the only thing that was clear was the sky in San Diego. The lack of clarity is pervasive not only with investors but owners and operators of real estate as all grapple with the depth and breadth of the recession.

Chief concerns from my perspective include mounting job losses, continued credit freeze and the decrease in consumer spending. Job losses in ’09 are approaching 2 million and as you may have heard me say often, jobs fill up office buildings.

The debt markets remain for the most part frozen as evidenced by some of the largest and most well-known life companies having been out of the market for extended periods of time.

As an update we are communicating weekly with several life companies, one of which is Babson Capital, to earmark $375 million for Fund 2 and was noted in our November call as not lending at that particular point in time. Babson has recently begun to selectively quote with current quoted rates between 7% and 8% and we are watching daily for signs of a credit thaw from the other insurance companies. We have reason to believe that these life companies will begin returning to the debt markets early in the first of the year for loans under $100 million, 50% to 60% loan-to-value and good sponsorship.

From a debt maturity standpoint we only have $22 million of maturities in ’09, $66 million in 2010 and remain in compliance with all of our debt covenants. As noted before all 2009 and 2010 maturities can be met with the existing availability under our line of credit even if the life companies are not available.

As discussed during our third quarter call I believe it is prudent to delay investments on behalf of our fund with Teacher Retirement System of Texas until we see clarity in values and liquidity. Mitch and I had a productive visit with our partners at Texas two weeks ago and they like we believe some of the best real estate purchases in our careers will be made in the next couple of years. With both parties remaining flexible as well as disciplined the partnership will bring significant value to both.

On the leasing front 13.5% of our total portfolio rolls in ’09 with a majority of this roll occurring in the fourth quarter. Nearly 50% of our lease roll occurs in Chicago and Houston representing a GSA entity in Chicago and several large oil-related companies which we believe have a high probability of renewing.

We recently announced a reduction in our dividend from an annualized rate of $2.60 to $1.30 per diluted share. Parkway projects that our FAD will cover our dividend in both ’08 and ’09. The change in dividend policy will offer greater flexibility with an additional $20 million of reduced borrowings under the line.

We’re also preparing for a slowdown through certain operating and G&A cost reductions. We project 2009 G&A savings of approximately $1.5 million, a meaningful 18% reduction as compared to 2008 G&A based on a recently completed realignment. This reduction includes the elimination of certain salaried positions and payroll costs, reducing certain professional fees and a general belt-tightening companywide. In regards to our operations we will reduce expenses in areas that are least intrusive to customer service and renewals.

The volatility in the capital market presents both challenges and opportunities for Parkway. Capital transactions are difficult to predict right now and therefore our outlook today is mainly focused on core operations. I can assure you that we remain active in the area of asset recycling and remain committed to the previously-announced GEAR UP sales.

As 2008 draws to a close our strategic plan for the past three years GEAR UP will also conclude. The results of this plan will be announced in January following the completion of our year end. We will also share details of our next strategic plan which we refer to as FOCUS in our February 2009 conference call.

That said, the objectives of the first year of FOCUS are simple and straight forward: Use cash from the decreased dividend to reduce borrowings under our line, delay new investments with Texas until there is further clarity in value, reduce expenses at the corporate and property level, achieve the embedded rent growth on our expiring leases, make strategic asset sales previously announced in GEAR UP, and act upon opportunities which have become increasingly clear will be unprecedented. We believe these actions will make for a better Parkway over the long term.

I’d now like to turn the call over to Mitch.

J. Mitchell Collins

First I’d like to take a moment to briefly recap Parkway’s policy on our annual earnings outlook. Banks within our range may occur due to variations in our recurring revenue and expenses of the company as well as from certain nonrecurring items. It has been and will continue to be the company’s policy not to issue quarterly updates or revise our annual estimates unless such estimates are outside of our original range. This policy is intended to lessen the emphasis on short-term movements that do not materially affect our earnings or the long-term value of the company.

For 2009 the company forecasts FFO in the range of $3.50 to $3.85 per diluted share. The wider outlook range this year reflects our view that the economy could have more volatility in relation to our rents, occupancy, embedded growth and the possibility of above-average bad debt expense. For 2009 we’re going to highlight the key assumptions included in our outlook as follows:

An annual average occupancy of 88.5% to 89.5%. At December 1, 2008 our portfolio occupancy was 90.4%.

The average rental rate per square foot will be in the range of $21.85 to $22.85 versus $22.13 through the third quarter of this year.

Recurring same-store net operating income increase of -2% to 0% on a GAAP basis and a -3.5% to -1.5% on a cash basis.

G&A savings of approximately $1.5 million or $0.10 per diluted share in FFO.

The capital activity assumptions included in this outlook are as follows:

For 2009 we have $22 million in debt maturities related to three assets that are 97.8% leased. We plan to pay this maturity in March ’09 utilizing our line of credit with the goal to place a first mortgage on these three assets as the credit markets ease.

For 2010 we have approximately $66 million of maturing debt assuming that we exercise a one-year extension option related to our $60 million Cap City loan in Atlanta.

We currently have approximately $130 million available under our line of credit to handle future debt maturities and project compliance with all loan covenants for 2009.

The company is estimating total capital spending for building improvements, tenant improvements and leasing commissions in the range of $20 million to $25 million as compared to $25 million projected for 2008. Based on our anticipated capital spending one can see that our FAD is projected to cover our dividend in 2009.

The only asset under construction, the Pinnacle at Jackson Place at our corporate office, opened on December 8, 2008 for a total projected cost of $48.5 million. The company previously funded its equity and has a $37.6 million nonrecourse first mortgage provided by US Bank. The Pinnacle also has a 1,734 space adjacent parking garage on a long-term lease with the City of Jackson and the combined cap rate of the project is expected to be approximately 8% once stabilized. To remind everyone, we are in the middle of an $11.6 million partnership syndication related to this project that we are targeted to complete by year end.

We’re also assuming that there are no investments that will be made for the discretionary fund with the Teacher Retirement System of Texas for 2009 and we’re also assuming no sales or joint ventures for 2009 yet we will continue pursuing asset sales as outlined in our previously-announced GEAR UP plan that we’re coming to fruition on. We will provide further information at such time as a sale or joint ventures is completed as to the impact on the earnings outlook.

With that I’d like now to turn the call back over to Steve.

Steven G. Rogers

We’ll be happy to answer any questions you have at this time.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Jordan Sadler - KeyBanc Capital Markets.

Jordan Sadler - KeyBanc Capital Markets

On the potential fund purchase opportunities it sounds like 2009 you haven’t put anything in guidance and it sounds like you don’t think you’ll see the opportunities really bubble up necessarily in 2009 either. If you could sort of work through your thought process on the evolution of the market and when you think the availability of assets will become most attractive? I know it’s hard to predict but maybe what’s in your crystal ball?

Steven G. Rogers

The policy of not giving out capital activity is different than my belief that there will be opportunities in ’09. It is our guidance policy just to say that right now there’s so much uncertainty out there that we’re just not giving it out as guidance. What we would rather do is to just see them as they come and report them as we see them.

Everything that I’m seeing out there today indicates to me that there will be opportunities in ’09. In fact there are already some opportunities out there today and those opportunities are spread out throughout Parkway’s markets. Although we’re not reading about many closed transactions and that I think spooks people, we are still seeing things being marketed today and we’re seeing what it at least looks like some anticipated trades are.

I think we’ll probably have a fair chance of buying some things in ’09. We’ve just decided not to give guidance on this matter at this point in time. It’s just a little early for me to be guessing where those cap rates will settle in and whether that hits in June or August or September of next year.

Jordan Sadler - KeyBanc Capital Markets

But you’re still looking at deals and evaluating and you’re seeing some flow at least?

Steven G. Rogers

Yes. Jim is in here, our Chief Investment Officer. We still get out in the market place and see the activity. We’re in touch with the brokers; when things are set up for marketing we take the package, we underwrite it; we are still actively analyzing everything out there today, although we have not closed anything since very early in 2008. I think that’s just an indication of our unwillingness to get our toe in the water right now at a cap rate that about the time you start underwriting it you see a new cap rate the next day, and the liquidity picture’s a little less clear. So it’s just kind of pushed us back to say, “Okay we’re seeing a lot of stuff out there; not many closings; but let us just maintain the discipline.”

We sat down with our partner a couple of weeks ago in Austin and had a great meeting and they feel the same way we do. So we’re perfectly aligned in our interests here both to make money for our respective interests and we’ve got plenty of time. This thing’s got a four-year life on it so we’re just going to sit back and [inaudible] similar to what we did last quarter.

We told you I think in the May meeting in Atlanta that we were going to go out with a couple of assets in Columbia, South Carolina and a couple in Virginia. And instead of trumpeting that too much this summer we just waited till they closed and reported the $80 million of closings as they closed. I’d probably rather do that today rather than give you an expectation for a March closing that may be dashed over the next 90 days.

Jordan Sadler - KeyBanc Capital Markets

That asset in Atlanta, Buckhead, was it Cap City?

Steven G. Rogers

Yes.

Jordan Sadler - KeyBanc Capital Markets

Is that one still up on the market?

Steven G. Rogers

It is not. We got a couple of offers in September and then October happened and October changed a lot of people’s minds to be quite frank. So the offers we had in September just really weren’t valid in the October/November timeframe and we pulled that building from the marketing effort. We may come back at it another time. It’s still a great asset. But that’s kind of what we’re out there doing today is putting our toe in the water, getting some indication of values, liquidity, buyers. If one feels right like the three we did this summer, we’ll pull the trigger on it and if it doesn’t, we’ll hold it and come back at it later.

Operator

Our next question comes from Stephanie M. Krewson - Janney Montgomery Scott.

Stephanie M. Krewson - Janney Montgomery Scott

I didn’t see a filing on your new interest rate swap agreement. Do you have the terms on that? What’s the spread to LIBOR and when does it mature?

J. Mitchell Collins

It’s an all-in effective. We’re quoting a 493 and we are at 130 on the line so let’s call that 360. We did that back in May. I think we announced it in our May call because we had just closed on it. It’s a $100 million swap that starts in January. You should have it in the model.

Stephanie M. Krewson - Janney Montgomery Scott

Yes, we have it in our model.

Steven G. Rogers

Of course, LIBOR dropped pretty precipitously since May.

Stephanie M. Krewson - Janney Montgomery Scott

Just the way it was phrased in this press release, we thought it was something new that we had missed.

Secondly, we had been anticipating based on your prior comments that you would joint venture your Pinnacle asset. Did you complete that joint venture or did the joint venture become effective with the C of O?

Steven G. Rogers

We have not completed it yet. We have till December 31 to complete it and we’re right in the middle of it. I can’t talk too much about it just because of the legal, the blue sky laws and the like but suffice it to say we’re still working on it, we still are trying and we anticipate a closing December 31.

Operator

Our next question comes from David AuBuchon - R.W. Baird.

David AuBuchon - R.W. Baird

Assuming you feel comfortable with your capital position, I would imagine at some point you’re going to feel compelled to move forward with deals. What sort of valuation metric do you hang your hat on and say, “I’ve been in the business a long time. This feels like a good deal to me. We’re going to go ahead and do it?”

Steven G. Rogers

I still like the three, and it may sound like a boring broken record, but I still like cap rate, discount to replacement cost and internal rate of return. Those are the metrics that our partner likes as well and on a leveraged IRR they have a published number which I think would be low today. We would not want to offer on such a low number today even though we might have that legal right to do, I think we’d have no moral high ground to be using that low leveraged internal rate of return.

Cap rates have moved up a good bit since the October meltdown in the REIT markets; the implied cap rates have jumped up to 9%, 10%, in some cases 11% out there. I think it’s probably a little oversold is my personal gut feel on it but nevertheless if the REITs which are only 10% of the overall commercial income producing property in America, if that’s a correct window to the world then that’s sort of what the REITs are telling the world is the valuation of real estate today. Will the private market win out on that or will the public market win out on that? I guess that’s one of those things that’s a little less clear today.

I think replacement costs are probably coming down. Commodities are coming down and the cost of building a new building has peaked probably this year, probably mid-’08 and with the cost of petroleum properties dropping and concrete and steel and copper and other commodities, then we may well see the cost to build a new building come down. But it’s going to come down off an awfully lofty level that we’re at right now. I think our portfolio would probably value in the public arena today at under $100 a foot.

David AuBuchon - R.W. Baird

What I was going to ask is as you align those three metrics with what you’re specifically looking at today, what Jim is looking at, which one is way off? It sounds like replacement costs?

Steven G. Rogers

Replacement cost is off the charts today I think, meaning even if replacement costs came down 25%, then the valuation of the public securities is probably 30% to 50% off the mark today if we go by that one.

You’ve got implied cap rates out there, companies like ours that are approaching 10 and that just feels a little high relative to the Treasury market today. We have about a 260 Treasury today. Even at 500 points on top of the Treasury that’s 760 and that’s 250 over that number. Just a good rule of thumb for me has been you need to be a couple hundred basis points above the all-in cost of debt.

So when debt was 5 not long ago you could be at 7 and feel pretty good about life, and yet it was a lower cap rate. It’s tied to the Treasury world very heavily. The weighted average cost of capital has a huge component of the US Treasury and your marginal cost of borrowing implied in that calculation. And the cost of debt is pretty low right now. It’s just not very available.

All things considered, I think cap rates are probably a little too high right now so we might just get back on the playing field and take advantage of that. Discount to replacement cost is way off the mark and IRR is kind of following suit.

David AuBuchon - R.W. Baird

You mentioned you talked to Texas. It’s your opinion that they feel still very comfortable with their allocation to you guys?

Steven G. Rogers

Yes. I’ll brag on them a moment here. They may be listening; I don’t know. But they have just acted beautifully during this awkward period of time for everybody out there. Let’s face it. We’ve got a written document dated in May that probably would just be a tough deal for anybody to consummate in December of the same year. It’s probably beneficial to Parkway in that regard but they know we wouldn’t take advantage of the debts condition and they have offered great flexibility to us as we just sort of look into the future.

We just want to keep up a good line of communication with them as we’re doing. We’re talking weekly. Jim and I and Mitch and Will, all of us really, are catching up with our counterparts there on a weekly basis because we feel like it’s just a wonderful highly accretive opportunity to Parkway when we do get back out on the playing field. It’s the best asset we have today that’s not on our balance sheet.

David AuBuchon - R.W. Baird

Relative to your same-store outlook which was -2% to 0% on a GAAP basis and a little bit worse than that on cash and that your 2009 roll is weighted toward the back half of the year which I believe you said and 50% is in Houston and Chicago, do you see at this time that your same-store NOI growth on a quarterly basis is going to improve throughout the year and into the first half of 2010?

Steven G. Rogers

I’m not sure I can answer that one. Will, can you or Mitch?

William R. Flatt

I think the cash number does include a termination fee in 2008. I think I wouldn’t read anything into the fact that the exposure is later in the year. That comment is more related to just sort of where the risk is. At this point looking into ’09 the projection is really based on just smoothing out over the year general risk. We’ll get a few months into it but there is not a quarter-by-quarter percentage that I think we’re giving out. I think the average number is really based on the 12-month period and some allowance for bad debt, some allowance for customers that we think may renew today but we want to be cognizant of what may happen. So that’s how I frame it up.

David AuBuchon - R.W. Baird

Do you feel that your embedded rent growth, your best opportunity for rent growth is in the Chicago and the Houston leases?

William R. Flatt

It would be in the Houston leases. Sitting here today its impact to 2009 is obviously limited. Oh, I understand your question now. Going into 2010 would we project that that rent would matriculate into the portfolio? Let me refrain on comment on that one. I hate to look into 2010 when 2009 is an uncertain year. But yes, the answer would be that to the extent that we meet the embedded growth in Houston that will roll into 2010 numbers.

Operator

Our next question comes from Jordan Sadler - KeyBanc Capital Markets.

Jordan Sadler - KeyBanc Capital Markets

I just wanted to follow up on a couple of things. I think Mitch you talked about the upcoming maturities, $22 million on a few assets, mortgages and you said you’re going to repay them with the line. Have you talked with the lender on potentially extending those maturities?

J. Mitchell Collins

No, we have not as of yet just given where the markets are. That’ll be a top priority in January. That’s a March maturity so our intent here is if the markets don’t hold, we plan on paying it with the line and then coming on the back side of that and putting it with a first mortgage which is our traditional pattern. We will be addressing that. That’ll be a top priority with me starting in January.

James M. Ingram

It’s John Hancock Life that holds the paper and we’ve got a great relationship with them and they are in the market right now. We just haven’t wanted to go too forward with you guys by saying we will renew it with people. I just don’t think people believe that today to be honest with you so we’re just sort of giving you a fallback. We’ll absolutely go to John Hancock and we’ll go to our other lending sources. We’ll put this in front of Babson. We’ll have a pretty good chance of one of those guys doing it. But what we’re really trying to give the capital markets is the assurance that it’ll just get done.

Jordan Sadler - KeyBanc Capital Markets

So in doing so you’re saying we’ll just fund this off the line right now?

James M. Ingram

That’s a last resort and we’re willing to do it if we need to go there. We’re just telling you that because I think people are being valued today as if you can’t get a loan and that’s just not true. We get loans in this company. We get them from life companies. But instead of me trying to convince the world that we can get a loan, we’re just saying if we can’t this is what we can do.

J. Mitchell Collins

It’s our intent to have a first mortgage and like we said we’re trying to articulate for the next two years if the first mortgage market completely dried up, which we don’t believe it will or has, then we would have adequate line capacity to refinance all of our maturities.

Jordan Sadler - KeyBanc Capital Markets

It just sounded like you were going to pay down with the line and then come back to it when the market stabilized a little bit.

J. Mitchell Collins

My comments say when we’ve given you our budget and our assumptions, and our assumption is right now we will pay it on the line and then refinance it as the credit markets ease. If we get in here in January with a good competitive quote, we’ll lock it down right then. We can prepay it starting January 1 at PAR so there’s no prepayment penalty.

James M. Ingram

A few of the life guys just sort of finished their allocation in ’08 so they’ve dropped out but not forever. They just sort of had gotten out in ’08 because they finished their book in September and October hit and sort of spooked everybody and everybody just said, “We’re not going to lend for the rest of the year.” They’ll be back in the market. We have strong reason to believe we’ll see good activity from the life companies beginning in January and we’re just going to be patient there. Hopefully by February we’ll be able to tell you exactly what we’re going to do on that asset and it may be a life company solution.

Jordan Sadler - KeyBanc Capital Markets

Moving on to leasing a little bit, what do you have in terms of a retention rate expectation for 2009 on your customs? I know this year was a little volatile and you had like a 60% quarter and an 87% quarter. But where are you pegging it for ’09 right now with these assumptions?

William R. Flatt

It’s always volatile quarter-to-quarter. We are generally in the 70% to 75% range. I think that we’re keeping that same expectation. Where we’ve brought down expectation is in the amount of new leasing. I would assume that it would be consistent with prior years.

Jordan Sadler - KeyBanc Capital Markets

On the JVC income I think the number that you were saying before overhead and G&A was $0.41 was expected for 2008. What’s embedded for 2009 in fee income?

Steven G. Rogers

It’s basically flat.

J. Mitchell Collins

I would assume it’s flat. There could be some volatility of maybe some leasing and fees in there and then there are two assets that we purchased for the fund that were not full year for 2008. Remember we purchased them in January of ’08. But to the extent it varies around that number it shouldn’t be materially different subject to any leasing fees.

Operator

Our next question comes from Analyst for Christopher Haley - Wachovia Securities.

Analyst for Christopher Haley - Wachovia Securities

On the occupancy line the average looks like it’s going to be at midpoint down about 150 basis points from where you are right now. Where should we think about the year-end occupancy rate embedded within your guidance?

William R. Flatt

I think it depends on where we feel like we may lose occupancy. If you kept a current occupancy today for six months, obviously it’s going to imply a couple hundred basis points of erosion in occupancy by the end of the year.

What I think that average occupancy number is really economic occupancy to say that as we look into ’09, we know what our occupancy is today, it’s sort of reflective of uncertainty about new leasing and erosion of customers who can’t pay the rent. I think that it is less of a prediction about an absolute number for the end of the year than sort of an average economic occupancy based on all things: Estimated customer retention, estimated renewal and estimated bad debt expense.

Analyst for Christopher Haley - Wachovia Securities

I know you guys don’t want to comment on 2010 but it just seems like given the nature of lease rollovers I would have to assume that the year-end number would be lower than the average number just because you’re starting significantly higher.

Steven G. Rogers

That’s implicit with what we’ve given out. That’s correct. Implicit in what we’ve given out, we start at 90%, our budget is 88.5% to 89.5%; therefore it’s going to be lower at the end of the year; implicit. But I think Will’s commentary is really more, ours was more a generic feeling on ’09 being a tough year and we just sort of solved for a reduction there rather than actually probably budgeting pro forma the reduction and that’s really what I think you’re hearing from this management team today.

Analyst for Christopher Haley - Wachovia Securities

You mentioned kind of capturing or achieving some of the embedded rent growth that you’ve got within the portfolio. How should we think about that for what your expectations are for 2009, what the embedded rent growth may be on new leasing?

Steven G. Rogers

I forgot. What are we at? $1.14 today?

William R. Flatt

$1.09.

Steven G. Rogers

$1.09. If we kind of look back over history, these recessions tend to take us a little bit of time to get in there and take hold. I would probably just say we’re assuming we’re probably just going to be at $1, somewhere in that neighborhood, embedded growth.

Analyst for Christopher Haley - Wachovia Securities

So roughly holding close to flat from where you are right now?

Steven G. Rogers

Just slightly down is in our pro forma budget. I don’t have the percentage handy off the top of my head but it’ll fall a little bit.

Analyst for Christopher Haley - Wachovia Securities

On the G&A I’m just trying to understand the $1.5 million expected reduction from ’08 levels. Included within your ’08 level, are you including any G&A related to the comp plan or is this just truly taking out $1.5 million of operating costs going into ’09?

Steven G. Rogers

We’re truly taking out $1.5 million of overhead. It’s not related to the comp plan. In fact we’ve done a realignment here in October and there’s just been some reduction there. Not a fun part of my job; probably the part I dislike the most; but I think that we’ve run a lean operation in Parkway historically. I think the evidence bears that out from G&A as a percentage of revenues, G&A as a percentage of total assets.

But in every organization no matter how lean it is run or how well it is run, at times like this there is room for improvement and our company must and will make improvement in these regards. That’s what we have done; it’s now in the past; and that will be an increase in cash flow or decrease in expense effective 1/1/09.

J. Mitchell Collins

The run rate is just as you take the net G&A this year is projected to be $8.5 million and it’ll run just for rounded numbers say $7 million next year for 2009.

Operator

Our next question comes from Irwin Guzman - Citigroup.

Irwin Guzman - Citigroup

I just have a follow up to the question on the metrics that you look at when evaluating acquisition opportunities. I’m wondering where you see your own cost of capital today, whether that fits into the equation and whether the opportunities that you said that you’re looking at the leverage returns on those is actually higher than where you see your leverage returns based on your stock?

Steven G. Rogers

We do do a cost of weighted average cost of capital by modern financial measuring sticks every quarter in our company. I don’t have it handy in front of me but it has been coming up obviously but it is being mitigated by the marginal cost of debt in some of our 10-year Treasury matters, the 10-year Treasury’s coming down.

The beta on Parkway is at an all-time high and all things considered we’re probably running some place at about 8.5% to 9% using a WACC formula today. It feels a little low just sitting here today talking about it but we have to run the math and look at it accordingly. Obviously our own leverage returns need to exceed that to be creating proper shareholder value and nothing we’re considering would fall beneath that, I can assure you.

The benefit of having an institutional partner, whether it be Ohio or Texas or others, is that their actuarial returns are just simply lower than most people’s weighted average cost of capital and we can then blend our weighted average cost of capital in with theirs and achieve the lower expected yields or allowing us in many cases to be more competitive on the pay side and still achieve everybody’s goals.

That was a mouthful so I’ll try to shorten it if I didn’t answer your question.

Irwin Guzman - Citigroup

No, that’s helpful. Thank you. Just one other question. One of the things that several people mentioned at NAREIT was following the decline in everyone’s valuation it may have opened the window to sell some assets at valuations that may previously have been unacceptable but now could actually be valuation accretive to the extent that stocks are now trading at double-digit cap rates. I’m wondering if where you’re trading today has increased the appetite at all to maybe sell some assets at valuations that may have been unacceptable six or nine months ago?

Steven G. Rogers

I was probably one of the guys that mentioned some of that at the conference. If you believe that the private market is trading at a couple hundred basis points less than the public market today on cap rates, therefore the strategy should be sell into the private market and buy in the public market. That would just be kind of a buy low/sell high kind of mentality that we ought to just always keep in mind as there’s still a strong entrepreneurial spark in our organization. So yes, I think is the short answer. How much has that moved up? I don’t know. We’ve kind of got a few assets in the market place today. I’d rather just get some offers and bids and just see where they shake out. We didn’t really know where the three assets we sold this summer would shake out because people were saying pretty much the same things this summer. Although October came and devalued everybody greatly, people were still talking in July about there were no transactions, cap rates had gone through the roof, and when the dust settled on everything we did I think we were in the [pri 8s].

J. Mitchell Collins

We had about an 8.5 cap rate.

James M. Ingram

Blended cap rate on the buildings we sold this summer.

Steven G. Rogers

I think that was probably maybe surprisingly good news. So I’d rather not say we’re going to end up at a high cap rate just because the public markets are valuing us at a high cap rate. There are still people out there that have an appetite to purchase and their goals and agenda and yields are based on a lot of things that I can’t figure out. I’m not going to try to give the customer an excuse not to come to the closing table. I’m just going to go to a fully marketed situation, get some bids and then we have a free option to evaluate offers. At that point we’ll make hopefully an informed judgment.

Operator

Our next question comes from [Bruce Garrison - Saley & Trow].

[Bruce Garrison - Saley & Trow]

Would you comment on a couple of things: One, your expectations for capital costs going forward; not necessarily in ’09 but just for the REIT model in general? And then do you have a strategy in hand to start lengthening the average maturity of your debt or changing your total debt ratio?

Steven G. Rogers

Let me clarify the first part of your question. When you’re talking about the expectation of ’09, is that like your weighted average cost of capital, what investors expect or is that capital costs to put a customer in the building?

[Bruce Garrison - Saley & Trow]

I think you addressed that on the previous call. You’re working on 8.5 to 9.

Steven G. Rogers

So it’d be the capital cost to put a customer into the building?

[Bruce Garrison - Saley & Trow]

Right.

Steven G. Rogers

We’re really not budgeting much change for next year, the principal reason being that we are really thinking that most of the customers during a recession actually don’t feel like moving. It’s kind of hard to move into the more expensive building with a lot of pretty TI next door and give pink slips out simultaneously.

During recessions people tend to stay and not as for as much TI. In fact what we tend to find during recessions, and we’ve not budgeted this way but it could well come to pass, is that people will come to you and say, “I want lower rent and I don’t care if you give me any TI,” or “Give me less TI and less rent.” It’s just kind of less is more during recessions. So we may find that occurs again.

[Bruce Garrison - Saley & Trow]

Are you finding any evidence that your financial flexibility relative to competition is helping attract tenants? I know in terms of your retention rates are going to be high because of what you just said, but I’m just wondering if the REIT format’s going to give you some competitive edge in the midst of a tough environment?

Steven G. Rogers

I’m going to let Will opine on some of that as well, but my short answer is yes. People that have capital can execute things that people who do not have capital do. And we still have a line of credit in Parkway that serves that purpose and allows us to make such improvements. The dividend cut that we made just gives us a $20 million infusion of cash that we didn’t have, therefore offering additional flexibility for tenant improvements or other matters.

Will, any thoughts?

William R. Flatt

Yes. I would agree with that. I wouldn’t say it’s systemic but beginning to hear anecdotal cases of a building down the street that’s maybe a different capital structure than an REIT that is not able to fund TI or maybe is giving free rent and low rates because they can’t fund TI. I can’t point to any one deal we’ve won yet but at the margin I think that is happening.

Then also if you’re in a building that may or may not, our capital structure lend itself to secure ownership of a building, I think that a building that’s whispered to have debt trouble or certainly subleased space where someone’s having to go into where the underlying customer is in trouble, I think all that bodes well for us. I think that’s a very good question that I hope somebody asks again next quarter because I think I’ll have a better feel.

Steven G. Rogers

Bruce, you had another part of your question dealing with lengthening maturities on debts. Our principal goal here is to make sure that we take care of the obligations of ’09 and ’10 which I think we’ve outlined carefully and often to the capital markets. And I believe strongly that we have no problem in ’09 and ’01.

I don’t really think we have a problem in ’11 but yet our line of credit does mature in ’11 and therefore that needs to be the highest priority we have to ensure that our line of credit is at a reasonable level for a company our size so that when we go back to our line providers, which we have nine or 10 of and they’re great national providers and have been with us a long time, that we make it a layup for them to say, “We want to renew your line of credit.” Now maybe 311 turns into 250 or something and maybe LIBOR + 130 turns into LIBOR + 135 or something but the goal is to make sure that that guy’s taken care of.

We’ve always been a long-term nonrecourse life company borrower and that’s just not going to change in this company.

Operator

Our next question comes from Nap Overton - Morgan Keegan.

Nap Overton - Morgan Keegan

Two clarifying questions. One, the same-store GAAP NOI range of 0% to -2%, does that include the $3.6 million year-to-date term fees in the 2008 base?

J. Mitchell Collins

No, it does not. That’s recurring same-store.

Nap Overton - Morgan Keegan

Do I also understand, which I believe I do, that the key factors in the range of FFO that you set forth as an estimate are operational things like occupancy, rent and bad debt expense and not really capital items like possible dispositions that might occur during the year?

Steven G. Rogers

That’s correct. We have no acquisitions or dispositions or equity offerings or stock buy-backs factored into the budget although I think from the commentary you’ve heard today you should surmise we’re out on the playing field on both of those and they will have some impacts on it, positive and/or negative. That’s why we have a pretty good range in front of you today.

In other words, with a sale which could be advantageous to Parkway could well have the effect of dropping out the FFO and NOI from that sale and that would be something that would pull down the estimate by a little bit. Purchases with Texas Teachers are highly accretive today. That could have the opposite effect and add to the accretion and therefore bring us up higher.

Nap Overton - Morgan Keegan

So while they’re not in your assumptions, those factors are an ingredient in the breadth of the range?

Steven G. Rogers

They are actually not in the $3.50 to $3.85 now, are in no place to get to either of those numbers have we placed any of those items in there. I’m just trying to give you a little additional color that we’re out there on the playing field and some of that stuff’s just going to happen. It’s just not in the $3.50 to $3.85 number.

Operator

Our next question comes from Stephanie M. Krewson - Janney Montgomery Scott.

Stephanie M. Krewson - Janney Montgomery Scott

You discussed replacement costs and I agree at this point in the cycle it’s a pretty critical metric. Can you provide what you think your replacement cost is or range both with and without the underlying land costs?

Steven G. Rogers

Sure. Land cost is really not a big factor in replacement cost contrary to popular opinion in the office building area. Study after study after study indicates it’s a very small fraction unless you’re in a city that has an extraordinary high barrier to cost like Manhattan. I can give it to you with land cost in there and quite frankly you would only need to pick out just a few percentage points to change the land cost.

What you’ve really got is probably on the low side places; we just finished the Pinnacle and it cost $48.5 million. Now it’s a very high quality lead certified class A+ building; it was $250 a foot; so that’s a real-time number that was a bid number with out-of-state contractors and subcontractors all bidding; hard bid job; $250 a foot. I think that kind of sets the low end of a southern urban building. You can go out on the prairie in suburbia and build a building for a little less than that. There’s no doubt about it. You could come in a little north of $200 probably today. But $250 is an all-in fully loaded cost number.

Then you’d go up from there if you go to Buckhead it just costs a little bit more. You’d be over $300 a foot. In Chicago new buildings there are over $400 a foot and that would probably set the higher end of Parkway’s replacement costs because those are the only cities we’re really in that get up that high.

So I’d say smaller suburban buildings in the south you can come in at $200 to $250; high quality suburban buildings, urban southern centers $250, $260, $270; and then you’d be in the $400 range for the Buckheads and the Chicagos.

Operator

Our next question comes from David AuBuchon - R.W. Baird.

David AuBuchon - R.W. Baird

Overall comments Steve about tenant credit? I would assume that it’s going to get much worse. Can you put it in context relative to some of the past cycles you’ve been through?

Steven G. Rogers

My only comment here is we have more budgeted for bad debt this year than in my career and 2X to 3X what we did last year. I have no reason to know of any single customer that’s driving that; therefore what I’m really saying to you is there’s a wide range out there of expectations and I just don’t know. It’s kind of like my quip on the only thing clear at NAREIT was the blue sky in San Diego. I wasn’t kidding. That was what I left San Diego with even after being in front of a lot of smart people, and it’s not just the analysts and investors. I’m talking about other CEOs from my work at NAREIT. We sit around and we talk often.

And I’ve just got back from New York in front of 20 guys that are all in the private business last night. There are people out there that have question marks. So we’ve just sort of dialed in that question mark into our budget in the form of dramatically increased bad debt expense even though I really have no individual customer to blame it on.

David AuBuchon - R.W. Baird

Is there any way to quantify that number that you’re anticipating versus past cycles?

Steven G. Rogers

I’m saying probably 2X to 3X.

David AuBuchon - R.W. Baird

But that was last year.

Steven G. Rogers

That was last year. Will?

William R. Flatt

We’re running right now estimating between $2 million and $2.5 million of bad debt expense for next year. We were at $1 million or $2 million-ish in our forecast; $1.3 million back at our last announcement. So we’ll just have to see and again we think this thing will play out sooner rather than later.

J. Mitchell Collins

The difference I would add and Steve’s been through more cycles than I have but the difference I would say that I see today is you used to be able to look at the rent roll and say, “Okay these customers will be at risk.”

I won’t name the building or the market but I had a medical services firm that could not get their line of credit renewed on their accounts receivables. It wasn’t that they were buying expensive equipment; it’s just their sort of cash receivables were unable to finance. So I think it was not someone you’d normally think of would be a victim of a credit crisis.

I think that’s sort of the uncertainty that plagued where we are, what might be. But from a large exposure, we do have a very diversified rent roll and we do have a quality customer base, is we are not pointing to any one market or customer where we are at risk.

Operator

Our next question comes from Jordan Sadler - KeyBanc Capital Markets.

Jordan Sadler - KeyBanc Capital Markets

Lease term fees; anything in the guidance for ’09 that you know of?

J. Mitchell Collins

Very nominal. I think it’s about 33 [inaudible].

Operator

This ends our Q&A session so I’d like to turn the call back to Mr. Rogers.

Steven G. Rogers

Thanks for your attention to what we’re doing here at Parkway now. We wish everybody a very happy holiday season. We look forward to talking to you next year. Have a great day.

Operator

We thank you for your participation on today’s call. Have a wonderful day.

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Source: Parkway Properties, Inc. 2009 Earnings Outlook Call Transcript
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