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Piedmont Office Realty Trust (NYSE:PDM)

Q4 2012 Earnings Call

February 08, 2013 10:00 am ET

Executives

Robert E. Bowers - Chief Financial Officer, Executive Vice President and Treasurer

Carroll A. Reddic - Executive Vice President of Real Estate Operations, Assistant Secretary, Member of Executive Committee and Member of Investment Committee

Raymond L. Owens - Executive Vice President of Capital Markets

Robert K. Wiberg

Donald A. Miller - Chief Executive Officer, President and Director

Eddie Guilbert

Analysts

David B. Rodgers - Robert W. Baird & Co. Incorporated, Research Division

Anthony Paolone - JP Morgan Chase & Co, Research Division

Michael Knott - Green Street Advisors, Inc., Research Division

John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division

Young Ku - Wells Fargo Securities, LLC, Research Division

Brendan Maiorana - Wells Fargo Securities, LLC, Research Division

Operator

Greetings, and welcome to the Piedmont Office Realty Trust Fourth Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Robert Bowers, Chief Financial Officer. Thank you, Mr. Bowers, you may begin.

Robert E. Bowers

Good morning, and thank you, all, for taking time to join as we review our fourth quarter and year ended 2012 financial and operational results, as we also share our perspectives on the current leasing and transactional environment. Last night, in addition to posting our earnings release, we also filed a Form 8-K, which included our unaudited supplemental financial information. This information is available for your review on our website at www.piedmontreit.com, under the Investor Relations section.

On today's call, the company's prepared remarks and answers to your questions will contain forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters which are subject to risk and uncertainties that may cause the actual results to differ from those we discuss today. Examples of forward-looking statements include those related to Piedmont Office Realty Trust future revenues, operating income and financial guidance, as well as future leasing and investment activity. You should not place any undue reliance on any of these forward-looking statements, and these statements speak only as of the date they are made. We encourage all of our listeners to review the more detailed discussion related to risk associated with forward-looking statements contained in the company's filings with the SEC.

In addition, during the call, we'll refer to some non-GAAP financial measures such as FFO, Core FFO and same-store NOI. The definitions and reconciliations of these non-GAAP measures are contained in the supplemental financial information available on the company's website.

I'll review our financial results after Bo Reddic, our EVP of Real Estate Operations, reviews our leasing results; and Ray Owens, our EVP of Capital Markets, updates us on Piedmont's investment activities. In addition, we're also joined today by Bob Wiberg, our EVP of Development and Head of the Mid-Atlantic Region; Brent Smith, Senior Vice President of Capital Markets; Laura Moon, Chief Accounting Officer; and Eddie Guilbert, Vice President of Finance and Strategic Planning. All will be available during the question-and-answer portion of the call. Don Miller, our CEO, plans to limit his participation today, as he's recovering from some recent planned surgery. I'll now turn the call over to Bo.

Carroll A. Reddic

Good morning, everyone. I'm please to speak to you today about this quarter's leasing results. Our leasing activity for the fourth quarter totaled approximately 900,000 square feet, which brings our total leasing activity for 2012 to almost 3.4 million square feet. Combined with the record leasing year we had in 2011, approximately 4 million square feet, that translates into leasing more than 1/3 of our total portfolio's square footage during the last 2 years.

We're even more pleased to have maintained our historical average tenant retention ratio of approximately 70%, despite the tepid job growth environment and economic uncertainty the U.S. has experienced during this time period, particularly affecting large corporate tenants. You may recall that our primary customers are large creditworthy tenants, as evidenced by approximately 80% of our portfolio being leased to tenants taking over 40,000 square feet, and over 66% of our annual lease revenue comes from investment-grade rated companies.

Our continued leasing success has increased our overall occupancy metrics by 100 basis points, or more, when compared to the previous year. Total portfolio was 87.5% leased at year end, versus 86.5% at the beginning of last year. And our stabilized lease percentage was 90.5% at year end, up from 89.1% a year earlier.

In the fourth quarter, the larger completed leasing transactions included a 395,000 square foot 10-year renewal in Minneapolis for U.S. Bancorp's headquarters, a 5-year renewal of Lockheed Martin's 115,000 square foot requirement at 9221 Corporate Boulevard in the Washington, D.C. market, an approximately 41,000 square-foot new lease for 12 years with Standard Parking at Aon Center in Chicago and a lease for 45,000 square feet has been signed for 5-plus years with Wells Fargo at our Glenridge Highlands Building in Atlanta.

During the year, we've seen meaningful positive net absorption in our portfolio, and importantly, the lease up of several large blocks of formerly vacant space, such as 133,000 square feet with the U.S. Foods at River Corporate Center in Phoenix, 145,000 square feet with Schlumberger at 1200 Enclave Parkway in Houston and 301,000 square feet with Catamaran at Windy Point II in Chicago. We strongly believe a contributing factor towards our leasing momentum is that our properties are consistently among the highest quality assets within their respective submarkets.

Furthermore, we believe our unique leasing model helps us achieve this success across a geographically dispersed portfolio, particularly the expertise and efficiencies of our in-house leasing by our asset management team is focused on renewals, and new leases with large corporate users of our office space. And under the oversight of our asset management team, we augment this effort with top quality submarket-focused, third-party brokers, sharpshooters in their respective markets, if you will, to ensure our properties see all potential tenants in the market. You will continue to see us adapt this model as our portfolio grows in scale and concentration in particular markets. For instance, our recent hiring of Bob Wiberg to run our mid-Atlantic region is an example where, in this circumstance, our scale in the market warranted a stronger local touch point for operations, acquisitions and leasing.

As we've discussed in the past, it's important to note that our leasing achievements are tempered by some government consolidation that will impact our portfolio in 2013, that will result in additional available space in the D.C. market at One Independence Square, beginning in March, and at 3100 Clarendon in the heart of the RB corridor at the end of this year.

Looking forward, however, we have 858,000 square feet of signed leases that have yet to commence, an additional 1.8 million square feet of commenced leases that are currently in abatement, which bodes well for our future cash flows once these leases begin and the abatement period burns off, resulting in a 10% contribution to our economic occupancy. In addition, I think it's important to note that we have now stretched our average remaining lease terms to 6.9 years, which gives us good visibility into our revenue stream over the next several years.

Looking at our lease expiration schedule, which is detailed in the quarterly supplemental information package, you can see that we have relatively modest leasing exposure for '13, of the 2 expiring government leases which I discussed. There's one large government lease reflected in the 2013 expiration schedule that relates to the National Park Service, which has been in hold-over since July of last year, for 220,000 square feet at 1201 Eye Street in Washington.

Park Service and GSA have just begun looking at their future space needs and discussing the possibility of a renewal. We'll be entering in a multi-year period with relatively low lease expirations in 2014. And in view [ph] of recent achievements, over the next few years should beat our organic earnings growth, and when combined with any material acquisition accomplishment, should drive FFO growth for the company. That said, leasing market, in general terms, remains soft with the exception of markets that [indiscernible] technology, energy or health care.

With that, I'll turn the call over to Ray Owens to review our 2012 capital markets transactions and view on future activity.

Raymond L. Owens

Thanks, Bo. Fourth quarter transactional activity was limited to a land parcel purchased adjacent to our Glenridge Highlands building here in Atlanta. This transaction was both an offensive and defensive move, enabling us to control the land parcel adjacent to our office building which could provide the opportunity to enhance our current asset in the future, due the addition office space or in added amenities, such as a hotel. The site has direct highway access and is currently zoned for office.

We did end the year as a net seller of 7 assets, totaling approximately $100 million, which advanced our strategy that we stated during our listing and IPO in 2010. That is, focusing investments on fewer markets, the 10 to 12 major U.S. office markets. The 7 dispositions allowed us to exit 2 markets, as well as sell our last 2 industrial assets. We continue to pursue a number of potential acquisitions and, in general, our pipeline is more robust than what we saw in the latter part of 2012. We remain focused on CBD and urban infill locations in cities we classify as concentration markets. I would add that during the second half of 2012, we continued to witness a disconnect between real estate operating fundamentals and pricing of properties in some of these higher barrier markets.

Despite our acquisition goals in 2012, we continue to find investing in our own stock to be a better allocation of capital. We will continue to evaluate the risk-adjusted returns of all our investment options and maintain our discipline.

During the fourth quarter, we continued to utilize our stock buyback program, effectively buying our own Class A real estate at a discount. We purchased approximately 0.5 million shares of our common stock at an average price of $17.48 per share and increased the total shares purchased since December 2011 to 5.5 million shares at an average price of $16.83 per share or $92 million. The 2-year board-approved stock buyback plan had $208 million of capacity remaining. We plan to use the program when our shares traded at what, we believe, is a meaningful discount to NAV.

As I mentioned earlier, we began 2013 already seeing more investment opportunities, and we believe our low leverage and national platform will help us successfully compete for the high quality Class A office properties in our target markets. Some of our strengths to help us achieve this are: our balance sheet. With a debt-to-gross assets ratio of 27.2%, we have the capacity to add over $1 billion of debt and still remain under the 40% leverage threshold. Our $500 million line of credit, which is priced at 117.5 basis points over LIBOR and can be extended through 2017.

Cash and capacity on our line, which is, as of year end, totaled $365 million. And our investment grade credit rating, which, if the opportunity arises, will allow us the potential to access the unsecured bond market at attractive long-term pricing levels.

With that, Bobby will review some of the financial highlights for the quarter and provide guidance for 2013.

Robert E. Bowers

Thank you, Ray. While I briefly discuss our financial results for the quarter, I encourage you to please review the earnings release and supplemental financial information, which were filed last night, for further details.

For the quarter, we reported net income of $0.09, FFO of $0.33 and Core FFO of $0.36 per diluted share. Annually, we reported net income of $0.55, FFO of $1.35 and Core FFO of $1.43 per diluted share. That's in the upper end of our previously provided guidance. Core FFO for the current quarter includes the add back of approximately $5 million of net expense associated with damages incurred in our New York and New Jersey portfolio, primarily at our 60 Broad building in the financial district in lower Manhattan, where water penetrated of some portions of the basement as a result of the tidal surge of Hurricane Sandy that occurred late in October. Obviously, our damages pale in comparison to the struggles many had and continue to endure related to the storm and our deepest heartfelt thoughts and prayers go out to the victims across the region. 60 Broad Street was open to tenants within approximately 2 weeks of the event. It's completely operational with power from Con Ed. We're diligently working with our insurers to recover the majority of our losses and have already received some insurance recoveries that are reflected in the fourth quarter's net casualty expense.

Accounting standards require the recognition of losses immediately upon occurrence, and the offsetting insurance recoveries are not recognized until receipt or confirmation of payment. We anticipate that the majority of these losses, which relate to cleanup and repairs, equipment replacement and rent abatements, will ultimately be recovered and recognized as insurance reimbursement income or contingency gains over the next few quarters, when collected. This accounting treatment for insurance recoveries is similar to the litigation settlement expense that we reported in the third quarter.

Operating revenues, before management fee income and other income, were up about 1% for the year and flat for the quarter compared to the prior annual and quarterly periods, reflecting increased occupancy by year end 2012, but offset by downtimes between leases and some lower rate roll downs and abatements on operating expense reimbursements, which are not included in straight-line rent adjustments.

Looking at expenses, quarterly G&A cost decreased about $1 million compared to the same quarter 1 year ago, as we recorded lower compensation expense, which is tied to our stock performance plan. On an annual basis, total G&A expenses reflect lower compensation expense and lower legal expenses associated with the timing of insurance recoveries. We anticipate that our normalized quarterly run rate for G&A is approximately $6 million to $6.5 million, with some seasonal variances associated with the various recoveries and timing of discretionary annual stock compensation awards.

The annual results for 2012 and 2011 also reflect the discontinued operations and net gains from the dispositions of 7 properties during the current year, as Ray mentioned, as well as the disposition of 35 West Wacker and 2 other wholly-owned assets in 2011.

On an AFFO basis, we generated $0.81 per diluted share, covering our current dividend. As Bo discussed earlier, we are approaching the end of an extended period of high lease expirations. Our same-store NOI has declined throughout this multi-year period, with rental rate roll downs tied to the slower economy and downtimes between expirations and the commencement of new leases. We believe we are near the end of this trend. In fact, our fourth quarter same-store NOI actually improved on both a cash and accrual basis by approximately 2%, with commencement of several leases in the second half of 2012. However, based on a known move out in March of the OCC, our same-store NOI is expected to be down slightly 2% or 3% in 2013. Ignoring the impact of the OCC lease, overall same-store NOI is expected to be positive in 2013.

On a quarterly basis, this same-store NOI ratio will vary considerably in 2013, as will our occupancy percentage and our Core FFO. This is due to expiration and commencement of various leases. Our overall occupancy rate at the end of 2012 was 87.5%, and this percentage is expected to be between 88% and 89% by the end of 2013, irrespective of anticipated property acquisitions or dispositions.

The combination of the OCC impacts and the decrease in net operations as the result of the sale of 7 assets in 2012, leads us to introduce guidance for 2013 in the same range as 2012's guidance, with Core FFO expected to be between $1.35 and $1.45 per diluted share. This annual guidance includes the continued repositioning of the portfolio, with dispositions approximating $300 million and acquisitions estimated to be about $400 million during 2013.

Additionally, we anticipate the FFO results in 2013 to exceed the Core FFO guidance, as the insurance recoveries I previously discussed from the litigation settlement and for our Hurricane Sandy expenses are collected.

Looking further out, as the expiration schedule subsides in 2014 through 2016, and the burn off of rental abatements of 1.8 million square feet of leases concludes, we anticipate marked growth in cash, NOI and Core FFO.

That concludes our prepared remarks today. And we'd like to open the lines for questions. We'll attempt to answer all of your questions now or we'll make appropriate later public disclosure, if necessary. We do ask that you try to limit your questions to one follow-up question so that we can address as many of you as possible.

Operator, can you provide our listeners with instructions on how they can submit their questions?

Question-and-Answer Session

Operator

[Operator Instructions] And we will hear first from Dave Rodgers with Robert W. Baird.

David B. Rodgers - Robert W. Baird & Co. Incorporated, Research Division

With regard to acquisitions and dispositions in the guidance, I think I had read $400 million of acquisitions, $300 million of disposition. Can you talk about what's in that disposition pool? What the average yield is on what you're looking to sell? And whether or not, an Aon center JV or sale is contemplated for this year?

Raymond L. Owens

This is Ray. What we are anticipating is probably Philadelphia would be the largest one in there instead of Aon. We will probably still look at possibly do with something on Aon the latter part of the year, but that's really not in that guidance. The others would be either assets that are in submarkets that we're trying to get out of, as we've mentioned in our -- continue to mention in our disclosures, those will probably be yielding somewhere in the 8% to 9% range.

David B. Rodgers - Robert W. Baird & Co. Incorporated, Research Division

And maybe either Bobby or Ray, what have you modeled for acquisitions, i.e. what's the positive or negative spread on the reinvestment?

Raymond L. Owens

Dave, as you can imagine, that's going to depend on what the opportunities are. What we're seeing in the core markets, our concentration markets, for CBD and urban infill, those cap rates are probably going to be in the 5s percentage range or around 6%, between 5% and 6%.

David B. Rodgers - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then maybe a question for Bo or Bob. It sounds like the National Park Service activity is still fairly early, but you did kind of highlight it in the supplement as something you are working on. That building had a pretty good loss-to-lease for some time. Do you expect to be able to get all of that back, if you go with the National Park Service, or are you taking a little more cautious view on D.C. area leasing, and perhaps going back with the government means you give up a little bit on the rental rate side? Can you talk about that a little?

Robert E. Bowers

Bob, do you want to address that for us?

Robert K. Wiberg

Sure. We have remained in conversation with the National Park Service for a long time. And really their situation is defined by other moves in the federal government sector and opportunities that they may have. We continue to proceed with them. It does appear that there's more clarity on what is in and what is out as far as their relocation options, and we think it's probably trending favorable toward us.

David B. Rodgers - Robert W. Baird & Co. Incorporated, Research Division

And with regard to leasing there, is that the best use of that space today and can you kind of close that gap on where their lease had been relative to market?

Donald A. Miller

Dave, this is Don Miller. I think there's a subtlety to your question, and that is, obviously, they are paying a little below market today. And if they do a short-, intermediate-term renewal, we would hope that there will be some capture of some of that difference in rent, maybe even going back, probably even going back to the original expiration of their lease, and so there could be a minor windfall from that if we are able to do an intermediate-term renewal. Obviously, longer term, if they decide that they want to stay in the building, we'd love to have them. We also will want to try to continue to talk about other alternatives for them but, by and large, if they want to stay, we'd love to try to accommodate them.

Operator

And we will go next to Anthony Paolone with JPMorgan.

Anthony Paolone - JP Morgan Chase & Co, Research Division

If I look at your lease expirations for 2013, it's about 1.9 million square feet. By my math, it seems like about 900,000 of that is kind of identifiable with some of the bigger, chunkier things that you all talked about. So my question really relates to the rest of it which, it seems like it's maybe 1 million square feet of, what we'll call, regular way [ph] leasing. How are you looking at that and how conservative or not are you being, with respect to rental rate changes, retention rates and so forth?

Robert E. Bowers

Tony, this is Bobby. I'm going to try to address that. As we look at the entire year and all the expirations that are out there and the renewals that will take place, we're looking at a, perhaps a slight roll down in some of the rates there. But do remember that we've got 2.6 million square feet of leases that are signed or have been banked, that will slowly be coming online as the year 2013, 2014 and even into 2015, progresses. That will give us some uplift as we have some roll downs.

Anthony Paolone - JP Morgan Chase & Co, Research Division

I guess what I'm trying to understand is, your disclosures been very good and I feel like we've all had a pretty good pulse as to what's coming on that front. So you're putting some insurance reimbursements in the number, in the low end of your range, at $1.35 just, ostensibly, it looks a little on the light side. So just wondering kind of where you see -- what has to happen to get to the low end of your guidance? Or how do we get to the $1.35?

Robert E. Bowers

Well, as you look at the model and the deltas of the changes that take place from 2012's actual results, looking at what we forecasted for 2013, there's probably $0.025 worth of disposition impact of the 7 properties that have rolled out, and there was an earlier question asking about acquisitions. We've expressed to everyone that we may forgo some FFO numbers in order to get long-term appreciation, buying properties in some of our concentration markets. So I'm not expecting a huge delta, even though we've got $400 million worth of acquisitions. Those acquisitions, as you are aware, will come in later in the year. Then you do have the expiration that you've already identified that's associated with the OCC. Their move out that takes place at the 1st of March is probably a $0.075 impact on us on an annualized basis. But we'll have to overcome that with leases, but we've got, at 200 Bridgewater, we've got Brother and Denredon coming online. At Aon, you'll have the full year impact of KPMG's lease, that was 222,000 square feet that began in August of this past year and we'll have the full year benefit of that. You'll have UnitedHealthCare also that will contribute, as well as the Schlumberger lease, as well as many others.

Donald A. Miller

Tony, the other aspect I think to your question was, of the sort of -- it sounds like you're doing the math and saying, hey OCC is 300, I can do that. DIA are going to be rolled out at the end of the year, that's really not till December 31st. That really doesn't effect this year's number, but that's part of the $2 million you're talking about. National Park Services 200-and-some-thousand feet, in there. We obviously are hopeful that will certainly be in, at least through the end of '13, if not well beyond. And so now you're talking about the other 1 million square feet and we have a pretty good sense, obviously, of what that 1 million square feet is doing. There is a fair amount of it that's rolling out this year of leases that we've known about for some time, that are in our '13 numbers already. So there shouldn't be any negative surprises from tenants departing this year that are not in our numbers. The real question is, how much new lease activity do we get to replace it? And that's probably the bigger question for us.

Anthony Paolone - JP Morgan Chase & Co, Research Division

And do you feel like you're being conservative on that front, or how are you thinking about just broader backdrop for that?

Donald A. Miller

I don't know that we'd say we're being overly conservative, but we are trying to take into account, when we think there's a really good chance that a tenant's going to leave, that we're not rolling them beyond their existing lease term right now. And like I said, the bigger question is how much new leasing do we get done relative to what we have pro forma-ed and then we always try to be cautious on that front, particularly given the economic environment we're in.

Robert E. Bowers

Yes, I was going to comment. I read one of the research reports this morning, and I thought one of the more astute questions was focusing on the new leasing that's taking place. We've historically signed 70% percent of our lease expirations, and you can use that for modeling purposes, I think, because that's happened since the last 7 or 8 years. Attracting new leasing right now, I'd say the leasing environment is a little light, except in some of the areas that was mentioned earlier by Bo, when he said the technology area, the health care area and then the energy is where we're seeing a lot of interest, a lot of tours taking place at the properties.

Operator

And we'll go next to Michael Knott with Green Street Advisors.

Michael Knott - Green Street Advisors, Inc., Research Division

Bobby, was your NOI forecast for 2013, I think, you said minus 2% to minus 3%, was that cash or GAAP?

Robert E. Bowers

Down 3% on a cash basis, 2% on a GAAP basis -- yes, on a GAAP basis.

Michael Knott - Green Street Advisors, Inc., Research Division

Okay, and then, can you repeat the very last comment that you made in your prepared remarks? You talked about NOI growth and FFO growth but I didn't quite follow you.

Robert E. Bowers

Well, you mind if I turn and look at the script? And try to figure out what you were...

Michael Knott - Green Street Advisors, Inc., Research Division

I think it was your very last comment.

Robert E. Bowers

I was trying to make a reference. I was talking about Core FFO and its relationship to FFO. This current year, we had sort of a negative, if you will, impact on our FFO due to some onetime nonrecurring items. We take those nonrecurring items, such as the litigation expense, out, and we took out the impact of the Hurricane Sandy damages, and so we had a better looking Core FFO number. This next year, and all of our guidance is in terms of Core FFO, we will be having add backs as we get insurance recoveries in 2013 that relate back to the litigation and back to the damages from Hurricane Sandy. We're just trying to make sure that, as we look at the forecasts that come out from the analysts, sometimes you refer to FFO, sometimes you refer to Core FFO. We're trying to draw a distinction between the 2 that there may be a $0.03 or $0.04 difference between those.

Michael Knott - Green Street Advisors, Inc., Research Division

Got it. And then I'll just throw out 2 quick questions and I'll cede the floor. First, would be could you maybe just go over what would be an expected case for the OCC re-leasing and then maybe a poor case? And then also, we saw that you're maybe marketing 1200 Enclave in Houston and just curious your thoughts on whether that's still an opportunistic market for you.

Donald A. Miller

Hey, Michael, it's Don. On -- we don't have -- in our base case, we don't have OCC leasing up until, I think, just a sliver of space late in 2013, is the first time we have anything going in there. There actually has been some activity at the building, positively and surprisingly, and Bob could address that if you want more detail. But overall, I'd say nothing imminent and nothing to get too excited about yet. But the point is, there's more activity there than we might have anticipated. And so that's sort of the first -- so there's not much of an impact, if at all, on '13 from any leasing activity at OCC. Our poor -- I think you said the poor or the downside would be, obviously, if we hold out and try to get the whole building leased, and it just takes longer to get the next agency to come along. Then I think our expectations would be we'd be lucky to do something in '14. On Houston, yes, we -- I guess Real Estate Alert or somebody reported that we were selling the building that we leased to Schlumberger in Houston. Obviously, we should have a really nice round trip there. It will continue to be an opportunistic market for us, but obviously, by definition, an opportunistic market is one in which we think we can take advantage of upside in value. We've done that with this particular asset in Houston. It maybe a little harder going forward unless we decided to do something on a partial development deal on our land that's there adjacent to our other building in the Enclave. But I think buying in Houston will be a much tougher opportunity to make money going forward than it was when we did this deal.

Raymond L. Owens

Michael, this is Ray. I mirror what Don was saying. We're happy with the type of ventures that we're already receiving on 1200 Enclave. But I think it's fairly consistent that value-add deals like that are becoming harder and harder to do, at buying [ph] . We will continue to look for those. There's a lot of capital that has been formed, not only to buy core, but to buy value-add type deals and that might make it a little more difficult for us to find that same type of transaction.

Operator

[Operator Instructions] And we will hear next from John Guinee with Stifel.

John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division

First, Bob, welcome aboard. Nice to have you there. And then second, Don, you're a very smart guy, as we all know. Can you just go to Page 49, and what we've got is we've got economic lease percentage of about 76.7%. What's that number going to be like at year end '13? Everyone's trying to figure out the ramp-up here. And I think, if you just go to the very last number in your supplemental and tell us what your projection is for economic lease-up.

Donald A. Miller

Let's me see if I can tell you exactly what we are -- looks like we're moving that from about 77% to 81%, 82% near the end of this year. And as you can probably imagine, that will average just at 80-ish for the year. And so, as you can imagine, that's probably a function of the fact that, obviously, you get free rent burning off in some of these leases, you got new leases commencing and then you've got a few rolling out, in particular OCC, that doesn't reflect any new economics associated with that deal at the end of this year. So there's obviously some offset to that. But that's probably our best estimate at this point, John.

John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division

How about year end '14?

Donald A. Miller

I don't think we've carried it out that far. We probably should, and if we do, we'll be glad to disclose that to you all.

John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then on Page...

Donald A. Miller

There should -- but John, I think -- John, real quick, I'm sorry to interrupt you. I think the answer is, it should move up materially from there as well, particularly if we have some leasing that we get done this year.

John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division

Okay. Great. And then Page 29, you guys do a great job of showing your cash, rents and accrual rent roll up and roll down, but you've only included about 2/3 of the leases. How does that look if you include all the leases, Bobby?

Robert E. Bowers

Well, John, you're comparing a number of 0, if it's vacant space that's been vacant for current year. That's the reason we exclude it.

John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division

But you can look back on the 2 or 3 years ago when it was last occupied, right?

Robert E. Bowers

Right, we could. I don't have that data for you, but what I'm trying to do for the shareholders and for the analysts is give them an analysis of what's going to happen to our annualized lease revenue as a result, and you're looking back only 1 year, or probably not 3 to 4 years?

John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division

And then, lastly, Bob, you guys do a great job on Page 33 of bifurcating between non-incremental and incremental capital. What's the sort of the theme on tenant improvements and leasing commissions that is actually incremental capital?

Donald A. Miller

John, I would say that there's a little bit larger -- I always get the terms confused, what I call good capital, a little larger good capital right now than there will be going forward, because not only do we buy some of these value-added deals, we've also had a handful spaces that have gone down for a long enough period of time that, for example, the Catamaran is a good example of that, where that was down for just over a year before we re-leased it. So that became good capital. And as a result, we're having a little bit larger percentage of our capital in that bucket now than I think we'll have going forward. But obviously, our overall capital needs are also going to decline as we move forward pretty substantially, just because the sheer value of leasing activity should slow down, now that we've moved through the heavier part of our lease rollover.

John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division

And does any of the incremental capital, Don, pertain to, what I call, recent acquisitions and capital that you probably would capitalize into the acquisition versus...

Donald A. Miller

Yes, John, a meaningful amount of that is related to GE in Chicago or the Schlumberger lease in Houston or some of the other larger deals that we've done recently on some of the new leasing. So yes, quite a bit of it is actually.

Robert E. Bowers

All of that capital, John, is included in our analysis on Page 34.

Operator

And our last question comes from Young Ku with Wells Fargo.

Young Ku - Wells Fargo Securities, LLC, Research Division

Just want to go back to the economic occupancy comment that Don made earlier. So you're assuming that economic occupancy is going to fill up about 4%, but a good piece of that is OCC which, on per square foot, basis is pretty high. So how should we compare that to kind of the NOI increase that you're expecting for 2013?

Donald A. Miller

Young, I think I may not understand, but we're going to gain -- we think we'll gain 4% notwithstanding the fact that we're losing 1.5% to 2% on the OCC deal, right? So does that make sense?

Young Ku - Wells Fargo Securities, LLC, Research Division

Right. So how does that translate to kind of like the net NOI increase, net of OCC? I mean, is that more like 2%?

Donald A. Miller

Well, I'm going to let Eddie try address on that.

Eddie Guilbert

Young, OCC contributes roughly 4% of our same-store NOI. So you can think, if you add back OCC, it'd be a 4% swing. So from, call it, negative 3% to positive 1%, so that was one of the comments that Bobby had made in his prepared remarks.

Donald A. Miller

Does that answer your question?

Operator

[Operator Instructions] And we do have a follow-up from John Guinee with Stifel.

John W. Guinee - Stifel, Nicolaus & Co., Inc., Research Division

Just to make sure we're all clear, what you're basically saying is you think that economic occupancy is going from 76.7% into the 81% to 82% range, despite losing 4%, because of the OCC expiration?

Robert E. Bowers

By the end of the year.

Operator

And we will move on to Brendan Maiorana with Wells Fargo.

Brendan Maiorana - Wells Fargo Securities, LLC, Research Division

Eddie, if I understood you correctly, you've got 2% of the your space that moves out OCC. You're expecting a 4% pick up in economic occupancy. So effectively, x OCC, it's a 6% tick up in economic occupancy. However, given that rents at the OCC space are double the average for the company, a 2% overall portfolio leased rate is 4% of NOI. So if it's a 4% net pick up on square footage, given that rents at OCC are double the average, it's about a 2% net pick up on NOI run rate end-of-the-year '12 versus end-of-the-year '13?

Donald A. Miller

Yes, but you're -- but we're mixing apples and oranges a little bit, because we're talking about lease percentages versus ALRs. We probably have to do a little bit more digging to get exactly right on that, Brendan. But I think your point is well made, that OCC would be about double the average NOI per square foot. And so, as a result, the impacts will be different on lease percentages versus economic percentages.

Robert E. Bowers

And let me weigh in there. One of the complexities you have on our model is that we have large tenants. As we've said, the average lease is between 35,000 and 40,000 square feet. And so you get that chunky volatility that happens. So during the course of the year you get, early on, the negative impact from the OCC, and it's not until the other leases pick up or abatements burn off, that you get the benefits. So the numbers we've given you is -- are as of the end of the year.

Brendan Maiorana - Wells Fargo Securities, LLC, Research Division

Yes. I mean, I understand there's sort of -- the movements during the year are going to move around but just sort of year end versus year end. So then next question, Bobby is, if we look at where economic occupancy is today versus overall occupancy, it's low, it's a wide spread. But there's probably -- but what do you think a fair spread is, normalized as you look out over a cycle, of where you typically would have economic occupancy versus the reported, stated occupancy in your portfolio? Because I imagine that, that number isn't a 0, or not a 0 very often.

Donald A. Miller

Brendan, you can do a number of different math problems on that one. And it really comes down to, ultimately, your average free rent in the market, to a great degree. And so, as a result, a lot of it depends on where you are in the cycle. If you were to suggest that every market is a 10-year market with a 1-year free rent, and you would suggest that everyone in the market should have about a 10% differential between economic occupancy and fiscal occupancy, now that is the case in many markets, today, it's not the case in all of our markets, obviously, but it is in many, but I think if you've sort of blended those all together and said, hey, lot of our average markets are -- 10% of the rent is -- goes to free rent. But then you say, a handful of those markets are giving little or no free rents or blend those 2 together, that's probably what you'd expect today at this point in the cycle. But obviously, as the markets improve, if they ever do, then we should see a lot smaller, I use the term, loss-to-lease, if you will, in parentheses, but you see a lot lower one over the course of time. But at this point in the cycle, 10% times the number of markets you're giving a month, a year, in free is probably a pretty good guess.

Eddie Guilbert

I think, if I could add to that, I'd say it's a function of the lease expiration schedule. So as we head into '14 through '16, we've got low lease roll overs, you'll see that GAAP narrow a good bit.

Donald A. Miller

Great point, Eddie. Great point.

Brendan Maiorana - Wells Fargo Securities, LLC, Research Division

Sorry, Don, I was just trying to follow that math. So if you've got 10% space rolling a year, you, on average, give a year free rents, so you say, okay, 10%. But your spread right now is 7%, or 6%, so are you saying that it's -- you think right now it's actually more narrow than average?.

Donald A. Miller

Well, first of all, I think it's about 10% right now. Actually from 87% to 77% but...

Brendan Maiorana - Wells Fargo Securities, LLC, Research Division

I'm sorry, 87%, I'm sorry...

Donald A. Miller

I'm not suggesting that that's exactly why, but I think that's a pretty good proxy for why there's a 10% difference today, is in a lot of our markets we're giving about 10% free rent. But I think Eddie's point is really well taken. You don't want to miss that one, which is, where we've had to give a lot of free rent because our rollover schedule has been higher, that probably drives a larger loss-to-lease, if you like that term, or difference, in that economic occupancy. As we move into a period where we have a lot less rollover and a lot fewer new leases coming into the portfolio, that difference should subside dramatically.

Brendan Maiorana - Wells Fargo Securities, LLC, Research Division

Okay, I mean -- just from an outsider perspective and you guys are a large tenant landlord, so it's a little bit different than some of your peers that are out there. Anything -- and you've only been public for a couple of years and you guys provide this stat which is very helpful. Anything that we could get with respect to historical context, I think, would be helpful, because it does strike me that this economic to stated occupancy percentage is wide, but I'm not sure if it's wide by double or if it's wide by 20%? I would -- I'd be interested in where it normally is for this portfolio over the long term. So anything that you can provide would be pretty helpful.

Robert E. Bowers

We'll go back and look at that, Brendan, and get you some information and probably put in as a supplemental exhibit in the supplement that we have, okay?

Donald A. Miller

Yes, I would tell you, Brendan, I think your intuition is right. This is probably the highest economic loss we would have seen anywhere in our history, at least so far, not that I think there's a lot of comparable periods of for us, obviously, given that we have a fairly short public history. But if you think about the fact that we're coming off the highest rollover percentage at a time when the market is giving its greatest level of concessions, it's hard to believe that we wouldn't be seeing the highest level of economic loss at this point than we should see at any point in the cycle.

Operator

And we'll go to a follow-up question from Michael Knott with Green Street Advisors.

Michael Knott - Green Street Advisors, Inc., Research Division

I was going to ask this about the same exact question as Brendan and I echo the comment that getting maybe a historical time series in an 8-K or as addition to your supplemental might be helpful with percent leased and maybe physical occupancy and economic occupancy. Just so we can see that, that will be great.

Donald A. Miller

Okay. Let's get to work on that. Thanks.

Operator

And with no further question from the queue, I would now like to turn the call back over to you, Mr. Bowers, for closing remarks.

Robert E. Bowers

Okay, well, we appreciate everyone being on the phone today. And I will tell you we've been through a period of uncertainty. If you look back at the consequences of Hurricane Sandy and its aftermath, even if you look at the tragedy of Sandy Hook, and if you look at the presidential elections and the government, and I'll use the word, incompetencies in dealing with unemployment, dealing with our deficits, it's been a tough period of time. But I think it has had an impact on the leasing and leasing prospects. I really feel quite fortunate that we have gone through what has been a pretty tough period of expirations here in the last 3 years. If you think about it, our leasing team, and I congratulate them for leasing 50% of our total square footage. And also looking over at our capital markets team preserving for us a very strong balance sheet where we can capitalize today on opportunities that come up for us. And then even still, as we've talked a lot today, I feel like we're really quite blessed and fortunate to have this backlog, if you will, of 2.6 million square feet, that will be contributing to our cash NOIs over the forthcoming 1.5 years. So we are optimistic long-term as you look at our numbers, and we appreciate your support. Thank you.

Operator

And that does conclude the call. We would like to thank everyone for their participation today.

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