DCT Industrial Trust's CEO Discusses Q4 2012 Results - Earnings Call Transcript

| About: DCT Industrial (DCT)

DCT Industrial Trust Inc. (NYSE:DCT)

Q4 2012 Earnings Call

February 8, 2013 11:00 am ET

Executives

Melissa Sachs – Vice President, Corporate Communications and Investor Relations

Philip L. Hawkins – Chief Executive Officer

Matthew T. Murphy – Chief Financial Officer

Jeffrey F. Phelan – President

Analysts

Craig Mailman – KeyBanc Capital Markets

James Feldman – Bank of America Merrill Lynch

John Guinee – Stifel Nicolaus

John Stewart – Green Street Advisors

Michael W. Mueller – J.P. Morgan

Brendan Maiorana – Wells Fargo Securities

Sheila McGrath – Evercore Partners Inc.

Eric Frankel – Green Street Advisors

Operator

Good morning and welcome to the DCT Industrial Fourth Quarter and 2012 Year End Earnings Conference Call and Webcast. All participants will be in listen-only mode. (Operator Instructions) Please note that this event is being recorded.

And I would like to turn the conference over to Ms. Melissa Sachs, VP, Corporate Communications and IR. Ms. Sachs, Please go ahead.

Melissa Sachs

Thank you, Keith. Hello everyone and thank you for joining DCT Industrial Trust's fourth quarter and full year 2012 earnings call. Today's call will be led by Phil Hawkins, our Chief Executive Officer and Matt Murphy, our Chief Financial Officer who will provide more details on the quarter’s results as well as our guidance for the balance of the year. Additionally, Jeff Phelan, our President will be available to answer questions about the market and our real estate activities.

Before I turn the call over to Phil, I would like to remind everyone that management’s remarks on today’s call will include forward-looking statements within the meaning of federal securities laws. This includes without limitation statements regarding projections, plans or future expectation. Actual results may differ materially from those described in the forward-looking statements and will be affected by a variety of risks including those set forth in our earnings release and in our Form 10-K filed with the SEC as updated by our quarterly reports on Form 10-Q.

Additionally, on this conference call, we may refer to certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures are available on our supplemental which can be found in the Investor Relations section of our website at dctindustrial.com.

And now I'll turn the call over to Phil.

Philip L. Hawkins

Thanks, Melissa. Good morning everyone and thanks for joining our call. We had a very busy and productive fourth quarter, an excellent way to finish off a really great year.

During Q4, our operating portfolio continue to perform well. We acquired 21 buildings for $242 million, we sold 7 buildings for $111 million, and our development program is progressing very well in some of the new starts and more importantly lease up. These results reflect many months and even years of effort by many people at DCT and I’m very grateful for their talents, hard work and accomplishments.

Let me start off with highlighting our key operating metrics for the fourth quarter which reflect continued progress as well as strengthening market fundamentals. Occupancy in our consolidated operating portfolio increased 50 basis points over last quarter to 92.3%. For the consolidated operating occupancy increased to 170 basis points. Same-store NOI increased 8.6% on a cash basis and 4.9% on a GAAP basis driven by both higher occupancy and higher effective rents. And rental rates increased 15.3% on a GAAP basis and 3.4% on a cash basis reflecting significantly reduced rental concessions as well as gradually improving base rents across our markets.

Current leasing activity is encouraging, we did see a drop in activity in December and the first half of January, which is not unusual given the holiday season, but also could be partially explained by fiscal cliff concerns. However, in the last few weeks, proposal activity is back to normal. My expectation is that 2013 will be pretty consistent with 2012 in terms of activity and net absorption. And like 2012, I'm sure there will be periods were that activity is more robust as well as less so. But overall I think tenants will continue to look for opportunities to upgrade and consolidate the distribution facilities to reduce their overall cost.

Small tenants also continue to be more active than a year ago, and my expectation is that this trend will continue if not further strengthen as the housing recovery gains momentum. With supply and check and demand remaining steady, I am optimistic that effective rents will continue to improve across most markets and in a few select markets we will also see continued growth in base rent as well. In response and reflected in our leasing and operating metrics, we continue to look for opportunities to push effective rents, rent bumps and other related economic terms sometimes if the expensive of quick occupancy gains as these will derive long-term growth and values.

Moving on to capital deployment, we had a very successful quarter acquiring $242 million in very high-quality assets. This includes the purchase of our partner’s interest in DCT Fund I for an incremental investment of $78 million. We know the real estate very well and we are able to accommodate the needs of our partner, and buy it at pricing that we considered attractive.

Shortly after acquiring the interest, we were successful in selling the two buildings that didn’t fit with our long-term investment strategy. The remaining four buildings are expected to generate a year one cash yield of 6.5% and after free rent on a few recently negotiated leases burn-off, a stabilized cash yield of 7.2%. In addition to the joint-venture acquisition, we closed on $164 million of acquisitions in the quarter, which are expected to generate a year one cash yield of 6.3% and a stabilized yield of 6.6%, with further growth expected in the future from annual rent bumps as well as rents rolling up to market.

In addition to acquisitions, we were very focused on prudently expanding our development pipeline to grow the company and create long-term value. During the quarter, we signed a lease at our Northwest 8 Distribution Centre in Houston. This lease will commence in March at rents significantly higher than we projected when starting of the building.

Other development activities of note include: we completed the 177,000 square foot Newell Rubbermaid expansion at SCLA. We commenced construction on two new projects that fully pre-leased 650,000 square foot Slover Logistics Center in the Inland Empire West, and the 267,000 square foot DCT Airtex Industrial Center in North Houston. We are committed to start construction on our 133,000 square foot Beltway Tanner project in the Northwest submarket of Houston this quarter, a site which we will be working on for quite some time, but formally acquired in December. We signed an agreement for a 130,000 square foot build-to-suite at our 8th and Vineyard project in the Inland Empire West. Overall, our pipeline of under construction and recently completed development projects is 70% leased with good activity on the remaining spaces. I am confident that our market teams will exceed their lease up and economic projections on each of our projects underway.

In addition to Beltway Tanner in Houston, we closed on the acquisition of four additional development sites located in Southern California, Seattle and Atlanta which will support approximately 3 million square feet of distribution buildings. Site planning and preleasing are underway at each of these projects.

And last but not least, dispositions. We were successful in selling 7 assets generating proceeds of $111 million. These buildings are located at Atlanta, Columbus and Memphis. In addition, we have a 400,000 square foot building located at Memphis that is under contract for sale with the buyer’s earnest money non-refundable. Package out for our remaining San Antonio assets with office expected to be called for later this month. While we are price sensitive as always, I’m encouraged by early investor interest in the portfolio.

We continue to make good progress in selling assets which we consider to be low growth or otherwise not consistent with our investment and ownership objectives as we actively manage our portfolio improving future growth and focusing on fewer markets.

In summary, I am very pleased with all we’ve accomplished in 2012. We continue to make great progress strategically by repositioning, strengthening and focusing our portfolio to acquisitions, development and asset sales and our operating portfolio continues to perform well demonstrating consistent improvement in terms of occupancy, rental economics and same-store NOI.

The fourth quarter is a great lead into a new year in 2013 and I look forward to continued success in progress for DCT Industrial.

With that, let me turn the call over to Matt Murphy to provide further details on our 2012 results as well as 2013 guidance.

Matthew T. Murphy

Thanks, Phil, and good morning everyone. Thank you for joining us today. I’m going to provide some color on our fourth quarter results and then walk you through our guidance for 2013.

Our fourth quarter was very strong particularly with regard to the continuing improvement in operating results. As Phil mentioned, our consolidated operating occupancy increased 50 basis points in the fourth quarter. 2012 was the third straight year in which occupancy has improved and our year-end occupancy is at its highest point since the great recession.

Over that span, our consolidated operating occupancy has increased 700 basis points to 92.3%. While the number is a little below third quarter guidance, the shortfall is almost entirely attributable to transactions during the quarter including the joint-venture acquisition Phil mentioned which brought down operating occupancy by approximately 15 basis points due to vacancy in the Memphis and Atlanta assets which we sold shortly after year-end. Additionally, the 2.1 million square feet of buildings we sold in the fourth quarter were 100% occupied which brought down occupancy another 25 basis points.

If you eliminate the impact of these transactions, the occupancy of our 930 portfolio of assets was 92.7%. This was despite effect that short-term occupancy was only 1.3% well below plan and previous years’ experience. The most important way to think about our year end occupancy is that we're ahead of plan in terms of long-term leasing and start the year off on an excellent trajectory.

Our same-store results were another bright spot for DCT in the quarter and for all of 2012. Same-store net operating income increased 4.9% on a GAAP basis and 8.6% on a cash basis in the fourth quarter as average occupancy in the 53.5 million square-foot same-store pool was 170 basis points higher than the fourth quarter 2011 and with higher effective rents. For the full year of 2012, same-store NOI rose 2.8% on a GAAP basis and 5.7% on a cash basis bringing us in at the higher end of guidance in both cases. Sequentially, same-store results were also very strong.

Fourth quarter net operating income grew 4.4% and 4.6% GAAP and cash respectively from the third quarter of 2012 based on an increase in average occupancy of 120 basis points and $1 million decrease in operating expenses. When you added all up, we finished the fourth quarter of 2012 with fund from operations of $0.11 per share slightly ahead of our own projections and $0.42 per share for the full-year of 2012, above the top end of our initial guidance for the year and an increase of 5% over 2011.

Turning to capital funding, we had a very active year on the real estate front, which in turn led to a great deal of activity in the capital markets arena. As you’ll recall, we began the year talking about how we would match fund our growing deployment efforts with the combination of dispositions and the proceeds from equity issuances. For the year, that strategy has worked out very well.

We invested approximately $328 million on acquisitions during the year and spent an additional $116 million funding development. The capital for these activities has come from dispositions of $285 million including year end 2011 transactions as well as the three buildings already sold or under contract to sell in 2013, plus $172 million in net proceeds from equity issuances.

Taking into account all of these transactions, we were able to match fund with a difference of only $3 million based on total activity of over $900 million. All of this leads our balance sheet stronger and with excellent flexibility to execute on continuing real estate opportunities in 2013 and beyond.

Included in the equity amount mentioned earlier is just under $60 million from the sale of shares under our ATM program, which we utilized for the first time since 2010 in order to fund the joint-venture acquisition. Given the nature, size and timing of the transaction, we felt the ATM was the ideal way to fund this acquisition. We sold approximately 9.5 million shares at an average net price of just over $6.33 per share and received proceeds of $59.2 million, which was approximately what we needed to pay for the four assets that we ultimately retained in the transaction.

Now let me take you through some of the details of our initial guidance for 2013. We have initiated our 2013 FFO guidance with a range of $0.40 to $0.45 per diluted share. We have based our guidance on an economic backdrop of continued modest economic growth, which we believe will generate positive net absorption of industrial space at about the same levels as 2012. We believe new supply will remain muted and these supply demand dynamics will result in improving fundamentals in virtually all of our markets in 2013.

More specifically, our guidance is based on the following assumptions. Occupancy, for the consolidated operating portfolio, is expected to average between 91% and 94%. As is typically the case, we expect occupancy to decline a little at the beginning of the year as December 31 leases expire and seasonal short-term tenants vacate, although as I mentioned earlier, we have lower short-term occupancy than years past. So the impact of this will not be as significant. However, we do have somewhat higher than usual known non-renewals in the first quarter, so we still expect occupancy will fall in the first quarter in a similar fashion to the past couple of years. We expect occupancy will then build during the year and end somewhere between 93% and 94%.

Same-store net operating income is expected to increase 2% to 5% on a cash basis and 1% to 4% on a GAAP basis as we expect continuing occupancy increases and positive rent growth in many of our markets. It’s important to keep in mind that these projected operating statistics do not take into account potential impact of any acquisitions or dispositions, but they do reflect the projected impact of our current development portfolio stabilizing and (inaudible) operating portfolio. It should be noted however that our same-store results do not contain development or re-development assets until they have been stabilized throughout both periods.

Shifting to acquisitions, we continue to uncover opportunities to deploy capital at attractive returns into target markets and submarkets which we believe will continue to perform well overtime. Consequently, we have included in our guidance $100 million to $200 million of acquisitions. These acquisitions will be a combination of stabilized assets and value add opportunities in a mix which is likely to be similar to 2012. Additionally, we are planning to start construction between $125 million and $200 million of development projects in 2013. All of the projects assumed are on land we currently own as we continue to focus on putting land into production quickly in markets where we have great visibility into fundamentals and confidence in leasing activity.

From a capital market perspective, we plan to fund the capital deployment I described from the proceeds of property dispositions and were appropriate the issuance of equity in a manner similar to 2012. We expect that the combination of investment and development and value-add acquisitions as well as the effect of disclosing of non-strategic assets will cause short term dilution of approximately $0.01 per share in 2013.

With regard to the $175 million of debt we have maturing in June of 2013, we intent to refinance that debt in conjunction with an extension and repricing of our existing bank facilities, which is nearly complete.

This week we have received final commitments to extend our revolving line of credit for four years, extend our existing $175 million term loan for five years, and add an additional $175 million tranche of unsecured term debt to refinance the June maturity. In addition to the extra term we will achieve on these facilities, the existing pricing will be reduced providing us with an interest savings of about 50 basis points on our outstanding bank debt at our current leverage.

In summary, we believe the 2013 will resemble 2012 in many respects. We expect market fundamentals will continue to strengthen albeit at a somewhat slower pace. We believe the investment sales market and capital markets will remain open allowing us access to attractive sources of capital to fund our investment activities. But most importantly, we expect our market teams to continue to do an outstanding job, focusing on our customers, and sourcing and executing on prudent real estate transactions that will continue to upgrade our portfolio and to create value for our shareholders.

With that, I will turn it back over to Keith for questions. Thank you.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And the first question comes from Craig Mailman of KeyBanc Capital Markets.

Craig Mailman – KeyBanc Capital Markets

Good morning guys. Question on the rent spread, it was obviously a pretty positive surprise here that they were that positive certainly in the year. Is it sustainable you think that sort of level the particular renewals and then may be could you give us some insight into the 11% roll down on new leases. Was that just older vintage spaces that you guys are able to lease up and that’s the discrepancy.

Philip L. Hawkins

Craig, this is Phil. Let me take the first part and then hand it over to Matt for a little more detail. I think we’ve been pretty consistent for a while, but that metric is going to move around a lot based on mix. I think that the overall direction is encouraging and reflective of the fact that rents are improving across, I think, all markets effective rents certainly, but mix matters and timing matters. So I think that we had a great quarter on that metric, but I think I would show a brighter light on that today than I would two quarters ago whenever when perhaps that metric wasn’t quite as favorable. I look at the trend as oppose to a specific data point. Matt, may be you can comment on the 11% and the mix of that that drove that number lower.

Matthew T. Murphy

Yeah. First of all, I agree with Phil’s comments, but it really is – there is a mix, there is a very large transaction in Phoenix where we had a tenant moving out of a space that was very highly improved and as a result, there was outsize rent roll downs on that specific space. I think by and large, Phil is right, which is – what you look at is that the combination of improving effective rents and market rents in many markets, you will see the trend line continue to improve over time and I expect that to continue but I also expect the volatility of it to continue. And I think particularly on a cash basis, cash tends to be more volatile than GAAP.

Craig Mailman – KeyBanc Capital Markets

What you have baked into guidance for rents growth in ’13?

Philip L. Hawkins

We haven’t guided to it historically or this year, but I think my expectation is that you will continue to see GAAP spreads be positive and probably progressively so. And cash ones I think are likely to be positive although they’ll be volatile from quarter to quarter. We have a couple of large leases, there is a 700,000 square foot one that was signed in 2005, it was really at the peak of the market, and when those roll, it’s going to create volatile results.

Craig Mailman – KeyBanc Capital Markets

Okay. And just on the match-funding side you guys have been pretty successful here. Just curious may be one, are you guys putting – how much San Antonio is in that package on the market? And then two, may be just some thoughts about what you’re seeing in the sales environment from terms of demand and pricing, and is there any potential that your dilution expectation that you guys could be if pricing comes better on some of these assets?

Philip L. Hawkins

This is Phil. We don’t have, we did not put action price in the San Antonio package, so hope – but we certainly have expectations, but we’re not going public with those expectations. And for marketing reasons and other reasons, we are not doing it. So from a sales marketing perspective, my sense is that market is pretty good. Strong demand may have picked up if anything in the last quarter for a variety of reasons. There are more names in the business that we’re seeing. Then we did say six months ago, new names to the industrial sector, which clearly creates opportunities if you are a seller, makes it much more competitive if you are a buyer, which is why we continue to focus with our market teams to try to find the one-off deals, take on a little bit more risk if necessary in the right buildings, the right markets and the right submarkets to try to compete in a very competitive world. But it’s – cap rates have probably moved down a little bit in the last quarter. The one thing that’s probably hasn’t happened yet is the spread between B’s and A’s or between secondary markets and primary markets hasn't narrowed like I thought it might have, it's held pretty constant. So I think that is more capital try to buy industrial and especially we have to buy that attempt that capital continue to flow where its not today, not as prevalent, which is stabilized assets in the secondary markets as well as probably even taking on more risk. I don’t know if I had answered your question.

Craig Mailman – KeyBanc Capital Markets

Yeah, and just one last quick, you said there is more people in the market, is that more pension money or more private equity type money chasing the assets?

Philip L. Hawkins

Pension money, pension advisors, private equity funds, both industrial focus as well as general real estate funds, foreign money, Canadian's benefited for a while, but certainly some more Canadian names to be active, European names, you name it. A pretty much all categories of institutional capital seem to be attracted to the recovering industrial sector and it’s a sector that always is under weighted in most investors, real estate investor’s portfolio anyway. So it seems I guess, I think its not showing up yet in the numbers that the various services report and closed deals, my sense is that and our sense collectively internally is that cap rates will probably come down 10 basis points or 20 basis points from the last quarter.

Craig Mailman – KeyBanc Capital Markets

Okay, thank you.

Operator

Thank you. And the next question comes from Jamie Feldman from Bank of America Merrill Lynch.

James Feldman – Bank of America Merrill Lynch

Great, thank you. I want to go back your comments on; you think supply will be relatively in check. Jeff, can you give us some thought cruncher market in portfolio, what gives you comfort saying that, it does seem like reserve are starting to ramp up their pipeline kind of what's going on with the private guys, and where you think we stand kind of inside next year?

Philip L. Hawkins

I think when you look at what’s under construction and what’s expected to start in the market, the market that we are focused on, I don’t see supply being, I see supply thing and check. Southern California, the buildings under construction and like that happened our large box buildings and Jeff can comment more if you want, but it strikes me a lot of good leasing activity in those buildings, lot of growth in that area. Houston, demand is strong, there is construction, yes, but it’s relative to the vacancy rates that are in the market and relative to net absorption, again, I consider that to be in check.

If you look at the other coastal markets, similar comment, honestly, we are not that active in Indianapolis. I know there are some buildings under construction there. Dallas, where there are some buildings under construction, strong net absorption is taking those buildings. So almost market by market, maybe you’ve got a specific example you want to test me on, but there is clearly more construction today than it was two years ago, but the construction that’s happening is funded all by equity whether it be REITs and clearly those on this call probably see more in the REITs and therefore extrapolate that for us more broadly.

And then the private guys also funding their deals primarily leases of speculative construction entirely by equity. Forward committed structures, joint venture structures, whatnot and that equity coming from institutional investors is a lot more disciplined than perhaps the banks might be, the spigot was open on lending and we’ve not seen any indication that banks are taking any more risk in the lending portfolios with respective to construction. Builder suits, different matter, which is why you see builder suit pricing pretty thin, because you can get financing at the credit season. But when it comes to speculative construction, I think the capital remains very discipline. I hope it will, no guarantees, that’s my expectation at least for the next 12 months.

Jeffrey F. Phelan

Jamie, this is Jeff, a couple of things I will keep it in check. Number one, land sites are still very difficult to find and number two, the entitlement process in most of these markets is also very lengthy. So I think those two elements will also add to that keeping in check.

James Feldman – Bank of America Merrill Lynch

Okay. And when you think about your land bank in your pipeline, I mean, is this a good time to aggressively ramping up even more than what you talked about?

Philip L. Hawkins

I think we are doing exactly what we’ve been talking about, which is buying sites in markets that we believe are ready for development and buying sites at economics that work today as oppose to waiting for some leap in rental rates and where we think demand is likely to prove us successful. We have volume, Seattle is a good example, we bought a project there and we called the other site. That is a two phase project. We are underway with site preparation right now, final site planning and then also permitting, zoning and other approvals. So we will hopefully start in third-quarter of this coming year.

There is another building behind it when we lease the first one, so the two phase project which we said, one to phase projects that we can put into production pretty quickly. That’s true really across the way, it is still my view that we’re not rewarded nor that prudent to buy multiple years of future land. So I am happy, there are few markets where I like to see us acquire land, a few markets that we are working on buying land, in fact many have some under contract, but those of the alter markets if you would consider to be really ready for development and maybe with some development already underway.

James Feldman – Bank of America Merrill Lynch

Okay. And just my final follow-up on that, so we are getting close to the Panama Canal opening, there has been a lot of talk about strike in the different ports, East Coast, West Coast and then a lot of talk about same-day delivery and the retailers want to get closer to population centers. Are you thinking differently about the markets you want to be in at all or as you're thinking about where you would develop over next couple of years?

Philip L. Hawkins

Well, there are lot of different trends that can have some impact on our business, but they all lead to one thing in my opinion, the benefit of buying infill locations, Class A high functional buildings in markets with strong deep diverse demand as oppose to markets where that demand may not be a diverse or where there may be plentiful land forever and that's going to change it out. So I think we reinforce what we are trying to do which is quite a real estate debt. We’ll be well served, perform well as the world changes, the world will change.

Number of those factors you mentioned, I think will be small changes at the margin, but the indication of the noise and the changes going on around not just in our business, but every business. Which is why I think we will continue to focus on the kind of real estate we're buying, which is infill functional location, primary markets with good deep diverse demand.

James Feldman – Bank of America Merrill Lynch

Okay, thank you.

Philip L. Hawkins

Thanks.

Operator

Thank you. And our next question comes from John Guinee from Stifel Nicolaus.

John Guinee – Stifel Nicolaus

Well, nice quarter guys. Actually a lot of questions I'm go ask if already been addressed, but just one question for you when I looked at the land basis you’ve incurred, it looks fairly reasonable with a couple exceptions. Your are in at Southern California Slover and then Rialto at about $800,000 an acre that seems awfully high. Is there something unusual about those markets? And then also you are in at Houston looks like around $250,000 to $330,000 an acre also seem pretty high. Am I just behind the times or what can you tell me about those land base situations?

Jeffrey F. Phelan

John this is Jeff. The Slover property was purchased for roughly about $10 a square foot so that would be roughly $450,000 an acre. So I don’t know where you got your numbers. I don’t know if you took the total number, that would be under the building cost, may be that’s where it came from, but the price per square foot for those properties are in check and if anything they are below market in my opinion, not only in Houston, but also in Southern California.

Philip L. Hawkins

Hey, Bob and Matt, afterwards we will work on the numbers to make sure you are looking at land numbers; it’s hard to do on the phone.

Jeffrey F. Phelan

John, I’d be happy to talk to you as well.

John Guinee – Stifel Nicolaus

Okay, great. Thank you.

Operator

Thank you. And the next question comes from John Stewart with Green Street Advisors.

John Stewart – Green Street Advisors

Thank you. Matt, I had a couple of questions on the guidance. I guess, first of all, may be I missed it, but did you give a specific dispositions number?

Matthew T. Murphy

No, John. The way I characterize it which is the way we think about it and correctly the way it worked out in 2012 is, we talk more specifically about deployment and acknowledge the fact that we will fund that through what’s likely going to be a combination of both dispositions and the issuance of equity. And I think we are in a good spot today that quite honestly I think the market is receptive. We could fund entirely with dispositions and quite honestly entirely with equity, but we will continue to evaluate the right mix, the right source for the right opportunity and approach it that way. So it’s really the combination of dispositions and equity will add up on a match winning basis to the combination of deployment.

John Stewart – Green Street Advisors

And have you issued anything on the ACM so far in the first quarter?

Matthew T. Murphy

No, we have not.

John Stewart – Green Street Advisors

Okay. I know that you obviously don’t want to talk about San Antonio specifically, but could you kind of help us think about your appetite for and put yardsticks around how big the disposition pipeline could be?

Philip L. Hawkins

I think it could be as much as – unlikely to be, but as much as all of our acquisitions plus the cash dispersions on development, unlikely to be that. But again we’ve not put a yardstick exactly what mix that should be, but 2012 saw a good guy post which is some combination of the two.

John Stewart – Green Street Advisors

And how about a sense for a weighted average stabilized cap rate?

Philip L. Hawkins

Dispositions?

John Stewart – Green Street Advisors

Yes.

Philip L. Hawkins

That’s between 7 and 8, I think its going to be a mix that’s similar. We are really focusing on assets that are likely to be well received in the market. And we will mix that with some user sales from time to time which as we talked about will drive the averages down, but I think guidance and expectations are based on sort of a range between 7 and 8, and the mix of that will be if not that we are not necessarily just targeting a lowest cap rate, because there are strategic implications involved as well. But I think you are likely to see the outcome fall within that range.

Matthew T. Murphy

There will be some low 8 cap rate probably, as we saw some flex phase perhaps and hope it will be some really low cap rates because we sell some, to use as a very attractive prices but I think that’s right, kind of low to mid seven should be my guess.

John Stewart – Green Street Advisors

Okay, that's helpful. Thank you. Matt, on the same-store guidance, could you give us a little bit of a sense for the components and specifically wondering how much an improvement in net effective rents or burn off of free rent might be contributing to 3.5 at the midpoint?

Matthew T. Murphy

Yeah, I think it’s a combination again similar to what we've seen in 2012 of occupancy, because we are still expecting to have average occupancy increases in our same-store pool in excess of 100 basis points at the midpoint. And the combination of net effective rent both on future transactions and the continuing improvement in the burn off, the progression of rent bumps as well as the burn off of free rent, and its going to be a combination of the two but I don't think that that is that dissimilar to 2012 although, I think occupancy increases will obviously get tougher on a comparative basis as the year progresses.

John Stewart – Green Street Advisors

Right. I was just kind of trying to get a sense for how much was already baked in and how much was contingent upon that occupancy gain?

Matthew T. Murphy

Haven't looked at it that way, my tummy tells me sort of half-and-half. I look at occupancy gains that are similar on average for the full year as what we experienced in 2012 and the mix in 2012 was roughly 50-50. I haven't analyzed exactly that way, but it got to be pretty close to that.

John Stewart – Green Street Advisors

Okay. That's helpful. Thank you. And then lastly, Phil, just curious if you've got any serious on why the construction lending figure is still so tight?

Philip L. Hawkins

I’ll let Matt – Matt has worked with bankers than I do. Matt, you better bet to me.

Matthew T. Murphy

Yeah, I think at the end of day there is still a pretty meaningful focus on credit and performing loans. Non-performing loans, that doesn’t mean that they are not going to be paid back, but from a capital charge perspective the way the banks think about it, speculative loans are very expensive. So the combination of the risk aversion hasn’t completely gone away. And the credit guys are still in much better control of the conversations in the banks today than the business development guys who were the only ones anyone was listening to in 2007 and 2008.

I think it’s interesting you talk to the bankers nine months ago and they would have told you that they thought that the result would have probably cracked a little bit and it hasn’t. I think most people that have observed the banking industry over long periods of time would expect it to get a little bit looser as time progresses, but quite honestly it hasn’t happened yet. And I think it’s the combination of the regulatory environment, the capital charges that they get and just some of those loans are still reasonably fresh and it hasn’t changed much yet.

Philip L. Hawkins

John, this is not your question but I – I thought have – with respect to the banks, and that is the banks and insurance companies were not interested, it appears to be taking on risk in terms of construction lending. Have been very aggressive in secondary market in Class B building lending which is really what’s helped open up the specked for our ability to access the market and sell buildings in Memphis, Columbus, etc. So that has been a benefit to a lot of people including the buyers of those assets. I mean they are get good spreads. So banks are absolutely eager to lend money as witnessed by their pricing of our new facility, but thankfully, and I think its some regulatory impact limitations, they’ve not yet turned attention to the construction lending world.

John Stewart – Green Street Advisors

Great. Thank you.

Operator

Thank you. And our next question comes from Mike Mueller of J.P. Morgan.

Michael W. Mueller – J.P. Morgan

Hello, most things have been answered, but in terms of the first quarter occupancy drop, how significant can that be? I think last year, was it down between 50 and 100 bips?

Philip L. Hawkins

Right. Like I said, that’s kind of earmarked the last two years Mike, which is what I said, I think it will fall sort of at a similar fashion, could potentially fall in a similar fashion to that. It’s an interesting dynamic and I mentioned that we had some higher than normal no move outs, so our retention will be undoubtedly lower than what we’ve experienced over the last couple of years. It’s really for pretty good reasons. We’ve got few of the larger ones that we know are going to move out. We’ve got 150,000 square feet in Atlanta for our restaurant oriented 3PL. They are building almost twice a large building right down the street and because of expansion in their business and its specific location that we can accommodate.

We’ve got almost 200,000 square feet in Chicago that we know is going to move out. This is a metal supplier sort of an aerospace supplier that’s doubling their space right down the street. So we’ve been the beneficiary of some consolidations I think in many ways in our development portfolio. It’s part of the dynamic that’s going on. Sometimes you are a loser in that equation and that’s happening, it’s sort of a bad thing for a good reason, that’s happening on a couple of big spaces in the first quarter.

Michael W. Mueller – J.P. Morgan

Okay. And I know this is a small number, but management fee income, I am assuming nothing changes to dramatically even with the buyout of JV partner?

Matthew T. Murphy

Yeah, you will – I mean specifically you are probably going to lose 10%, 12% of that number next year.

Michael W. Mueller – J.P. Morgan

Okay, got it. And then last thing, just I know we talked about this before in terms of disclosures, wondering if it's possible in future releases to maybe put some sort of a sequential call the same-store type concept around occupancy because you tend to have a lot of acquisition and disposition activity, and it can be hard to cut through all the transaction to see what's really happening to the operating portfolio from a leasing perspective. So just a few sense on that if you would mind?

Matthew T. Murphy

You are not the first person to say that Mike, and you can rest assure it will happen, particularly at the level of activity that we've had this quarter.

Michael W. Mueller – J.P. Morgan

Great. Appreciate it. Thanks.

Matthew T. Murphy

Yup.

Operator

Thank you. And the next question comes from Brendan Maiorana from Wells Fargo.

Brendan Maiorana – Wells Fargo Securities

Thanks. Good morning. I had a couple of quick ones. So Matt, on the development spend for the year, I think in the start you mentioned were 125 to 200. What do you think you actually spend during 2013 if you're sort inside the scope of?

Matthew T. Murphy

Yeah, I think so we got about $35 million left to spend on the stuff that’s already under construction. I suspect we’ll spend between 75 and 125 probably on the 2013 starts, obviously timing has a big impact on that. We've got some entitlement stuff to continue in Seattle, but I think those are pretty good numbers. I think we're likely to spend everything that’s left to spend or darn near on the existing construction. And the starts for the remainder of the year are pretty well spread throughout the year.

Brendan Maiorana – Wells Fargo Securities

And is that – if I look at your predevelopment projects, is the starts number as you guys kind of define it include – is it sort of all those projects or the majority of those projects, are there other projects that are outside of the pre-development pipeline. How should be able to think about that?

Matthew T. Murphy

Yeah. As I mentioned in my comments, the guidance that we’ve talked about is entirely on assets that we own today. But if you look any pre-development, there is multiple phases in a couple of instances, Phil mentioned we call it White River actually in the supplemental in Seattle, where we will start one phase probably and not start the other. So it’s a bit of a mix, but what I can tell you is what’s in guidance is only on land that we own today.

Brendan Maiorana – Wells Fargo Securities

Yeah. So I guess if I look at that cost incurred on those pre-development assets, its $67 million and if you spend $75 million, let’s call it $100 million between the midpoint of that $75 million to $125 million, you are really only spending an incremental like $35 million kind of give or take on that side?

Matthew T. Murphy

The number I think will likely be higher than that. But again it all depends on timing.

Brendan Maiorana – Wells Fargo Securities

Okay. All right. That’s helpful. And then the only other one I had, I think we are talking this, you were talking about this a little bit earlier in the Q&A, but with respect to the straight-line rent number, if I look at where you guys run right now, it’s straight-line rent as a percent of overall rent is probably around 2.5% may be 3% of that overall rent number. It’s about in line with the long term average, but it strikes me that may be its still a little bit higher than where you probably could run the portfolio if you are getting to 93%, 94% occupied by the end of the year. Where do you sort of think that number can shake out or that ratio can shake out longer term?

Matthew T. Murphy

Yeah. I think you are thinking about it the right way. What I will tell you and may be I shouldn’t emit this, but what I’ll tell you is when I try and predict that number it’s extremely difficult to do. I think what will happen? We’ve gone through a period where free rent and we’re passed that, but we are still feeling the effects of the fact that we’ve gone through a period where free rent was a far more prevalent part of the equation than is normal. And what that does is it really pulls forward the free rent component of rent. And so I think what you see is, I think, it’s likely that the historical average if you’re looking over the last five years, will be higher than what the average will be for the few years after we get out of the fee rent cycle, if you follow me.

Because what’s happening is, again, the percentage of free rent that is, or the percentage of straight-line rent that is recognized early is far higher in a free rent heavy environment, then where you have a month’s free and 2% bumps over five years. So I think you’re going to see that number end up as a lower percentage than what you probably think of it as a historical average, if you follow me.

Brendan Maiorana – Wells Fargo Securities

Yeah, now that makes perfect sense. So when you think that dynamic started getting better or I guess is it sort of in a normalized environment as we sit here in the first quarter of 2013 and I sense that its gone better in probably the second half of ’10, it got better throughout’11, it got better throughout ’12. I’m just sort of wondering when – where were it in ’12 relative to where you sort of think the long term normalized environment ought to be?

Philip L. Hawkins

Well, I’m not sure I’ve ever thought about it exactly what you are describing. But what I can tell you is that, I think the point of inflection really started in early 2012. The reason I say that, so you just look at the average free, again I think by far the biggest driver of this. Rent bumps cancel each other out, if it is a pure rent bump environment they effectively cancel each other out overtime. But 2012 and we’ve talked about this in a number of different ways, is really when you started to see dramatic decreases in free rent.

I mean our fourth quarter average free rent per number of months per year of term was 2.27 months per year, but that number is – we have been anywhere near that in four or five years. And that really started to decline, you’re right in 2011 really, but it was declining modestly for a long period of time and it really dropped dramatically throughout 2012. It was better in early 2012, but it got much better as the years gone along. I would say it was 2.27 months in the fourth quarter, its 0.35 months for the year, so you can really see that trajectory start to drop. I think 2012 was when you really started to see the impact of that, it's hard for me to think about it sort of longer year-over-year, because it's really a dynamic layering that’s going on again easier for me to think about that trend line and try and predict any single point time.

Brendan Maiorana – Wells Fargo Securities

Sure. Okay, that's very helpful. Thanks.

Matthew T. Murphy

Yup.

Operator

Thank you. And the next question comes from Mitch Germain, JMP Securities.

Mitch Germain – JMP Securities

Good morning guys. Phil, just curious in terms of your – how you're thinking about specular development in terms of looking at that $125 million to $200 million of start. Are you going to look to manage the amount of exposure you have to spec development?

Philip L. Hawkins

Look about it in three ways. First way, we think [compared to] the market. Are we confident in our ability to build the building on a location that we believe will be successful? And clearly there’s risk there, but we want to make sure, we are confident you can possibly be in that kind of business. The second one we think about is management balance sheet and making sure that the non-productive assets that we're incurring during lease and construction period of time and beyond do not put our metrics into a spot that would sacrifice balance sheet quality. And then the third way we think about it is risk assets is the percentage of total assets. And we said 10% to 15%, any one point in time no more than that – it’s not a goal to get there, it’s a goal not to get over that. Should no more than that should be in the form of risk assets i.e. unleased development and value-add assets.

I guess the last thing, I look at is that, we are getting paid for the risk. I’ve been an advocate for now some time, going back to prior 2011 which I doing more value added acquisitions and then later in 2011 and in 2012 as we said during speculated development, as long as we are comfortable in underwriting locations and the buildings. And we are happy with the premium we’re getting on our risk and our efforts, that I would rather do that and build a building that we love long terms. We’re building long term buildings that we want to own long-term not in the merchant building business. I am much more comfortable putting my capital. and our resources, people resources into that effort and competing with everybody else out there on the non-risk assets, and non-risk development.

Currently we have a great land site and a unique use and we think, I love businesses, I’m well at making more money with less risk, believe me. But I have been comfortable with the dynamic that we’ve seen so far of the risk return balance as leases we see it, and we may feel wrong, but that’s how we see it.

Mitch Germain – JMP Securities

Great. And Matt, what was available on the ATM at this point?

Matthew T. Murphy

So we used $9.5 million, out of $10 million, out of $20 million, so you got $140 million in current stock price, plus or minus.

Mitch Germain – JMP Securities

Okay great. Good quarter guys thanks.

Philip L. Hawkins

Thanks.

Operator

Thank you. And the next question comes from Sheila McGrath from Evercore.

Sheila McGrath – Evercore Partners Inc.

Yes. So could you talk about the buying of the joint-venture, how that opportunity came about, did you have to match other people’s offers, and if you think there is any other JV buying opportunities for you?

Philip L. Hawkins

It was entirely off market for a variety of reasons, one is it a portfolio and a conversation we’ve been having with our partner for quite some time. Because of the CMBS debt on the portfolio and the inability to split the portfolio up, I think it was marketing as is in one throughput and practically anyway. And then we are able to respond to a need that partner that frankly shows not to be in the business in the U.S. with us and an opportunity to buy the assets, I think price – they should feel this fair, but clearly we're happy with.

So I hope both parties went away and say, we are happy. Other opportunities – we've got good partners, good relationships, good portfolios, have good dialogues with partners, an opportunity to do something that is mutually beneficial that is different than the current status call, absolutely be available to have that discussion and hopefully make that happen. But it’s not our goal, we're not here to try to push partners out or whatever, we’re here to respond to their needs, and happy with the current business, but also mindful that if there are opportunities there, that are mutually beneficial we're all over it.

Sheila McGrath – Evercore Partners Inc.

Okay. And then 2012 was pretty active on the acquisition front. If you could give us an idea how the pipeline looks right now, are there any portfolios that you're looking at or that you are aware that of the interest that might be coming on the market?

Matthew T. Murphy

Pipeline is good, but still fair amount of work to do on most of that pipeline, couple of interesting opportunities that may or may not happen. I think in terms of active portfolio, we never try to signal anything in past, nor do I want to do that now, but given the competitiveness anything in the marketed portfolio of large quality assets, it may be tough for us to compete. I'd rather use our people to go after one-off deals, may be one-off market, take on some more risk in terms of value-add acquisitions or redevelopments and development, but we've got a number of – we've got a lot of market teams that are out there, I'll try to do the right thing and we've got a number of small deals in the pipeline and one or two medium-size deals that hopefully will happen, I feel okay about the pipeline, but its competitive.

Sheila McGrath – Evercore Partners Inc.

Okay. And the last question, Jeff, if you have to rank your markets in terms of the top two for rental growth outlook or two or three this year and the weakest kind of per rental growth in 2013?

Jeffrey F. Phelan

It's hard to differentiate between the top five or six markets, Southern California is strong, but it also has strong rental rate growth. I think they will continue. Seattle is strong, Northern California is strong, Miami, Houston, although Houston I think were probably slow down a little bit, it didn’t fall thus far in the downturn, has risen pretty significantly in the last two years, but I think with the construction, I think that’s going to – we'll see continued rent growth, may not be as dramatic.

The market that we struggle with is Columbus with a good leasing activity in a lot of the Midwest secondary markets, but Columbus and I think as a result I think Columbus is probably at the bottom of the list. Not a scientific analysis by my part, but more emotional, but Columbus would be at the bottom of my list for our rent growth. Seen some improvement in net effective rents there simply because concession is come back little bit, and kind of the crazy phase rates bounce at the bottom. But I put Columbus at the bottom.

Sheila McGrath – Evercore Partners Inc.

Okay. Thank you.

Jeffrey F. Phelan

Thanks Sheila.

Operators

Thank you. (Operator Instructions) And we do have a follow-up question from John Stewart from Green Street Advisors.

Eric Frankel – Green Street Advisors

Thanks. This is Eric Frankel for John Stewart. I was just wondering you comment on your risk appetite and the fact that you have a certain quarter you want to set in terms of quarter you want your development assets to be relative to your total asset base. Could you tell me your balance sheet philosophy a little bit more detail perhaps, any targets you have on leverage?

Matthew T. Murphy

Yeah Eric this is Matt. As we’ve talked about before, I think the business we’re in today is very important that we maintain a very strong balance sheet. And I think that includes, leveraged includes flexibility. I think where we stand today is probably higher than sort of an ideal spot from a debt to EBITDA, which is really kind of the most meaningful metric in my mind today. But really that’s byproduct of the fact that we started a lot of our value-added activity sort of at the same point in time. And well the leasing of those has gone extraordinarily well, very few of those people are in cutting us checks today. So I think what you will see is the natural growth in EBITDA, which is the best weapon against leverage, is really point and ready to take effect in 2013, it just hasn’t yet. So I think where we are today, if you just took the snapshot in time, our leverage metrics are quite a little higher than you think are ideal, but I feel comfortable about it, because I think that they work themselves out not through things that we hope will happen in the future, but that are already poised at. But I think the bottom line if you look at leverage perspective, I think 35% to 40% leverage is a good place to be, and I think on a value basis, we're probably on the higher end of that, but we’re sort of comfortably in range. Its meet our cash flow to grow and I think it will based on things that have already happened.

Philip L. Hawkins

This is Phil, we made a lot of progress, I think debt-to-EBITDA will come around quickly as -- as those development projects kick in and we're not done, which is why we talk about how we are going to fund growth. We didn't mention increasing leverage. We continue to view our approach is kind of delever through growth and then I'll continue through 2013.

Eric Frankel – Green Street Advisors

Thanks. Just a follow-up to that, I guess if you look at page 14 and in terms of your fixed charge coverage ratio and adjusted EBITDA item, could you give a sense perhaps of excluding additional development leasing or activity how that grows given the cash flow growth you are assuming just kind of get a sense of a run rate on that?

Matthew T. Murphy

Yeah, I'm not going to try and do that of the top of my head. Again I think I look at the forecast you're asking for a pro forma year end number, like I said I’m not going to try and do that on top of my head, I look at the forecast and you can see the relative metrics improve over time, we can certainly talk about that off-line.

Eric Frankel – Green Street Advisors

Okay, thanks. I guess just a last question. Any thoughts an additional alternative capital sources in the right size of the balance sheet, I mean the insecure public markets seem to be pretty wide open as well as the preferred markets, any thoughts of pursuing those options in the future?

Philip L. Hawkins

We’ve made it clear, we’ve been pretty open with our desire at some point in time to become publicly rated in an excess to public debt markets. That will be the next step and then from there you can obviously look at other sources as well, but looking at the timing, and really comes back down to the balance sheet progressing to a point where we think that we’ll be happy and that remains a goal. And I hope it’s near rather and further in the future.

Eric Frankel – Green Street Advisors

Okay great, thanks guys.

Matthew T. Murphy

Yes, thanks Eric.

Operator

There are no more questions at present time. So I would like to turn the call back over to Phil Hawkins for any closing remarks.

Philip L. Hawkins

Well, thank you everybody for participating. I look forward to seeing many of you in the near future and always available to answer phone questions whenever you have them. Thank you.

Operator

Thank you. Conference has now concludes. Thanks for attending in today’s presentation. You may disconnect your lines. Have a nice day.

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