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Executives

Doug Donatelli - Chairman and Chief Executive Officer

Nick Smith - Chief Investment Officer

Skip Dawson - Chief Operating Officer

Barry Bass - Chief Financial Officer

Mike Comer - Chief Accounting Officer

Joel Bonder - General Counsel

Analysts

Chris Lucas - Robert W. Baird

Jordan Sadler - KeyBanc Capital Markets

Paul Adornato - BMO Capital Markets

Stephanie Krewson - Janney Montgomery Scott

Chris Haley - Wachovia

John Guinee - Stifel Nicolaus

Bill Crow - Raymond James

Carol Kemple - Hilliard Lyons

Jordan Sadler - KeyBanc Capital Markets

First Potomac Realty Trust (FPO) Q4 2008 Earnings Call February 26, 2009 11:00 AM ET

Operator

Good day and welcome to First Potomac Realty Trust conference call. Today’s call is being recorded. At this time I would like to conference over to Joel Bonder, General Counsel; please go ahead.

Joel Bonder

Good morning. Welcome to First Potomac Realty Trust, fourth quarter 2008 conference call. On the call today are Doug Donatelli, Chairman and CEO; Nick Smith, Chief Investment Officer; Barry Bass, Chief Financial Officer; Skip Dawson, Chief Operating Officer; and Mike Comer, Chief Accounting Officer.

After the market closed yesterday, our company issued its earnings press release and we posted supplemental information relating to fourth quarter operating results and portfolio performance on our website. Many of you have signed up to receive this information automatically by email. If you did not receive it, please contact Ken Avelos [Ph] at 203-682-8341

During this call, we will discuss our anticipated operating results and future events, including our anticipated earnings, FFO, AFFO, dividends and our ability to identify additional acquisition to candidates. These forward-looking statements are within the meaning of the Private Securities Litigation Reform Act of 1995.

We believe the expectations reflected in these statements are based on reasonable assumptions. However, the company’s actual results or events might differ materially from those projected in the forward-looking statements.

Additional information concerning factors that could cause actual results or events to differ is contained in our company’s 2007 Annual Report on Form 10-K and described from time-to-time in the company’s other filings with the SEC. Many of these factors are beyond our ability to control or predict.

Now, I’ll hand the call over to Chairman and CEO, Doug Donatelli. Doug.

Doug Donatelli

Thanks, Joe. Good morning everyone and thank you for joining us. My comments today are going to briefly recaps of our 2008 and fourth quarter highlights, then I’ll discuss our markets and overall outlook. Skip, will then talk about leasing and Barry, will add some color around our financials.

In 2008, First Potomac was able to improve our operations and our capital position. We generated record leasing volumes and maintained an 80% retention rate, while also de-leveraging our balance sheet. We also improved our financial flexibility by reestablishing our relationship with a highly respected well capitalized JV partner AEW.

On the leasing front, we had secured over 3 million square feet of leases during 2008, down-rating nearly 300,000 square feet of positive net absorption. Skip, will take you through some of the details, but needless to say we are proud that we were able to achieve our best leasing year ever as a company, against the tough economic backdrop.

Leasing was our number one priority of the company in 2008 and I thank every one of our employees who contributed to our leasing success last year. Our ability to driver occupancy at attractive rates, at the same time upgrading our tenant roster, speaks to the strength of our team, the benefits of our regional and property focus and the overall stability of our markets.

Regarding our balance sheet and liquidity, from the beginning of 2008 we felt that it was important to focus on strategically de-leveraging the balance sheet and finding ways to increase our financial flexibility and investment capacity. We made solid progress against these initiatives in 2008.

We sold out in the Corporate Park, a large property for us for early in the year for $52 million or 7% cap rate, generating a $14 million gain. We purchased $40 million of our exchangeable senior notes at an average 20% discount. We contributed to the recently acquired River’s Park, a six building business park in Columbia, Maryland to a joint venture with AEW at our cost basis, generating net proceeds of $11.6 million and we complete a $44 million equity rise in the third quarter.

Less visible, but just as important, our aggressive and successful leasing efforts will result in improve occupancy and cash flow increasing the value of our assets and creating further capacity within our credit facility. We backed away for acquisitions two years ago, because of what we viewed as unattractive returns or pricing relative to replacement cost, but as this economic downturn continues to unfold, we are now a part of the cycle where the markets moving on our direction.

First Potomac concludes 2008 as company with improved occupancy, a better balance sheet, more financial flexibility and improving external growth opportunities. The economic headlines continue to get worst, but we’ll remain prudent in our allocation of capital and we’re managing and forecasting assuming that the environment will remain difficult.

However, I believe the D.C. Regional, our asset class will deliver superior relative performance as they have in prior downturns and we will continue to focus our own operations and capital management to the position the company for optimal performance during this period. Our markets continue to hold up well and we thought it was important remind investors of some of the attractive characteristics of the region that benefit our portfolio.

The D.C. Region in general remains one of the top markets in the country for commercial real estate, in terms of size, but more importantly in terms of liquidity and the market continues to appeal to domestic and global investors. A recent survey by the Association of Foreign Investors in Real Estate named the Washington, D.C. region at the most attractive market in the world for real estate investing.

Federal government spending in the region is the financial anchor, contributing to nearly a third of the region economy and though our administrations may change the federal government spending keeps growing and the recent stimulus package ensures that the spending will grow for at least the next few years.

Our product type is attractive in the region for both tenants and investors for several reasons. The government, government contractors and conventional tenants like the low cost, high quality space, that’s highly configurable. As the largest landlord of the property type in our region and the only publicly traded company focused solely on this property types here, we’re a very attractive landlord in this uncertain economic environment, with the resources and our transparency. In addition, our assets are easier to finance, given the lower average value and higher quality locations.

In 2009, we believe our markets and our portfolio will be able to weather this economic storm successfully, but we know it will be a challenge. We continue to intensively manage our portfolio, looking for each and every leasing opportunity, with our key objective being to manage and mitigate the effects of an increase in bad debt and to maintain and grow our occupancy, continuing the momentum from our successful 2008.

With that, let me turn it over to Skip Dawson, for some comments on leasing.

Skip Dawson

Good morning. As Doug mentioned, 2008 was a record year for First Potomac on the leasing front as we leased over 3 million square feet of space. As we ended 2008, our leasing focus was on executing renewals and improving our retention rate. We were able to accomplish both of these goals. Our retention rate for the year was nearly 80% and we reduced our future expiration to aggressive leasing efforts. We also generated a nearly 300,000 square feet of positive net absorption for the year.

The fourth quarter continued to trend up strong leasing and we were able to generate positive absorption even in the face of a tough economic environment. Let me give you some highlights from the quarter and then talk about the activity that is helping drive these solid results.

Of the total 671,000 square feet release in the fourth quarter, roughly one third or 220,000 square feet was new leasing. For 2008 we executed 1.2 million square feet of new leasing, a 50% increase over both 2006 and 2007. Rental rates on new leases increased 9.8% on a GAAP basis during the fourth quarter and 13.6% for the year. In terms of renewal activity, we renewed 451,000 square feet of space in the quarter with 38 transactions.

As I mentioned earlier, one of our major focuses in 2008 was to maximize our renewals and increase our retention rate and we dramatically improved results over the previous year. For the year we renewed over 1.8 million square feet of space, a 50% increase over 2007, reflecting our aggressive push during the year to reach out to tenants and proactively work our leasing solutions.

Our retention rate for the fourth quarter was 81%, bringing our overall retention rate for the year to nearly 80%, a dramatic improvement over the 64% we incurred in 2007. We will continue to focus on maintaining a strong retention rate in 2009, as this is the most cost effective leasing we can do from a capital and overall cash flow perspective.

Now, let me touch briefly on the centers of our tenant build-outs we have underway. We delivered over 300,000 square feet of space for new tenants in the fourth quarter. These tenants are now in their space and we’re recognizing rent. In addition to our fourth quarter accomplishments, we expect to deliver another 20,000 squarer feet of space for new tenets during the first quarter of 2009.

2009 will likely to be a tougher year from a leasing perspective, but we feel good about our markets relative performance and we’ll continue to work diligently to address our expirations. We have roughly 4.8% rolling in our portfolio or 433,000 square feet rolling in the first half of 2009 and 8.4% rolling or one million square feet in the second half. Looking at 2010, we have approximately 14.2% of our entire portfolio set to expire next year.

With the record leasing volume generated in 2008, we have done a very good job of reducing expirations for the next few years. If you look long term, 44% of our portfolio will not roll in to 2013 and beyond. This is up from 25% just a year ago as we have successfully extended and reworked many of those close-end expiration, further reducing risks. As a company from a portfolio perspective and activity wise, we are much better positioned today compared to a year ago.

Our 2009 leasing objectives are clear. (Inaudible) our high retention rate, focus on controlling bad debt in the existing portfolio and work diligently to fill space. We will also continue to focus on minimizing TI leasing commission expenses as we move through 2009. While the outlook is challenging, we believe our markets portfolio and asset class position allow us to perform in this environment.

Our markets should be among the most resilient the country. On a relative basis, new supply is essentially non existent in our market. Also given the government spending plan for next three year, the region should somewhat buffer from the increased unemployment occurring nationally.

Our portfolio has a very diverse tenant base. The top 30 tenants in our portfolio are responsible for 42% of our revenue; this group is anchored by the federal government. A list of these tenants can be found on page 16 of our supplemental. The next 70 tenants of our portfolio are responsible for an additional 23% of our revenue and the top 100 tenants in our portfolio generate 65% of our total revenue. The rest, over 500 tenants are response for the balance of our revenue, about 35%.

Our portfolio offers a low cost, high quality solution for tenants, but is critical operating markets and we think these attributes will help our property talk during these tough economic times.

With this, I would now like to turn the call over to Barry Bass, our Chief Financial Officer. Barry

Barry Bass

Thank you, Skip. 2008 marked a year of progress for the company, operationally and from a balance sheet capital perspective. Significant events that we completed during the year include the sale of our Alexandria Corporate Park in June; the refinancing of our $70 million suburban Maryland portfolio loan that was slated to mature last September; the retirement of $40 million of our exchangeable notes at an average 20% discount; the issuance of $44 million at equity; and the closing of our joint venture with AEW in mid December.

We now have only $38 million of debt maturing between now and 2011. In fact we have no debt maturing until May when $8 million matures and we have a total of only $16 million maturing over the next 20 months.

Leasing wise as Doug and Skip outlined, we made significant progress, setting the stages for meaningful cash flow improvement, as we finished spending CapEx on build up and tenants take occupancy and begin paying rent.

FFO for the quarter ended December 31, 2008 was $12.2 million, compared to $11.4 million in the fourth quarter of 2007. On a per share basis, fourth quarter FFO was $0.45 per share compared to $0.46 per share in the fourth quarter of 2007. For the year, we reported FFO of $47.1 million or $1.84 per share compared to $41.7 million or $1.67 per share in 2007.

Same store NOI for the quarter increased 0.4% on a cash basis and increased 2.1% on a GAAP basis. Our AFFO for the quarter was $8.4 million or $0.30 per share, up from $5.3 million or $0.21 per share in Q3, as higher revenue and lower tenant improvement in leasing commission costs drove the positive variance.

Our balance sheet improved as we progressed through 2008 and we ended the year with capital availability via our credit facility to fund all of our near term obligations. We included a schedule on page 12 of our new and improved supplemental that shows where we stood relative to the covenants associated with our bank debt and senior notes at the end of quarter that gives more insight into our balance sheet capacity.

Our fixed charge coverage ratio for the quarter was 2.2 times, marking the four consecutive quarters that our coverage level has improved. As I mentioned, we have no large maturities until 2011 and outside of our leasing related CapEx, we have no significant construction commitments.

We ended 2008 with $657 million of debt outstanding, about $20 million less than at the end of 2007 and we had $16 million of cash on the balance sheet, an increase of $11 million from the end of 2007. $567 million of our debt was fixed rate debt or hedged variable rate debt, with a weighted average interest rate of 5.4% and a weighted average maturity of four years.

Our borrowings on our line of credit of $75.5 million and $15 million of a secured term loan represent the only un-hedged floating rate debt on our balance sheet, about 15% of our total debt. Going forward, we will continue to opportunistically de-lever the balance sheet and create capacity via numerous mechanisms, including asset recycling, additional debt repurchases and continued NOI growth.

Let me take a second to discuss our dividend. In January, our Board of trustees declared dividend of $0.34 per common share, for the company’s fourth quarter ended December 31. The decision by the Board to maintain the dividend rate was based on numerous factors, including from an operational perspective, the successful leasing accomplished in 2008 and the expected cash flow ramp up as build out ceases and tenants take occupancy.

From a financing balance sheet perspective, the Board considered the fact that we have very minimal debt maturities over the next two years and furthermore, the Board took into account the taxable income that has been or could be generated by retiring debt or by selling assets. We in the Board understand that one of these variables has changed, as the recently enacted stimulus package defers taxable income associated with debt extinguishment, gains that are realized in 2009 and 2010.

However, this is one of many variables that the Board considered when determining the dividend level and they will continue to evaluate all of these variables going forward when setting dividend policy, and will make the best decision for the long term interest of shareholders.

In last night’s press release, we provided 2009 guidance of $1.55 to $1.80 per share. The guidance includes an approximately $0.05 per share reduction from the implementation of APB 14-1, the FASB pronouncement that requires us to fair value the interest on our exchangeable notes and the guidance also includes $0.13 per share of debt retirement gains that have already been realized in the first quarter.

We provided an analysis in the release that we believe makes it clear as to what we anticipate from our core operations and allows for an apples-to-apples comparison with our prior results. Bottom line is that we anticipate same property NOI to be flat to up 5% in 2009, based on the occupancy gains we’ve realized from our 2008 leasing, which we believe will offset somewhat by higher bad debt and slower leasing velocity in 2009.

Now let me hand it back to Doug for some closing remarks.

Doug Donatelli

Thanks Barry and thanks to all of you for listing to our call today. Despite the turmoil in the broader economy and the dollar concern, the commercial real estate fundamentals are forced to deteriorate again in 2009 and perhaps 2010. We continue to execute our business plan and operate in markets that provide some downside protection.

I hope you all take away from this call that we are well positioned in the near term from both an operational and balance sheet perspective. Over the near and intermediate term, we are going to continue our focus, more intensive portfolio management, optimizing our capital structure and looking for potential external growth opportunities.

There is little to note in new construction of our property type in our region and our region continues to benefit from the presence and growth of the federal government, which will drive the job growth and demand for our property type in the region and we have the local knowledge, contacts and access to capital to generate long term value for our shareholder.

With that operator, let’s take some question.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) Our first question comes from the line of Chris Lucas with Robert W. Baird; please go ahead sir.

Chris Lucas – Robert W. Baird

Good morning guys.

Doug Donatelli

Good morning Chris.

Chris Lucas – Robert W. Baird

Skip, can you just kind of walk through the markets in terms of where you are seeing decent activity and where it’s slower?

Skip Dawson

I mean a snapshot of what we saw in the fourth quarter numbers to be as far as new leasing and then kind of give you an idea of what we’re seeing across all markets as far as total activity in the first quarter.

Of course I believe we’re some 100,000 square feet in Northern Virginia market in the fourth quarter, a lot of the big deals that were generated in that region for us and the same, in Richmond Southern markets we were able to generate another 100,000 square feet down in that area. A little slower earlier in the fourth quarter and we’re seeing that again in the first.

As far as the other two territories in Northern Virginia is also kind of quite and we’re seeing some little bit of traffic in Southern, but comparable to last year I mean its no surprise. People are really taking a look at what’s going on and comment or not, there is not that much true activity throughout all regions.

Chris Lucas – Robert W. Baird

Okay and then I guess, you talked a little bit about the government spending. What’s your sense of timing on that, and those particular areas i.e. funding at the NIH or defense, whatever it is. Can you give us some sense as to where you might see incremental improvement based on improved or increased federal spending?

Doug Donatelli

It’s a little earlier to tell specifically Chris and I know that they’re probably going to try to push spending through as rapidly as possible, but even that takes some time. So the package is going to pass through in a week or so. So it’s hard to know precisely what the impacts going to be, but we’re in touch with a lot of tenets and other people who are operating in the region. I think there’s a lot of optimism about spending impacting our region pretty rapidly. So, we’ll see how that shapes out.

Chris Lucas – Robert W. Baird

And then Barry, a couple of things on guidance; are there any asset sales or acquisitions modeled in at all?

Doug Donatelli

No, there are not.

Chris Lucas – Robert W. Baird

And then on the tenant credit issues that you highlighted, are there specific tenants that you’re really honed in on is this just an increase over what you would normally expect in terms of how you budget it?

Doug Donatelli

Well, we do a pretty fulsome analysis of our whole tenant roster and so these numbers do stem from that tenant-by-tenant analysis. We assign probabilities, we assign credit watch metrics to each of our tenants and this is kind of a fall out at the low end and the high end in terms of look bad debt we are expecting. I mean just for comparison purposes our bad debt in 2008 was about $0.5 million and so anticipating going from that to $1 million to $2 million.

Chris Lucas – Robert W. Baird

What was the rate in the fourth quarter?

Doug Donatelli

It was about $300,000

Chris Lucas – Robert W. Baird

Okay and then a quick follow-up question or more clarification questions. First, thank you for the additional disclosures related to the covenants and the NOIs supporting various debt maturities. I do have one question, there is a term loan that I guess you described it as sort of mezzanine type financing and there’s a footnote that describes that there are series of first mortgages underlying that portfolio; what’s the balance on those first mortgages?

Barry Bass

The balance of the first mortgage is about $225 million.

Chris Lucas – Robert W. Baird

Okay and how should think about the NOI that’s supporting that entire package?

Skip Dawson

The annualized NOI on those assets is about $34 million. The reason we presented it that way, just so you know, we did wrestle with exactly how to present that particular loan. The way that the banking group and its just two banks, so it’s not a widely syndicated loan, Key has the lion’s share of the loan, the way they analyze it was the cash flow available to service their debt. We’ve already talked to Key about the possibility of extending that, modifying it, we’re confident that as that date approaches we’ll be able to get a little bit more term out of them.

Chris Lucas – Robert W. Baird

Okay and then my last question, in the AFFO statements of the apex there’s cash payments that acted as a reduction in basis, sort of a purchase price; that number seemed relatively larger; was there some acceleration or is that a good run rate. I know that asset ended up in the JV, but…

Skip Dawson

Yes, that’s not a good run rate. What we did there actually was, that is a payment that we received from GGP. When we bought the asset from GGP at the end of the third quarter, they leased back some space. We basically recorded that; any payments they make to us, we record as a reduction in our basis as you pointed out, but we do receive the cash.

We had them terminate two of the spaces and we received a payment of about $1.2 million. So, $1.2 million is an extraordinary number if you will and the balance is probably a better run rate for you.

Chris Lucas – Robert W. Baird

Okay and then I guess just one other comment or question on that which is, that NOI that sort of will be ongoing, is that additive or included in how your debt covenant analysis has gone through?

Skip Dawson

It is not included in our overall debt covenants; it is included in the debt covenants for the U.S. bank loan that supports that specific property.

Chris Lucas – Robert W. Baird

Okay, great. Thanks a lot guys.

Operator

Thank you, sir and our next question comes from the line of Jordan Sadler with KeyBanc Capital Markets. Please go ahead.

Jordan Sadler – KeyBanc Capital Markets

Good morning. I just wanted to just follow-up on one of Chris’s questions there. Were there any lease term fees in the quarter or other fees related to…

Barry Bass

Yes, for the quarter we had about $350,000.

Jordan Sadler – KeyBanc Capital Markets

How much, sorry?

Barry Bass

About $350,000

Jordan Sadler – KeyBanc Capital Markets

And what was it for the year?

Barry Bass

For the year $1.2 million

Jordan Sadler – KeyBanc Capital Markets

Okay and are they already baked into guidance at this point?

Doug Donatelli

The low end had about $0.5 million and the high end had about $1.5. That’s part of the other income that will show in guidance.

Jordan Sadler – KeyBanc Capital Markets

Okay and then just coming back to the dividend discussion. Can you maybe run through sort of the sources, maybe through 2010, just the liquidity you have right now, I guess the use is on the debt side.

Doug Donatelli

In terms of when you talk of liquidity, we have about $60 million of capacity on our balance sheet currently.

Jordan Sadler – KeyBanc Capital Markets

That’s liquidity to the revolver plus cash.

Doug Donatelli

That’s really just the debt capacity; that doesn’t include the cash that’s on the balance sheet, so that’s really just debt capacity that we have on the balance sheet based on our covenant metrics. I mean in terms of cash flow, we do expect in 2009 that our tenant improvement and leasing cost will actually decline in 2009 relative to 2008, because we don’t expect to do as much leasing in ‘09 as we did in 2008.

So, we’re anticipating in fact of the bucket and guidance costs for about half as much leasing in ’08, ’09 as we did in ’08. So we expect that that will also help our cash flow metrics and we haven’t provided AFFO guidance, so I’m going to stay away from that.

Jordan Sadler – KeyBanc Capital Markets

Okay and then just coming back to the leasing maybe, Skip how does that breakout, new versus renewal?

Skip Dawson

Well, Barry indicated that we’re projecting even less than half of what we did in ’08 for ’09 and that’s even lower than what we did in ‘06 and ’07. If you take a look at our expiration for the entire year, we reported 1.5 square feet that are expiring. Of that amount, $400,000 was expiring in 12/31.

So we get the full value of that revenue stream from the entire year. If you look at the 1.1 million square feet and you look as if we do 400,000 square feet of new deals in the year compared to just say a minute; I think 70% as a retention rate plus or minus would be neutral and that’s kind of what base line guidance is.

We are just very cautious about what ‘09 is going to bring. We’re very fortunate, we’ve got revenue coming online from the fourth and the first quarter going in and we’ve minimized exposure for the first half of this year and then (Inaudible).

Jordan Sadler – KeyBanc Capital Markets

And just Barry, just coming back to I guess investments or repurchases, can you maybe talk about how you’ll weigh investment opportunities versus repurchases and how aggressive we expect them to be there in 2009?

Barry Bass

We don’t expect to be aggressive. We’re going to be very disciplined and prudent as we have been with all of our capital allocations. We do see on the acquisition side, Nick is here by the way, so I can have him respond to that a little bit on the acquisition side, but as we look at deploying capital in terms of uses of capital, any opportunities need to be extremely compelling for us.

We have found retirement of our debt at a discount is a compelling opportunity for us that helps to de-leverage the balance sheet. So, we’re weighing opportunities against de-levering the balance sheet. We’re also going to make sure that we line up capital in advance of any opportunities that we do see out there, both on the debt and the equity side and so, that’s going to help us to determine the opportunities that we pursue during the year.

Skip Dawson

Right and which makes the relationship of AW or other potential joint venture partners important for us.

Jordan Sadler – KeyBanc Capital Markets

And next just on the acquisitions, any of the environment?

Doug Donatelli

Well, I think cap rates have gone up a little bit; there isn’t as much data out there. I think what we’re staring to see is sellers becoming a little bit more in tune with where the market is and that was really what has been stalling a lot of the investment sales out there. I mean, that and the lack of debt or the availability of debt, but a lot of sellers just haven’t been in tune with where buyers are and we’re staring to see that bid gap narrow a little bit. So, hopefully there will be some interesting opportunities coming forward. Narrow by having sellers reduce their expectations.

Jordan Sadler – KeyBanc Capital Markets

Will you guys look to sell anything?

Doug Donatelli

We may in 2009, but it would be a small transactions. Some of our smaller assets, were it’s easier to get bank debt and so therefore the pricing might be a little bit better and we could do some selective sales to users and the pricing on that could be recently attractive

Jordan Sadler – KeyBanc Capital Markets

Okay, thank you.

Operator

Thank you sir and our next question is going to come from the line of Paul Adornato with BMO Capital Markets. Please go ahead.

Paul Adornato – BMO Capital Markets

Thanks good morning. Barry, you went through a list of items that the Board considers with respect to the dividends and I think that you said one of those items was expect to gains on sale of assets. Did I hear you correctly?

Skip Dawson

That was one they considered, yes.

Paul Adornato – BMO Capital Markets

Alright and so is it safe to say that the board would rather pay a regular dividend than to have special dividends with respect to gains on property sales?

Barry Bass

That was certainly the determination they made when they were thinking about the dividend they declared for February. They were thinking about already the fact that we had repurchased some of our notes.

Now that point of the field has changed a little bit as a result of the stimulus package. So, as I tried to point in my comments, they do consider a variety of factors and they will continue to consider all of those factors on a going forward basis and make what they deem to be the best decision, that’s in the best long term interest of our shareholders.

Paul Adornato – BMO Capital Markets

Okay and do you happen to know if they considered what the rest of the industry, industry triumphs and any comments there?

Doug Donatelli

Sure, they’ve look at what the rest of the industry was doing as well. I mean it was a part of the consideration.

Paul Adornato – BMO Capital Markets

Okay and with respect to the credit quality, are there any particular tenants that are on your watch list or any particular industries that you have concerns about?

Barry Bass

Yes, I mean fortunately as Skip pointed out in his remarks, we don’t have a tone of those types of tenants in our top 30 or even in our top 100. So, we’ve done a good job. I think being mindful of our tenant in terms of making sure that we have good credit quality tenants and making sure that when we do have credit risks, that we get the security deposits and/or personal guarantees.

So sure, we have a watch list, but we’re fortunate that none of our big tenants are really on that watch list. I mean, Skip has a very compelling story. Visteon was a kind of tenant of ours up until the end of 2007 and we chose to take a termination fee from them. We negotiated a termination fee with them and Skip, you want to tell that story.

Skip Dawson

Yes, we take a look at the risk daily and what we decided to do back after the announcement of fourth plants closing down in Norfolk. We had a supplier Visteon, supplying fuel tanks for that particular plant and they were obligated to lease space into 2011 and realizing it might be a good thing to do now, to take them out of the equation and that filled the space of existing tenant demand that we had. So at the end of 2007, we took a termination fees in Visteon realizing that that 2008 impact on FFO will go down.

We worked with existing tenants within the portfolio, within that project and we were able to expand, Centera Healthcare. We were able to also extent and expand our general dynamics in the same area and we just released the balance in the space of that asset as 100% lease and those leases will be on our balance sheet and in full effect with the FFO at the end of first quarter.

So, we take a look at the entire portfolio, we see that we may have some concerns and in that particular case, we get out in front to carry our potential problem and thank goodness we did, because in reading today’s Wall Street Journal, obviously they are having some challenge right now and it’s nice to have them pass this.

Barry Bass

Yes, I mean in and Wall Street Journal about Existion’s [Ph], the headline says Existion’s risk for bankruptcy deepens and we saw that a year ago and decided we wanted to take a termination fees from them to negotiate that and it did have as Skip pointed out, the negative effect on 2008 FFO, but it was a right thing for us to do for that property and for the shareholders. So, I think the answer is, we spent a tremendous amount of time and always have weighing the credit quality of our tenant base and trying to get in front of it as best as we can.

Paul Adornato – BMO Capital Markets

And just finally given all the stimulus spending and change of administration, does that present an opportunity to increase your exposure, your direct exposure to the federal government and is that a goal of yours?

Doug Donatelli

We think it’s provide a tremendous opportunity for us and whether it’s direct leasing to federal government or additional leasing to the government contractors, those both represent solid opportunities for us and we have excellent relationships with the federal government and the leasing agencies inside of the federal governments as well as the contractors in the marketplace. So, we hope to be one of the first in line for these opportunities as these monies get spend.

Paul Adornato – BMO Capital Markets

Okay, thank you.

Operator

Thank you, sir and our next question comes from the line of Stephanie Krewson with Janney Montgomery Scott; please go ahead.

Stephanie Krewson – Janney Montgomery Scott

Hey, there. I apologize if this is redundant; if it’s already been asked, (Inaudible) for a few minutes. Your TI dollars I heard your comment on the call, but just trying to help for our international projection purposes, how much of your vacancy do you classify as first generation space?

Skip Dawson

Only vacancy that we acquire.

Stephanie Krewson – Janney Montgomery Scott

Well, I know that.

Skip Dawson

No, actually some people we understand put it back in after it’s been vacant for a year.

Stephanie Krewson – Janney Montgomery Scott

Actually that’s true, but we appreciate your conservative accounting.

Skip Dawson

How much of our vacancy? It’s about 50%

Barry Bass

Our total TI cost for the year for example.

Skip Dawson

So that’s how much of our TI cost. So, I’ll have to get back in terms of how much of our vacancy is currently classified, yes, I’ll get back to you on that Stephanie.

Stephanie Krewson – Janney Montgomery Scott

Alright, I’ll talk to you after the call.

Operator

Thank you ma'am and our next question come from the line of Chris Haley with Wachovia; please go ahead.

Chris Haley - Wachovia

Good morning.

Doug Donatelli

Good morning

Chris Haley- Wachovia

Some questions on concession levels. In 2008, FED or adjusted funds for operations for capital expenditures, straight-line rents etc. is approximately at $0.80 deduct off your $1.80. In 2008, we’ve seen the concession ratios on lease signed during the year, increase as a percent of the rent and those are committed capital dollars.

I would appreciate any color you could offer us on what you’re expected cash outlays might be; actual dollars spent on the leases that have been committed over the last six months to three months for the 2009 year. Give us some color as to what type of deductions we should using, look at ongoing cash flow, FED?

Doug Donatelli

In terms of the commitments for leases that have been signed and that are currently in progress, we have commitments outstanding of just under $10 million in terms of tenant improvements and leasing commissions.

Chris Haley - Wachovia

Okay and that’s on transactions that have already been done, and then any adjustment that we can make a forecast? What type of forecast on concession ratio should be use or are you using for the first half of 2009?

Doug Donatelli

I mean our expectation; we are seeing the tenants are signing shorter term leases at this point, so we would expect that in terms of total dollars out, our total dollars will be significantly reduced from 2008.

I know it’s hard to make the apples-to-apples comparison from the information that we provide and we need to think about how to change this, because not all of the leases that we sign are accounted for in the lease analysis paid, but all of the tenant improvements that we incur are, so it makes it a little bit tough to do an apples-to-apples comparison.

To the extent that we are doing shorter term leases, again our total dollar outlay will be less, so concession rate still might be approximately the same, but I think the $3 a square foot or so on renewal leases is about right and that’s about what we’re expecting. So, Skip went over those numbers. If we have $1.1 million expiring during the year, before December 31, since we have that 400 coming due on December 31 and we renew 70% of that, $3 dollars of foot on that; and then new leasing in the 400,000 square foot range…

Skip Dawson

16 parts is another, $6.4 million.

Chris Haley - Wachovia

Okay and any help on what you’ll be budgeting for building CapEx?

Barry Bass

Total building CapEx about $5 million, some of that’s first-gen, but total would be up $5 million.

Chris Haley - Wachovia

Okay, thank you. A follow-up on the GGP route transaction; if I recall a portion of that the agreement was a rent guarantee. Is this payment that you received associated with the release of that guarantee?

Barry Bass

Actually, there are two steps to the guarantee; one is the guarantee effectively that we got from GGP on a certain portion of the space when we bought the property from them and we did receive $1.2 million from them and that released them of their obligation on that space.

They continue to be obligated on two other spaces and as we pointed out in our release, the renewal of a tenant at that property and we are backstopping that to a total of about $1 million obligation on the lease; that’s the lease that they currently have at the property; so, we’re back stopping that over the next three years or until we lease that space.

Chris Haley - Wachovia

You guys are back stopping that?

Barry Bass

On behalf of the joint venture, that’s correct.

Chris Haley - Wachovia

Okay, so their $1.2 million Barry, how was that treated, was that a…

Barry Bass

That was not part of FFO, because it was treated as a reduction of basis. It was added to our AFFO’s since it was cash that we received.

Chris Haley - Wachovia

Okay, so that amounts to the full amount, okay great. Alright, where exactly is that on your income statement?

Barry Bass

I’d say, in expenses.

Chris Haley - Wachovia

So, operating expenses?

Barry Bass

That’s correct.

Chris Haley - Wachovia

Okay. My last question is in your guidance, your prior years forward expectations, you had talked about a strategy where recycling was more pronounced or it’s going to be a more regular strategy and therefore including gains and the results, where do you stand on that and is that still part of your guidance?

Doug Donatelli

No, we are not including gains in the FFO guidance and nor will we include it in FFO going forward, but we still believe that it’s important to recognize those gains that we realize and so in our supplemental we provide a number that is FFO plus gains on sale, but our FFO guidance does not include gains on sale nor will our FFO reporting on a go forward basis.

Chris Haley - Wachovia

Okay, thank you.

Operator

Thank you sir and our next question comes from the line of John Guinee with Stifel Nicolaus; please go ahead.

John Guinee - Stifel Nicolaus

Hi, John Guinee here, how are you?

Doug Donatelli

Does anybody able to get your name right John?

John Guinee - Stifel Nicolaus

No, actually people who kept us on hold for six minutes until they took down our name here got it wrong, but most people do get it right.

Doug Donatelli

Okay.

John Guinee - Stifel Nicolaus

11 million square feet Skip, you guys have been bouncing around between 85% and 89% leases and occupied for the last few years. Everybody knows that using FFO is an occupancy gain. Do you have just a few hundred thousand square feet that are functionally challenged and are just never going to lease up that we should take out of our expectations when we look at occupancy increases?

Doug Donatelli

No.

John Guinee - Stifel Nicolaus

Any space has been vacant for a couple of years now that maybe other people might think is functionally challenged?

Doug Donatelli

Very, very small spaces; I mean its 2000 square feet here and 4000 square feet there. I mean it really does get back to some extent the Visieon story that we told earlier and then that relates to TDF as well that we terminated early at another property in Chesapeake with an afford related use on them, but we have back rolled part of that space with FedEx.

I mean it really is part of the process of adding value to the properties that we do take back space when we believe that we can add value to the property on a more long term basis. I think it was the right decision to remove Visieon from that property, but the leasing that we’ve done to backfill that space is only now being recognized, 14 months later.

John Guinee - Stifel Nicolaus

Okay, the second question is having been there before I know it’s a lot more fun to acquire assets and dispose of assets. So it’s a lot more a fun to grow a company and than to shrink a company, but the facts are that you guys are fairly highly levered no matter which metrics you use and no matter how you value you guys, whether its an implied cap rate or FFO FAD multiple, you clearly are trading lower than most people would like and it seems to m to be a direct correlation between your discount to your peer group and excess leverage. Any agree or disagree and how much in the way of asset sales can we expect to see in 2009?

Barry Bass

Well, we answered the asset sales question a little bit earlier in a sense that we don’t expect that we are going to disposing of a lot of properties in 2009 and in fact that’s not the most efficient way to de-lever in the sense that you are removing value from the equation as well as loan too, so it kind of doesn’t help us much with the de-leveraging.

Frankly, retiring debt at a discount helps very effectively with the de-leveraging and then we will look at a lot of other ways to potentially de-lever over the course of the next two years. I mean I think we really do, we put ourselves in a great position in a sense that we have a nice window here in which we can de-lever and our goal is to accomplish some of that by the end of 2010.

Jordan Sadler – KeyBanc Capital Markets

Okay, thanks.

Operator

Thank you, sir and our next question comes from the line of Bill Crow with Raymond James. Please go ahead.

Bill Crow – Raymond James

Good morning, guys. Well the good news is that discount to your peers is shrinking a bit today, so congrats on a good quarter. My question really is the anticipation of what the growth in Washington could do to the property centers up there and it seems more obvious to us that office and residential could be beneficiaries. Could you maybe look inside your existing portfolio to give us some examples of how flex, where our showroom space might benefit from the growth in government going forward?

Doug Donatelli

Sure, we have a number and you can look at our tenant roster and see the kind of tenants that are going to be benefiting from the growth of the federal government, both direct federal government tenants, as well as government contractors or going to dominate the top 30 risk in our supplemented.

Those are the kind of groups that are attracted to flex properties and they like the locations of the properties, like the kinds that we own and they like the flexibility, as well as the low cost solution that our space provides for them; properties that we’ve targeted to acquire, we targeted because of their appeal to those kinds of tenants.

Especially that the Rivers property that we brought recently, the one on the joint venture has vacancy that we expect to be filled by government and government contracts, are the perfect space for those kinds of view. So, the uses of our kind of space windup very well with the kind of group that would benefit from spending through a stimulus packages that we’re talking about.

Bill Crow – Raymond James

Alright, good that’s all I have. Thank you.

Doug Donatelli

Alright

Operator

Thank you sir and our next question comes from the Carol Kemple with Hilliard Lyons; please go ahead.

Carol Kemple – Hilliard Lyons

Good morning.

Doug Donatelli

Good morning.

Carol Kemple – Hilliard Lyons

Your occupancy outlook for the 2009, you all consider that, did that take in effect the stimulus package or was that decided before?

Doug Donatelli

Yes I mean it does take that into account to some extents. I mean we’re expecting. I would say we would be hopeful that we see some of the results of that stimulus packages over the second half of this year and I guess implicitly the high end of range might include some of that influence.

I mean the truth of the matter is after having been through this after 9/11 when there was also a tremendous amount of additional spending pushed through Congress, it took a solid year and a half, almost two years before you actually saw that in terms of leasing affecting our bottom line. So, I don’t think there is a lot of optimism and a lot of upside there in the 2009 numbers based on spending from the stimulus package.

Carol Kemple – Hilliard Lyons

So, 2010 would be a better beneficiary of the package.

Doug Donatelli

Most slightly, yes

Carol Kemple – Hilliard Lyons

Okay and do you have any gains or losses from the JV built into your guidance?

Doug Donatelli

No and we’ve don’t expect any gains or losses from the JV.

Carol Kemple – Hilliard Lyons

Okay. Thank you.

Operator

Thank you, Ma'am. (Operator Instructions) Your next question is the follow-up from the line of Jordan Sadler with KeyBanc Capital Markets; please go ahead.

Jordan Sadler – KeyBanc Capital Markets

Just coming back to the debt repurchase opportunity, is there are more money available (Multiple Speaker) debt repurchasing?

Doug Donatelli

I mean we’re fortunate that the size of the assets that we own are very finance able. We currently have more unencumbered assets on our balance sheet than we need in terms of our total unsecured borrowing base. So, I mean we can go out and get first mortgage financing on a number of our assets and use that capital to retire some of the exchangeable notes.

Jordan Sadler - KeyBanc Capital Markets

Okay and then I guess just coming back to the dividend, I’m trying to gauge your posture there, you said a couple of different things. Do you think given sort of the ruling on debt repurchases and now you have the cover where its not going to be a required distribution related to any of that repurchases, that going forward the buyer should be more, the Board will be more inclined to cut the dividend at this point; is that a safe assumption?

Barry Bass

No, I can’t say that’s a safe assumption Jordan, but its one of the factors that the Board will consider once that is dividend at the next opportunity to do so, maybe next quarter.

Jordan Sadler – KeyBanc Capital Markets

So maybe could you give me your thinking Doug as a CEO and member of the Board, just what is sort of the position on liquidity right now?

Doug Donatelli

We’ll look at all sorts of factors. I think that the growth of the portfolio, the growth of the cash flows from leasing, the idea that we’ll have substantially less dollars going out for tenant improvements and leasing commissions going forward, that’s an important factor as well.

If you look backwards for a second the rate of the dividend that we paid up to this point was no more than it could have been. Our dividend last year in 2008 was roughly equivalent to our taxable income.

Jordan Sadler – KeyBanc Capital Markets

Sure, but if you actually strip out the gains, so if you assume you don’t have any gains this quarter, I mean 60% of your dividend was related to ordinary income and 40% was related to gains and so that would mean that you guys would overpay your dividend, if you just assume flat taxable net income which is not necessarily a safe assumption, but if you assume flat taxable net income in this environment, you’d be overpaying your dividend well to TNI by 40%?

Doug Donatelli

Yes, relative to taxable net income sold for sure, but the amount of taxable net income generated from operations, we expect to increase. There’s a lots of things that we’d have to look at on a go forward basis. The board will do that, the board will make the best decision based on the information that they have at the time and the best decision for the long term interest of our shareholders.

Jordan Sadler – KeyBanc Capital Markets

Is the stock dividend somewhat off the table at this point?

Doug Donatelli

Yes. I think that’s fair to say.

Jordan Sadler – KeyBanc Capital Markets

Okay, thank you.

Operator

Thank you, sir and our next question is a follow-up from the line of Chris Haley with Wachovia. Please go ahead.

Chris Haley – Wachovia

Thanks. In 2010, when you provide your 1099, how is the gain related to debt extinguishment going to be treated? Is that a capital gain?

Skip Dawson

In 2010, it will not.

Chris Haley – Wachovia

Sorry, when you offer your 2009 dividend composition…

Barry Bass

It’s not taxable in 2009. It gets deferred until 2014 to 2018.

Chris Haley – Wachovia

How will that impact that composition of the dividend? For example if your dividends are $1.30, $1.40. If your net earnings are just kind of $0.50 or whatever it is or whatever you say in your guidance and then you have these gains and then you obviously have recapture and then return of capital. I’m interested to know where that debt repurchases fits within the dividend composition.

Barry Bass

That fits in 2008.

Chris Haley – Wachovia

Might fit in or I guess also 2008, what bucket does that fall in, in terms tax treatment for the dividend?

Skip Dawson

It’s ordinary income.

Chris Haley – Wachovia

Ordinary income. Thank you.

Operator

Thank you, sir. (Operator Instructions) and I show no further questions in the queue at this time. I’d like to hand the call back over to management for any closing remarks.

Doug Donatelli

Thank you and thanks everyone for listening to our call today. If you have any follow up questions feel free to contact us.

Operator

Ladies and gentlemen this concludes the First Potomac Realty Trust fourth quarter 2008 conference call. This conference call will be available for replay after 1o’clock Eastern Standard Time today, through Thursday, March 5 at midnight. You may access the replay system at anytime by dialing 303-590-3000 or toll free, 1800-405-2236 and entering the access code number of 11123994. We thank you for your participation and you may now disconnect.

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Source: First Potomac Realty Trust Q4 2008 Earnings Call Transcript
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