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Executives

Gordon F. DuGan - Chief Executive Officer, Director and Chairman of Investment Committee

Emily Pai

Jon W. Clark - Chief Financial Officer, Chief Accounting Officer and Treasurer

Benjamin P. Harris - President

Analysts

Kevin Tracey

Jonathan Feldman - Nomura Securities Co. Ltd., Research Division

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

Gramercy Capital (GKK) Q4 2012 Earnings Call March 19, 2013 2:00 PM ET

Operator

Thank you, everybody, for joining us, and welcome to Gramercy Capital Corp.'s Fourth Quarter 2012 Financial Results and Business Plan Update Conference Call. [Operator Instructions] Please note, this conference is being recorded.

At this time, the company would like to remind the listeners that during the call, management may make forward-looking statements. Actual results may differ from the predictions that management may make today. Additional information regarding the factors that could cause such differences appear in the MD&A section of the company's Form 10-K and other reports filed with the Securities and Exchange Commission.

Also, during today's conference call, the company may discuss non-GAAP financial measures as defined by the SEC Regulation G. The GAAP financial measures most directly comparable to each non-GAAP financial measure discussed and a reconciliation of differences between each non-GAAP financial measure and the comparable GAAP financial measures can be found in the company's press release announcing third quarter earnings, a copy of which can be found on the company's website, www.gkk.com.

Before turning the call over to Gordon DuGan, Chief Executive Officer of Gramercy Capital Corp., we would like to ask those of you participating in the Q&A portion of the call to please limit your questions to 2 per person. Thank you, and please go ahead, Mr. DuGan.

Gordon F. DuGan

Thank you very much. Good afternoon, and welcome, everyone, to our year end earnings call to review the 10-K that you saw was filed, and the business plan update that we also filed as an 8-K. We have put that business plan update on our website, and I was just going to pause for a second to let anybody go to our website, if you need to access the business plan update. Emily, it's in which section?

Emily Pai

Investor Relations, News and -- Events and Presentations.

Gordon F. DuGan

Okay, so please go on our website at gkk.com and access the presentation. If you'll give me 30 seconds, we'll just let people do that.

So the format for the call today. I'm going to run through the business plan update to start. I'll turn it over to Jon Clark to describe. He'll give a relatively short review of the financial statements, and we're just checking to make sure the sound quality is good. Sound quality is good? Okay, good. I think we had a little problem with that last time.

So I'll start with the business plan update, turn it over to Jon, he'll go through a review of the financial statements, it's filed in the 10-K, and then we'll have Q&A. Ben Harris, our President, is here with us as well. And with no further ado, hopefully everybody has had a chance to pull up the business plan update. I will do a page turner. I promise I will not read the slides. I will just touch on the slides that I -- what I think is meaningful. I'll also try to keep up-to-date with page numbers so that everybody can follow along.

On that note, you'll see Page 2, the cautionary note about any forward-looking information. As the operator said, that is something that should be read or understood. And why don't we jump into it. Page 3, this is something everybody's seen before. It's a quick overview of the business plan for 2013 to 2015, in its most simple bullet-point form. We're going to step through where we are on each of these, and you'll see a new bullet point at the end in terms of what it is we're trying to create, which is a company that's able to provide durable growing dividends. And we'll talk about how we're getting there, the steps we're taking to get there, and how we're getting there, and dig a little bit more into that.

Moving right along. Page 5. Nothing terribly new here. Hopefully, you've seen the press releases, or I should say, nothing -- something is new here, which is the transaction did close, the transaction closed as of Friday. I think it's a terrific transaction for us. I think it's one of those situations where it's actually a win-win. A large servicing organization like CWCapital can take those assets onto their books, service them with the existing organization that they have, for the most part, and drive more profitability than we can. In my very first call here, I said some businesses are worth more in other people hands and I think this is a good example.

Our approach to the CDO sale was, let's maximize the value of the sale. So we sold the collateral management agreements as a separate entity. With that, we, in essence, sold the business unit that is Gramercy Finance. It's a separate business group within Gramercy that runs independently. And that has been sold and I'll talk a little bit about what that means on the G&A side.

We sold the bonds. In the press release relating to the original agreement, there was a $32 million number on the bonds. We were able to execute the sale of the bonds at a higher number, $34.4 million. So our strategy of not selling the bonds, along with the sale of the other, with -- along with the business, turned out to be a good one. We made a couple of million bucks off of it. We retained the equity, I'll come back to that. And the CDO advances, they just picked up. I have $14 million here, it's really closer to -- it's just over $15 million, as that number was in flux up until the closing date on Friday. The benefits, I think, we've touched upon these. I don't want to dwell on them. In fact, this will be the last time we really spend a lot of time on this. But it's going to have a massive simplification to our business.

If you take our 10-K, as filed, or you go to the earlier filings of the 10-Qs, the vast majority, page after page after page, had to do with disclosure relating to the CDOs. This is going to be a much simpler business to start, much simpler business to be able to focus and a much less-expensive business to run. And I'll, again, get into a little bit more of the details of that.

The equity retention. The -- we have retained the equity in the CDOs. The equity is in quotes because it's really lower-rated bonds, bonds J, K, the preferred stock and the common. It's -- we're the last piece of the waterfall. These CDOs are very leveraged, so that equity retention, our base-case model shows the value of $25 million. That number could be 0 like that because of the leverage, if asset values decline. It also could go up because it's so leveraged. But we felt as though, if we weren't getting a good price, it's a heck of a nice hope note, that we hope is worth something, absolutely no promises that it's worth anything. But we think it maybe worth something, and if the economy improves, the asset quality improves, continues to improve, and a couple of fulcrum assets improve in value, including some land parcels in California, the equity could be worth more, certainly, more than we could have sold it for today. And there's both upside and downside to that number. So I don't want to focus people too much on that. I just want to say what our approach was, which was keep the upside of the equity and hope that, that turns out to be valuable in the future. Absolutely no promises there.

Page 6. This is an as-adjusted balance sheet. Let me be specific, this is not a pro forma balance sheet. This was our best attempt to just give a sense for how much more simplified this balance sheet will be with the CDO sale. You've seen a version of it before. What's -- because of JV accounting, we don't consolidate the Bank of America JV. So we do have the Bank of America JV on there, otherwise it looks like we actually don't own any real estate and, in fact, we do. The other thing that's happened is we have disposed of the noncore real estate assets that were on our books previously. That will show up in the March financial statement. I'll talk a little bit more about that in a later comment.

Our job 1 today, invest the cash to create recurring cash flows. We fleshed out a little bit on Page 8 what our investment philosophy is. I won't read these to you but these are things that we've been doing for many years. Ben and I have been doing this as a team together for many, many years, constructing a portfolio of assets that will provide -- that will hopefully provide recurring durable cash flow. This is something that we've done our whole careers and we focus on things like diversification, having some -- maintaining pricing discipline. And this just gives you a flavor of what our investment philosophy is. It's something we've done for many, many, many years and it works when done well.

Page 9. This is a little bit more granular. These are the types of markets where we expect to buy assets. If you look -- if you track the acquisitions that we've made, they tend to track these areas. I would say that in certain areas, such as L.A., Inland Empire, New York, Miami, San Francisco, that are very hot, we're not going to be buying necessarily traditional assets. We might buy a cold storage building. We might buy a truck terminal. We might buy an industrial building. But they're not going to -- this is not a focus on trophy assets. It's rather a focus on quality assets that will provide sustainable cash flow, and in markets that we think are strong, demographically, and are friendly from a business standpoint.

One thing people tend to forget, the United States adds about 2.5 million people a year. That means certain cities, like Phoenix, are growing rapidly. Dallas is growing rapidly. Houston is growing rapidly, as most people know. We add people -- as you add people to a city, real estate becomes more valuable because there are more people and less land, just in a very general way. And I'm sorry if that sounds too simplistic, but demographics are an important part of how we look at markets that we want to own assets in.

Page 10. This is something that I thought was quite interesting. Our -- we have stated that we -- our primary focus will be industrial and office net lease. That's our background as investors. But what we've also seen, and it may not be a surprise, is that cap rates on single tenant retail are probably about as competitive as they've ever been. They continue to go down, at least anecdotally from this report, Shopping Center News, January's edition said, "How low can cap rates go for single tenant retail." And so we believe that's the most crowded, most -- and least attractive from a risk-return standpoint. Many of the large public companies are specialists in that area. They're very good at investing in that area. But it's a very crowded area, National Retail Properties, Realty Income, American retail properties. They're all specialists -- I'm sorry, American real estate partners or properties.

All of these firms, their vast majority of -- or a lot of their experience is in the single tenant retail. We're really more specialists in the area that I think is the more attractive area in the net lease arena, which is office and industrial. And that doesn't mean there isn't a chance we could do something in retail. We do have quite a bit of experience there. It's just it would be opportunistic or unusual. It's not our primary focus.

Page 11. Again, this is the type of thing you've seen before. We bring a lot of experience and a lot of relationships. We're mining that to build a pipeline. Pipelines are pipelines. We've learned long ago, don't count on anything until it's closed, or under contract and about to close. And even then, you don't count on that. So this is just to give you a flavor of the different areas we are mining to find pipeline, for -- to turn the cash that we have on balance sheet into property.

Page 12. I think this is something, almost at the risk of sounding a little bit immodest, something almost unique to Gramercy and the team that we've built here. We have the capability to do a lot of transactions. Since we've arrived, we've closed on $564 million of acquisitions, 117 properties. At the same time, the Gramercy asset management team sold 93 properties last year for $408 million. That's a lot of activity. So we have the capability to transact and to do a lot of business. We also have the experience doing a lot of business. So this is a scalable business with a team that is able to scale the business, is the point that I'd like to make.

And in terms of deal flow, we're seeing good deal flow. It is competitive. It is competitive for the types of assets that we're buying. We're trying to use our relationships, our reputation for moving quickly, to win deals.

Page 13. This is kind of the classic funnel analysis. We review billions of dollars, some of that is a high-level review. I don't want to overstate that point. We actively look at a subset of that, and we've been able to close, from that, a fairly good-size number of transactions. But it's from a much larger funnel. So there is a funnel that transactions have to work through before we find them attractive to invest in.

Page 14. This is our -- this is a snapshot of what we believe the portfolio will look like as of March 31. $20 million of core net lease real estate NOI, 98% occupancy, over 10-year average term, over 70% investment-grade tenancy. I should state that, that include subsidiaries of investment grade-rated companies that are not, in a number of cases, guarantors, but it includes those in that calculus. It's primarily weighted toward office by square footage, but that's because the Bank of America transaction was our first one.

And I'll come back to the upper portion of this later, but down below, you see that one of our goals was clean up the assets that we had. We had 4 assets when we joined Gramercy, 3 were noncore. We have disposed of those 3 assets, Whiteface, Makalei and AFR. They were a cash drag. They weren't worth the debt balance. And we have kept the 1 asset that was performing, which was the interest in the Philips headquarters building in New Jersey, and then we have an additional group of properties for sale from our Bank of America joint venture. Let's flip to that.

Page 15, I think, is a very good example of how we've been able to generate or create immediate value for Gramercy shareholders. The deal we put into contract was $485 million, roughly 81% occupancy, an 8.5% cap rate. The cap rate quoted here is straight-lined. We used, in some of the earlier releases, both the straight line cap rate and the initial cap rate. To keep things apples-to-apples for this analysis, we're using straight line cap rates.

The closing, because we were able to sell off some of the properties, we were able to increase occupancy and increase the cap rate by selling off assets that had a lower occupancy and a lower NOI for us, or sold them at a price that resulted in a lower NOI. So today, what we've been able to create is exactly what Ben said in a couple of calls ago. What we're hoping to create was this core portfolio, $285 million, 98% occupied by Bank of America, 9.4% cap rate, significant value creation, and taking a larger portfolio and selling off the assets.

Let me add that not all of the assets have been sold. If you look below, this is where we are in that process. It's a $50 million to $60 million valuation. We've sold $9.6 million. We have another, roughly $30 million, that were under LOI or contract. Obviously, not all of those may close. But this is the type progress that we're making to get to a core portfolio that's exactly the type of core net lease portfolio that we'd like to own.

If you flip to 16, we have a couple of photos there, but also look at the map. You see the -- most of the assets are located in target markets, especially a nice concentration of assets both in Florida and in California, places that are growing, places that have good demographics, the sort of places you want to own assets long-term, as well as Phoenix. And so we're very happy with this core portfolio.

Page 17. This is a version of the slide you've seen before. I'll just touch on the fact that we have a term sheet with Northwestern Mutual. I believe it's a contract at this point -- I mean, I'm sorry, commitment from Northwestern Mutual. So we were buying these assets at an 8.3% cap rate, and we have a commitment from Northwestern Mutual for a $14.5 million loan. I'll come back to one of the reasons I think that's significant.

If you flip to page 18, you see this -- you get a feel for the quality of the assets. Again, these are good assets, long-term leased, good tenancy, and we're able to get returns on these types of assets. For those who live in Indianapolis, I recommend drive-bys, see the assets. I think you'll be very happy with it.

Page 19. Again, this is the industrial transaction we just announced. It's in Memphis. Again, if you live in the Memphis area, it's actually in Olive Branch, Mississippi, on the Mississippi side of Memphis. If you get a chance, drive by and see the facility. It's a terrific facility. We have a 10-year lease term. But we also have the ability to expand the building on to a 14-acre land parcel that we own. We own that -- in essence, it's 0 basis, so we hope that the tenant will expand. That would be a good thing for us. The tenant also has a kick-out right after 5 years, with a significant payment. But our hope is, it's a fast-growing retailer, and that if there's a need for expansion, we've got the land to expand. And in the meantime, we're getting an attractive cap rate on this acquisition.

So where does that bring us for Q1? These are the investments, 5 investments, approximately $51 million, a 7.5% cap rate. This includes Memphis, so there are 4 others that have closed or are in closing. There's a small one that might flip out of March. I don't think it will, but it might flip out of March. The pipeline down below. These are assets that we have in contract at a high cap rate and a long average lease term, and we're continuously putting out letters of intent. Let me just caution, obviously, even in both the pipeline, the LOIs, obviously, those are not closed. They may not close. But it gives you a feel for the pipeline that we're building, and what we're trying to do.

Page 21. This is an important point to step back and get out of the weeds, if you will, on the deal-by-deal and say, what's the overall marketplace look like? One of the things that Ben and I have noticed is sale leaseback activity has been actually fairly quiet relative to pre-crisis, pre-financial crisis or pre-2008. It was very active in '05, '06, '07. And it's been relatively quiet since then. There's still an enormous amount of real estate on corporate balance sheets. As the net lease industry continues to grow and access capital, we think that gives us, as an industry, the ability to be an efficient owner of those real estate assets for corporations. And I think there's some pent-up supply of sale leasebacks. I've got the sense, that's not a fact. But we just haven't seen a lot of activity and it would not surprise me if we see a significant pick up in activity.

I thought there was an excellent quote in Josh Barber's piece on realty income that analogized where the net lease industry is to the healthcare industry. You can read the quote there, the healthcare REIT industry, I should say, 10 years ago. If there is a significant offloading of corporate assets on the net lease REIT assets about to occur, that would be an analogous situation. It's anybody's judgment whether that will happen or not, but there's certainly a possibility of that.

Before we get to the G&A side, let me quickly get through our Gramercy asset management. This is our third party asset management business. On page 23, you get a feel for the basic metrics of this business. Gramercy has 94 employees today, with the wind down of the Finance business. Those are 12 employees in that business. So that -- we'll see a reduction in employee count because of that. This is a terrific group of people, but we've exited that business.

Gramercy Asset Management is, as you see, the bulk of the employees at Gramercy. I've been asked why does a net lease company need so many employees? And the answer is, well, a net lease company for the net lease side of the business doesn't, but we happen to be in a very profitable asset management business. We like this business, but it is -- you need employees. You need good employees to provide the kind of service that we do, to provide the kind of profitability that we do. So these are good people, but you see where the employees are located.

And I think the important point here is to think of our asset management contract as a profit center. So all of the expenses and employees related to that are dedicated to creating profits for the core net lease business. And you'll see later, a contribution analysis.

Page 24. This is -- the asset management business has a number of positives for our net lease business. We source Bank of America through it. We're looking in a couple of properties that were part of a Wells Fargo portfolio that was recently sold. Maybe nothing will come of that, but this is certainly deal flow that we have a very unique insight into, that I think is valuable.

Let's move along. Probably the biggest question we've -- or one of the biggest questions we've received since arriving is G&A. What Page 26 is, we've taken what the predisposition of the CDO business G&A was running at, run rate. If you take the third quarter 10-Q and kind of annualize it, you come up with a G&A that's in the mid-40s. And we used to get questions, how can the G&A of Gramercy be $45 million or $40 million when it's a pretty small company? It doesn't make any sense. And so what we've tried to do here is bridge where those numbers actually come from and what they are. And what you see is, if you -- as filed with the 10-K, because the CDO is now a discontinued operation, you take the cost that were run through the MG&A previously, you bridge those out and you get to the 10-K number of $25 million. So those CDO advances and CDO expenses were running through our MG&A, previously. They no longer run through as of December 31, 2012. Jon, please correct me if I'm saying anything wrong here.

Page 27. So now let's take 2012 MG&A as filed. How do we get to a core MG&A that is rightsized? There are savings in insurance and legal and accounting. Everything is up for bid this year, in terms of professional fees, et cetera. It's a much simpler company to run. If you go back and think of our balance sheet that we have in here, which is again not a pro forma but just a balance sheet to give a sense for what it looks like, and compare it to our other balance sheet, you'll see why there's the potential for such savings. Project Glacier was the strategic initiative and the cost associated with that. We're also going to save money on executive and senior level compensation.

And then I'm pulling out the asset management MG&A because, again, asset management is a separate profit center and the MG&A related to that should relate to the profit center. And so this core $13 million, in one way of thinking of it, is subsidized by the $5 million that's generated within our asset management business. So you could almost think of it as, it's $13 million but it's subsidized down to $8 million by the profitability.

The only other thing I would say here, this core MG&A number for 2013, this is the number we will get to. This is not a projection for the year. For instance, we did have the CDOs on our balance sheet -- on our income statement for the Q1, so there's a loss there. So it will take us 2013 to get down to this core number. We have to bid professional fees, which we're in the process of doing, and go through that whole process.

Page 28. The existing core MG&A that we will get to, roughly $13 million, that is the core MG&A that allows us to grow, allows us to invest $500 million in assets or greater. If there was nothing to buy, nothing to do, obviously, we could cut it back to even a little further. If somebody were to ask, why don't you do that now? Because then we have to run around and hire the same people to grow the business, and we think now is a very good time to grow the business. So we think we can get it to a core number that's manageable. If there's absolutely no growth in any way, shape or form, then it can be cut back further.

Let's talk about growth, going to the next slide. One of the goals is to grow our equity base. Page 30 is the stock price. I don't want to dwell on that.

Page 31. The common equity base, we've been able to grow the size of the common equity base, which means that G&A is spread over a larger denominator, which is good. We -- our strategy with that, is to do -- is to not do dilutive offerings, but to grow the common equity base where we can. And I think there -- that, that's been a nice trend.

Page 32 on the preferred stock. It's just kind of interesting, the preferred stock trades very well. I think it's -- since the preferred stock investors are really, in some ways, credit investors, as well as equity investors, maybe more credit investors than equity investors, I think it's a good signal for how the marketplace views the risk of the business plan that we've embarked upon. We have not turned on the preferred dividends as of yet, and yet the preferred is trading very well. I'll come back to the preferred dividends.

But you'll see that I think this is really a sign that the preferred marketplace believes that our business plan is doable and has not a lot of risk associated with it. There's always risk, of course, and there are a lot of things that have to happen for us to be successful. But it's a nice data point, I would say that.

Page 33 is extremely important. The net lease environment today is terrific for net lease companies. You'll see companies trade at favorable valuations, both from an FFO standpoint and NAV standpoint. I'll come back to that in a second. Down below is what I wanted to touch on. Net lease rate, REITs raised roughly $1 billion in common equity last year, roughly $1 billion in preferred equity. So far, this year, between Realty Income and Lexington, they've raised roughly $1 billion in common. So again, through the first quarter of this year, net lease REITs have raised as much equity as they did all of last year, so obviously, it's a favorable environment for net lease REITs. These are more seasoned companies, Realty Income is a company I admire greatly. So I don't mean to overstate it, but just to say that it is a good environment for net lease companies and for the established players, clearly it is, and a lot of equity is being raised at attractive valuations.

Page 34. We've attempted to estimate where Realty Income and National Retail Properties trade as -- on an implied cap rate. If you look at the top 10 tenants, again, this is our top 10 tenants as of the Q4 public filings. What you'll see is what I described as a variety of real estate quality, some better than others. They are obviously underwriting to 4-wall profit in the profitability of the operations within those properties. But that's a slightly different business than the office and industrial business. But in their businesses, they're executing very well, and you see very attractive implied cap rates for those businesses.

Page 35. There have been 2 major M&A transactions, a third one on the way. Realty Income purchased what had been a private REIT. It became a publicly traded REIT, and then was purchased by Realty Income at an attractive price. And then Cole Credit II, another private or non-traded REIT, was purchased by Spirit Finance. What that shows is there's a very active marketplace to buy net lease portfolios, at attractive prices, in size.

So if I were to summarize on 36. Well-managed, well-capitalized net lease companies trade at a nice premium to NAV, at a very attractive multiple to AFFO. And the book concept is important because as Gramercy is now no longer a mortgage REIT, equity REITs book is a funny concept for equity REITs. It's not a perfect concept. This is maybe a bad example because it's so small. But our book value on our Philips Electronics JV interest is $200,000, roughly. And that throws off $0.5 million of cash flow for loaning to corporate headquarters of Philips Electronics.

So book is not the same concept as you convert from a mortgage REIT to an equity REIT. We need to sort of wean people off the concept of book. We're happy to look at book. But as you see, as it relates to net lease equity REITs, it's not always an immediately transferable concept. And as of March 31, we'll no longer be a mortgage REIT, having disposed of the mortgage business that we were in.

A couple of the net lease companies are investment grade, another one's on the cusp. And I think Gramercy has the ability -- has the opportunity to be a best-in-class office/industrial net lease REIT.

Page 37. I don't want to go too far with this, but just -- I want to point out that being a public net lease company, I think, is a potentially valuable asset. There are a lot of private portfolios looking for liquidity. I was actually quite stunned by the chart that shows how much secondary equity market issuance there's been relative to IPO market. There's a lot of headwinds in the IPO market. That may be changing. It's certainly maybe changing as it relates to single-family rental companies.

But if you exclude those, as far as I know, there's not a deep queue [ph] . So what that means is, public companies have the ability to use their entity to buy portfolios. I would also just limit or dial back any expectation. I don't think we have a lot of opportunity in that area until we have common dividends being paid, because people don't want to contribute a cash-flowing entity for no cash flow. But that is a potentially valuable asset. I would not want to overlook that.

Moving right along, and I promise we're almost at the end. Streamline the business, simplify the story. You've heard this before. We've exited the mortgage finance business. We've disposed of the noncore assets, except the CDO equity, where, in my view, we have more upside, our downside is 0, and our upside is higher than that, obviously. We've focused the business on where we see opportunity, net lease office and industrial. We think we're very experienced in that, as experienced as anybody in doing that business. And that's where we're going to focus this business.

Page 40. To kind of bring full circle the fact that we're now an equity REIT, we'll be changing the name to Gramercy Property Trust. I like the name Gramercy. I think Gramercy Property Trust sounds like an equity REIT rather than a lender or a hedge fund, as Gramercy Capital Corp. We're going to change the ticker to GPT from GKK, and I think it's, again, to focus and streamline the business around the story of a pure-play equity REIT, focused on the net lease business.

I hope you like that new logo. We didn't spend a lot of money doing it, but we do think we came up with a good logo. And we didn't spend a lot of money rebranding with a new name. So we kept it simple, new logo, new name. We're very excited about it.

Let's get to the heart of the matter on pages 42, on. So if you look at Page 42, what you'll see is the business dashboard or template. The way we will think about our business for 2013 is revenues by segment, net lease segment, asset management. We've given you the asset management projection in an earlier slide. The CDO business will be a slight loss for 2013.

That will all be in Q1. I'm sure everybody would like to see this thing filled in, but at this point, we're not giving projections. And it's, obviously, a quarter-by-quarter business plan. I would say we are ahead of plan in terms of where we were when we came into the company. But as you think about Gramercy Property Trust, this, in my view, is the way to look at the business revenue and expenses by business segment, with Gramercy Finance falling out eventually. It will still be in '13 Q1, slight loss in the first quarter, asset management will be a positive contributor as you saw earlier. And then the goal is get the net lease business revenues cranked up and the expenses cranked down. And that's what we're going to monitor quarter-by-quarter.

I would just remind everybody, this is our 2012 year end earnings call, and our projection of our business plan or our business plan update. It's not our Q1 2013 earnings call, so that's why we're not going through those types of numbers. But that's where we are.

Access to capital. First of all, mortgage financing. We are able to get mortgage financing. We're able to get mortgage financing from the finest institutions in the country. Northwestern Mutual is as well-regarded a financial institution as there is. A concern we had coming in was, given all of the history of Gramercy, is the mortgage market available? With both Bank of America portfolio and our commitment on Indi, we believe we've demonstrated access to mortgage financing at attractive rates from the, again, the finest institutions, lending institutions in the country.

The second goal that we're working on immediately is to put in place a line of credit. We hope to have that in place by the end of Q2. We think $100 million is about the right size, and we're working on that. It's not something we need right away. We have cash on the balance sheet and I'll come back to that comment in a moment. And the question on everybody's minds are probably the preferred true-up in dividend. When does that occur and when does the common dividend occur?

Those are quarter-by-quarter decisions. As of now, we will continue to accrue the preferred. We will revisit that each quarter. That is, obviously, a board decision. We are making tremendous progress at building the sustainable cash flow that we will need to pay those dividends. I've said it before, I'll say it again, you pay dividends out of recurring cash flow not out of cash. And our goal, very simply put, is to create a company that is -- consists of growing, durable dividends, maybe like a realty income. To do that, we, obviously, have to true up the preferred and pay dividends on that at some point. It is not now. Again, this is also not the Q1 2013 earnings call. This is the year end 2012 earnings call. So we will address that quarter-by-quarter as we go, both on the preferred and on the common.

And so while I would love to give you a better answer than that, I'm sure you would like a better answer or a more granular answer, that's the correct answer for where we are right now, as we lay out the updated business plan.

One last thing, I said I'd come back to the page where we lay out our business or real estate portfolio. Sorry while I rattle the papers. Page 14 is the Gramercy portfolio that we expect to have as of March 31, that's $285 million of real estate at a 7% cap rate. In addition to that, and obviously, the NOI is there, you can apply your own cap rate, but that's the core real estate as of March 31. In addition to that, we expect to have cash of approximately $104 million. We expect to have borrowing capacity of roughly $43 million. We would also -- we also have our CDO receivables of $15 million. Those are not available for immediate investment, but they will become available as those assets resolve themselves, the majority of which we expect within the first 6 months. So we have cash of $104 million, borrowing capacity of $42.5 million, CDO receivables of $15 million and then we have another roughly $25 million of asset sales. To total that all up for you, that's capacity or dry powder of approximately $186 million, $187 million, depending on how you round it.

If you reserve the preferred accrual of $32 million against that, that's net capacity or dry powder of $154 million. Assuming 55% leverage on that $154 million, we believe that we can generate new net lease NOI of between $26 million and $29 million, somewhere in that range, which would add to the existing net lease NOI as of March 31, of roughly $20 million. So as we start to think about what's the capacity of Gramercy to generate NOI, between the existing real estate we've invested in, plus our dry powder, that's a range of NOI that we believe we can generate. Obviously, that is subject to all sorts of things happening. There's no guarantee at all that we can do that, but that's our current range.

Against that NOI, and whatever cap rate one would apply to it, at that point, we would have roughly $347 million of debt and $88 million of preferred. Remember, included in the net capacity number is a true-up of the accrual. So only $88 million of preferred would be outstanding at that point. We also have our asset management business, that's not valued in the net lease business. That asset management business has the Garrison contract, which is valuable, the KBS contract that's valuable. And we're also actually doing a little bit of work right now for Oaktree on the portfolio they purchased. But there's significant value in those Garrison and KBS contracts.

So we don't publish an NAV number. We don't publish or project forward AFFO. As we make more progress with the business model quarter-by-quarter, I think you'll see more and more in terms of things that help translate into something like that. Again, this is our, hard to believe it's March 19, our year end 2012 earnings call, not our Q1 2013. But I hope that the capacity or dry powder discussion, along with where we expect our real estate in Q1, gives people a little better feel.

Let me just end by saying, before I turn it over to Jon, I'm sure everyone is tired of me talking, but we had a lot to get through. We feel very good about where our business plan is. It's ahead of where we thought it would be. And we are working extremely hard to continue to push all these balls forward. It's an entire team effort and we're very excited about that.

With that, let me turn it over to Jon, because I'm sure that's enough from me for now.

Jon W. Clark

Thanks, Gordon. I'd like just to take a few minutes to briefly walk through our financial statements, included in our 10-K filing yesterday and in our press release filed this morning. As Gordon described earlier, we aspire to have financial statements that are easy to follow and reflect our new business. These financials that we filed yesterday are not it. These financials are just beginning to reflect the company's exit from the commercial real estate finance business, which we also announced this morning.

Our first quarter 2013 financial statements will fully reflect the disposal of the company's Gramercy Finance segment. First, let's start with the income statement. The company's revenues are now reflecting only the rental revenues generated from our focus on deploying capital into income-producing net lease real estate and fee revenue generated from our asset management business.

Rental income is relatively small at this point, as the only revenue that appears is from the Indianapolis industrial portfolio, which was acquired in November 2012. You'll see this figure grow over time, however, with Q1 2013 acquisition of the Memphis industrial, as well as the growth of the investment pipeline that Gordon spoke about earlier.

We also earned fee revenue for managing real estate assets for third parties, through our Gramercy Asset Management segment. The most substantive and important part of our asset management business today is our asset management arrangement with KBS, which positively contributes to cash flow. We manage approximately $1.2 billion of real estate for KBS, which is primarily comprised of 387 bank branches and 136 office buildings. The managed portfolio aggregates approximately 12.3 million rentable square feet. The building count and portfolio size of the KBS portfolio has declined from 787 properties and 20.1 million rentable square feet as of September 30, 2012. However, a large portion of the decline was the acquisition of the Bank of America portfolio from KBS by our joint venture.

We earn management fees, administrative fees and asset management fees for the KBS portfolio, which are recorded on our operating statement as revenue. The management fees and administrative fees are variable, and decline as the overall portfolio declines. The direct costs related to generating asset -- or management fees and administrative fees are also primarily variable costs.

The asset management fee with KBS is a fixed fee arrangement, whereby we receive a fee of $9 million per year. The costs related to generating the asset management fees are generally fixed or not as scalable as the management and administrative costs are. The asset management fee for the KBS portfolio was $12 million annually until December 2012, when it was reduced to $9 million annually after the purchase of the Bank of America portfolio by our joint venture. We are also entitled to fees from our joint venture and expect that these fees will partially offset the decline in the asset management fees received from the KBS portfolio.

We expect our joint venture will contribute approximately $1 million of base asset management fees annually, plus we have the opportunity to earn an incentive fee from the joint venture. The asset management agreement with KBS also includes an incentive-based fee, subject to a minimum of $3.5 million and a maximum fee of $12 million. The incentive fee for the KBS portfolio is based on the portfolio equity value exceeding a threshold of $375 million with certain adjustments. While we're currently accruing the minimum $3.5 million fee, we are not yet accruing for any incentive fees from the joint venture.

Property operating costs include both the direct costs related to our asset management business, as well as costs related to our own portfolio. However, substantially all of the property operating costs as of December 31 are related to the asset management business. Only about $300,000 is related to the owned portfolio. Substantially, all of the costs related to our owned portfolio are eligible for reimbursement under the tenant leases.

For the year, management, general and administrative expenses was $25.4 million. However, this includes a few onetime items such as $1.2 million of extra payroll due to satisfaction of employment contracts for former executives. Additionally, MG&A includes $2.6 million of costs related to the conclusion of the special committee process in the second quarter of 2012. Excluding those other items, MG&A for 2012 would have been $21.6 million.

What's not reflected in MG&A just yet is savings such as lower insurance costs, professional fees and other overhead that we expect will decline with our go-forward business.

Our joint ventures, which includes the joint venture from -- that owns the Bank of America portfolio, as well as the 25% interest we have in the Philips building, recorded a loss of $2.9 million for the year ended December 31. Of this loss, approximately $2.6 million is related to our share of the acquisition costs expensed by the joint venture, as required under Generally Accepted Accounting Principles. Also included in the net loss is $669,000 of depreciation and amortization, which when added back, positively adds to FFO.

Finally, that brings us to discontinued operations. In the aggregate, the charge for discontinued operations for the year ended December 31, 2012, was $169.2 million or $3.25 per common share. Discontinued operations, as of December 31, reflects the beginning of the exit from the commercial mortgage finance business, which operated under the name Gramercy Finance.

During that process, in the fourth quarter, we determined that we no longer had the ability and intent to hold the assets of Gramercy Finance business, and accordingly, we mark-to-market all of the assets of the segment and took an accounting charge for any asset which had a fair value below its carrying value. For each period presented, the balance in discontinued operations reflects all of the revenue of Gramercy Finance, all of the expenses, including interest and direct MG&A costs, and in 2012, a charge for unrealized losses on assets held in the Gramercy Finance business as of year-end.

In addition, in January 2013, we also exited from certain legacy real estate assets, which were encumbered by mortgage debt within our CDOs. This included a portfolio of 41 bank branches and office buildings that we retained after the settlement agreement with KBS, that transferred the majority of the properties we owned at our Gramercy Realty division previously, as well as 2 REOs for the equity was held outside of our CDOs but was considered part of the legacy Gramercy Finance business.

These 2 REOs were the Whiteface Lodge in Lake Placid and Makalei Land in Hawaii. There was little to no equity value in these legacy real estate assets and the property has collectively operated at a net loss. So subsequent to year end, we contributed these assets to our CDOs in exchange for full satisfaction of the mortgage debt owed to the CDOs.

Let's just take a quick look at the December 31 balance sheet. This balance sheet presentation is substantially different than what you've seen in the prior periods. First, note that the assets and liabilities of Gramercy Finance are presented on the financial statements in only 2 lines: one for assets held for sale and one for liabilities held for sale. You'll also note that the carrying value of the liability is in excess of the carrying value of the assets by approximately $427 million.

On the company's first quarter 2013 financial statements, which will fully reflect the company's exit from the commercial finance business, you will see this difference reverse. And accordingly, there will be a gain from discontinued operations appearing on these financial statements in the first quarter. At that point, you will also see our shareholders' equity balance turn positive, once the full accounting of the exit from the commercial finance business is reflected.

The remainder of the balance sheet reflects the components of the company's new business, which Gordon described earlier. I would just like to note that the real estate investments of a net balance of $23.1 million are comprised solely of the Indianapolis industrial portfolio acquired in November 2012, as are the acquired lease assets of $4.3 million and the below-market lease liabilities of $458,000.

Finally, I'd just point to the cash balance that we had at year end, $105.4 million. And today, after taking into account the settlement of the CDOs, we have about $118 million of cash. Gordon?

Gordon F. DuGan

Thanks, Jon. Well, everyone, I appreciate the time that we've asked of you this afternoon. Thanks for hanging in there with us. If anyone still has the energy, we're happy to answer questions and I turn it over to the moderator for our Q&A section.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from Kevin Tracey of Oberon Asset Management.

Kevin Tracey

I guess first, I just wanted to ask, of this $50 million to $60 million you're targeting on receiving by selling the non-core assets of the Bank of America portfolio, what do you guys plan to do with that cash. Do you plan to pay off part of the $200 million in debt you took out? Or will that be just half that be distributed back for you guys to invest?

Gordon F. DuGan

Hi Kevin, it's Gordon. I'll let Ben answer that question.

Benjamin P. Harris

The reason we call it the non-core portfolio is we actually, at acquisition, broke the portfolio into 2 parts. The financing only applies to the core portfolio and we own the, what we call, the value-add portfolio unlevered. We did that for 2 reasons: one, to give us the most flexibility with respect to selling the assets, and two, so that we could distribute the capital back and deploy it into the types of assets that we want to own long term.

Gordon F. DuGan

Yes. And you'll see in our presentation, we're a little schizophrenic. We say $50 million to $60 million, that's the JV's interest -- that's the portfolio within the JV. Our interest is the $25 million to $30 million that you sometimes see. So we will take our portion out of the JV and invest it into more net lease real estate.

Kevin Tracey

Okay, okay. And then secondly, I was curious to ask, I noticed that the financing for the Bank of America is with floating rate debt. And I was just hoping you could talk about just kind of generally, are you -- in these leases, are there rent escalators or are they indexed to inflation, or how are you looking to protect yourself in an inflationary environment?

Benjamin P. Harris

Yes. The BofA transaction was a floating-rate transaction with a swap. The reason to structure it as a floating-rate is there may be a potential to restructure and extend that BofA lease. And so we wanted to have the most flexibility with respect to our financing, to be able to accommodate that opportunity if it does come about. If we're successful in doing that, we would go ahead and put long-term fixed rate financing on it. In general, we are acquiring leases with some sort of escalation, so in some cases, it's an escalation linked to CPI, in others, it's a fixed escalation. I think there is -- net lease assets and real estate assets, in general, are yield assets, for the most part, and there is no perfect way to hedge. We look very carefully at managing our interest rate exposure on the liability side. I would say one other piece, we touched a little bit on the types of markets that we want to focus on going forward. One of the big drivers that's distinguishing markets that we want to be in and own assets in is markets where the underlying economy of that specific region or that specific city is tied in -- closely tied into the global economy. We think those types of markets will have closer linkages with overall inflation, if and when we experience it. And if you think about real estate as an inflation hedge, it's a little bit inaccurate to say that real estate is an inflation hedge across-the-board, because there are a lot of parts of this country that have experienced very dramatic deflation. It's only certain places that we believe real estate will actually play that role, and where you will see rent growth if we do go into an inflationary environment. And we're really looking to buy assets that have long-term exposure to that potential rent inflation.

Gordon F. DuGan

Yes, and last thing on BofA. If we do -- our hope is to be able to restructure it. I wouldn't put a very high handicap on that. But we -- because of the financing we have in place, we have the ability to potentially, if we are able to accomplish the lease restructure, we've kept the flexibility to then put in place a long-term fixed rate financing on a newly restructured deal. We also have the ability, at some point, to buy out our partner. And they have a shorter time frame than we do, so that's kind of a built in deal flow, the way we think about it. On to the next.

Kevin Tracey

Okay, great. And if I could, just very quickly. Is it fair to -- I understand the uncertainty with regards to the ultimate recovery of the equity interest you have in the CDO, but is it the expectation that, going forward, you will not pass the over-collateralization test on a quarterly basis and won't receive distributions, or is there the potential that you could also receive cash flow from that?

Gordon F. DuGan

Yes, at some point, last year, I think we stated that -- the distribution test is different than the ultimate waterfall test. The distribution test is done, for good, on all of those CDOs and we will not see equity cash flows. I believe that's a fair statement Jon, there's no -- have we seen any model that would turn on cash flow?

Jon W. Clark

Not for the true equity. The over-collateralization test still applies, though. Right now, there is no cash flow going to the subordinate bond, neither the J or the K. But it's those J and the K, the subordinate bond notes, that at some point very far out into the future, towards the end of the CDO's expected life, where over-collateralization tests may be met and will kick in cash flow then.

Gordon F. DuGan

Yes, and that was the reference to our base model number. Again, on the downside, that number goes to 0 in a blink of an eye. This is highly levered. It took a loan collateral pool in '05 and '06, that's very highly levered. Loans made in '05 were better than '06, '06, better than '07, '07 is completely done forever. '06 and '05, there's a chance to get some money out of those, but again, it's very highly levered. The only -- so the downside is, it doesn't take much for that number to be 0 because it's so levered. On the upside, we are in a world of escalating asset values in commercial real estate, and so the ultimate recovery is very hard to predict but could surprise on the upside.

Jon W. Clark

I'd just make one more comment. After our exit from the commercial finance business via selling the collateral management contracts, what we've retained is essentially nothing more than a fixed income investment. We're going to book a yield. We're going to be constantly reevaluating the future cash flows and adjusting that yield.

Gordon F. DuGan

And that's, that $25 million or so number. So it's just -- we still own the J and K bonds, we really don't have anything to do with the CDOs anymore. That was a business that is now officially sold, but we do retain some bonds that may have value. It may have substantial value, it may not. It's -- unfortunately, it's quite speculative, but man, I love owning something like that, that has that much upside.

Operator

Our next question is from Jonathan Feldman of Nomura Securities.

Jonathan Feldman - Nomura Securities Co. Ltd., Research Division

Just a couple of questions from this end. First is, I know you guys have said now is not the point in time to provide guidance, but if we were trying to construct our own models just around the AFFO, conceptually should we, in terms of modeling this out, take our expectations of NOI less G&A, plus CapEx and depreciation to come up with an AFFO number, conceptually?

Gordon F. DuGan

Yes, there's not a lot of CapEx in this. The NOI -- yes, I mean you know what the definition of FFO is and how to model it. What we've done with that template, it's our internal sort of dashboard or template, I believe it's the second to the last page. I think that's a good way to think about different ways to model where and when we get to with an AFFO. There's net lease revenue, we've got -- we gave in my final statements, assuming the $20 million of net lease NOI as of 3/31. That's a go-forward annualized number, obviously. That's not a quarterly number. And that's not where we'll be for the first quarter, but that's a go forward annualized number. And then a range, given our dry powder, of what additional net lease NOI we believe we'll be able to generate is. And then we have the asset management business that provides an additional amount of profitability. And then you're going to have to make some assumptions on G&A. We've done that. I think we've helped give some indications of where we think it can go, and I think it's up to the individual to come up with their own model and their own sense of that.

Jonathan Feldman - Nomura Securities Co. Ltd., Research Division

And then just one quick follow-up or 2, on related -- on that note. Depreciation, how would you think about that, that would be added back?

Gordon F. DuGan

Yes. I mean those NOI numbers are pre-depreciation.

Jonathan Feldman - Nomura Securities Co. Ltd., Research Division

Okay. Those are pre-depreciation. And then just in terms of the KBS -- or the asset management profitability, you talked about the number of the asset management fee run rating -- or not run rating, but being lower over time as KBS sells assets. Is that the right way to think about it, or how would you think about it?

Gordon F. DuGan

No, it's funny. That's actually -- one would believe that -- well, let me say it another way. That is not how the contract works. We get $9 million a year. We get a participation in the ultimate upside of that portfolio. That participation is due at the end of June of 2014. We get a minimum $3.5 million number. The way things have been going, we have -- we were getting more optimistic about that back end participation, I think it's limited to $14 million. There's a cap on it, Jon, does that ring a bell?

Jon W. Clark

Yes, I thought it was -- isn't it $12 million?

Gordon F. DuGan

Or $12 million, I'm sorry. The limitation is $12 million. So it's a $9 million a year contract. As assets run off, hopefully, we can manage expenses and increase profitability, and we have a participation on the back end. So I would view that as a fairly steady earner of profitability, but not long term. It's not a forever contract. It's -- by the terms of it, it's a 3-year contract and if they want to terminate it sooner, they have to pay us a very substantial termination fee.

Benjamin P. Harris

We've also been successful in capturing asset management contracts on portfolios that have been sold. Gordon mentioned earlier, we're the asset manager on the joint venture that we created to buy the Bank of America portfolio and we also have a...

Gordon F. DuGan

Yes, where we have a promoted interest, that's going to be well in the money.

Benjamin P. Harris

And we're also the asset manager on that most recent Wells Fargo portfolio that was sold to Oaktree and an operating partner. And our hope...

Gordon F. DuGan

That's quite short term, but...

Benjamin P. Harris

Our hope is to capture incremental business on those asset sales and...

Gordon F. DuGan

And have looks at buying stuff. That's not the point of your question, but we think we get both benefits from it.

Jon W. Clark

So, Jonathan, the fee stream that we get, there's 3 components. There's the asset management fee, which Gordon and Ben just spoked about, that's the fixed component. But then, there's also a property management fee and an administrative fee. And that's the variable component, but that also is, primarily, just a recovery of costs. What people look at is, on our financial statements, is they see revenues that's far in excess of the $9 million. And the difference is that property management fee and the administrative fee.

Operator

Our next question is from Dan Donlan of Ladenburg Thalmann.

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

.

Just real quick, going back to the cash number. Jon gave like a $118 million number, you have a $143 million number I think on Page 6 of the presentation. Is the delta there just simply the Memphis acquisition?

Gordon F. DuGan

Yes, there have been some acquisitions. The better number to use -- yes, and sale of CDO bonds.

Benjamin P. Harris

The number, just so -- the number that Jon gave is the 12/31 number and the number on Page 6 is the 3/31 projected number.

Gordon F. DuGan

Yes, the number I would -- no -- yes, that's not projected for -- that was a...

Benjamin P. Harris

Estimated.

Gordon F. DuGan

That was as of about a month ago in time. So here's the number I think people should use. Jon's number trued up through 3/31, meaning we're closing deals as we speak. So he's at $118 million. That number will be down to $104 million roughly, that's roughly. That $104 million is the -- includes the acquisition capacity for the $20 million of net lease NOI that we're showing as of 3/31. So the way we, again, we think about our dry powder, is at 3/31 we're at $104 million of cash, $42.5 million of borrowing capacity, $15 million of CDO advances/receivables and $25 million of asset sales for a total of $186 million. Then I would -- you can deduct the preferred here, or you can deduct it later, but $32 million of accrued preferred would leave us with what I'm calling net capacity or dry powder of $154 million. And that, using 55% leverage on acquisition, will generate, again, $26 million to $29 million. We believe, we hope, our goal is to generate $26 million to $29 million of new net lease NOI.

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

.

In addition to the $20 million you already have?

Gordon F. DuGan

In addition to the $20 million we already have.

Benjamin P. Harris

And just one additional clarification that -- when we're talking about sort of borrowing capacity, the $40 million, what was the number?

Gordon F. DuGan

$42.5 million.

Benjamin P. Harris

The $42.5 million, that's...

Gordon F. DuGan

[indiscernible] $42.5 million or $43 million.

Benjamin P. Harris

That's basically assets that we've acquired unencumbered. And that would be the amount of mortgage that we could take out against those properties, or if we were to pledge them into a credit facility, the amount of availability that we would expect to be able to get.

Gordon F. DuGan

Yes, and it's a lower number than what we could get, but it's in line with our sort of lower leverage strategy. So it's not a -- it's like a low-50s leverage ratio.

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

.

Do you guys want to keep it at low-50s on kind of a going forward basis?

Gordon F. DuGan

Yes, I think so. I mean, I think it depends on the quality of the asset and the quality of the tenancy. But that -- we want keep the leverage around 1:1.

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

Okay. And not to beat this up a little, but on the asset management or property management revenues, I think I understood what you guys were talking about, but -- so that number that you're guiding to, that's kind of what's existing in place right now and what you think you can achieve, that's not adding anything?

Gordon F. DuGan

That's contracted -- that's all contracted revenue. And the employees it takes to run that business, 100% contracted.

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

.

Right. And you're also flowing through the property expenses into that, so therefore, your top line revenue, there's no more property expenses to then back out of that from -- since they are net lease, right?

Gordon F. DuGan

That's right. There's minimal other property expenses. And that NOI number, the NOI numbers on the net lease side we're giving you are post any property expenses, but they're minimal.

Daniel P. Donlan - Ladenburg Thalmann & Co. Inc., Research Division

Okay, okay. And then the G&A of $13 million, obviously, it's going to be higher in the first quarter. Should we then think about it kind of declining from there on a quarter-over-quarter basis, as you guys continue to trim and...

Gordon F. DuGan

Yes.

Operator

We have no further questions at this time. I will now turn the call back over to Mr. DuGan.

Gordon F. DuGan

Well, thank you all. It's been a 1 hour and 18-minute business update and earnings call. Obviously, we're in the process of a very exciting transformation, taking Gramercy Capital to Gramercy Property Trust. We thank all of our investors for their faith and trust in us. I promise you, we are working as hard as we possibly can to make this happen and to make it a very successful transformation, and thank you all, and we promise next time, it will be a little shorter. Thanks.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.

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