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Executives

Joel Bonder - General Counsel

Doug Donatelli - Chairman and Chief Executive Officer

Barry Bass - Chief Financial Officer

Skip Dawson - Chief Operating Officer

Analysts

Paul Adornato - BMO Capital Markets

Brendan Maiorana - Wells Fargo Securities

Jordan Sadler - KeyBanc Capital Markets

Dan Donlan - Janney Montgomery Scott

John Guinee - Stifel Nicolaus

Dave Rodgers - RBC Capital Markets

Bill Crow - Raymond James

Christ Lucas - Robert W. Baird

Craig Mailman - KeyBanc Capital Markets

First Potomac Realty Trust (FPO) Q2 2009 Earnings Call July 30, 2009 9:00 AM ET

Operator

Good day and welcome to the First Potomac Realty Trust second quarter 2009 Earnings Call. At this time, all participants have been placed in a listen-only mode. The floor will be opened for questions following the presentation.

It is now my pleasure to turn the call over to Joel Bonder, the company’s General Counsel. Please go ahead, sir.

Joel Bonder

Good morning. Welcome to First Potomac Realty Trust second quarter 2009 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 second quarter operating results and portfolio performance on our website. Many of you have signed up to receive this information automatically by e-mail. If you did not receive it, please contact Brad Cohen of ICR at 203-682-8211.

During this call, we will discuss our anticipated operating results and future events, including our anticipated earnings, AFFO, dividends, and our ability to identify additional acquisition and disposition 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 2008 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

Thank you, Joel. Good morning, everyone and thank you for joining us. First, I’ll review the highlights of our second quarter of 2009 and I’ll discuss our markets and overall outlook. Skip will then talk about operations, and Barry will provide some detail about our financials.

The second quarter was marked by progress on leasing operations and our capital position. During the quarter, we continue to focus on our priorities of leasing both new and renewal, cost controls, accounts receivable, and maintaining our financial flexibility.

In terms of leasing, we signed 100 leases for over a million square feet in the first half of the year. During the quarter, we signed 100,000 square feet of new leases with a solid increase in rental rates. We also signed 288,000 square feet of renewal leases, retention rate of 88% in the quarter.

Net absorption was flat for the quarter, which is better than the market which saw negative net absorption for the first half of the year. Our capital costs for both new and renewal tenants was down substantially during the quarter. We have one tenant to occupy 54,000 square feet move out in February. So we’ve already re-leased our space and the new tenants have already taken occupancy, but the temporary vacancy did impact our second quarter results.

We continue to benefit from our leasing efforts last year when we proactively signed leases to get ahead of upcoming expirations. For the next four quarters, we have only between 1.5 and 3.5% of our annualized base rent expiring each quarter leaving us with a manageable exposure to lease rolls in the near medium term.

The new leases we signed up the past year and a half have helped to mitigate the challenging environment. The market is very competitive as tenants are shopping around more and taking longer to make decisions. However, we’re in a strong position relative to the competition. Our properties are high quality, well located and are lower cost alternatives to multi-storey office properties. That makes our property type particularly compelling and resilient in this economic environment.

Additionally, just as landlords, we're analyzing tenants; tenants are looking at the financial stability of landlords. We have a solid balance sheet and strong operating history, which is type of the strong platform that tenants are seeking in this environment. Because of the efforts of our team, most of our properties are doing well in this environment and are outperforming the market in net absorption, leasing and rental rates.

Our Same-Property NOI in Northern Virginia and Southern Virginia were up nicely in the quarter. Our overall NOI was flat because of the poor performance of an isolated few properties in our Baltimore portfolio, not a key market for us, but a source of a number of tenants who are struggling in the current economic climate. This shows that while we made progress on leasing and cost fronts, our tenants are not immune to the economic headwinds.

During the quarter, we increased our reverse for tenant defaults by $983,000 bringing our year-to-date reserve to 1.4 million. As we previously noted, we expect to see pressure on this line item during 2009 and it did accelerate in fashion that we would have hoped. Historically, we've experienced credit losses of about 0.5% of our revenue. The $1.4 million reserve is more than 2% of our first half revenues. While we hope that we’ve seen worse of our tenant defaults and are working closely with tenants to get them back to current, as the economy continues to struggle, this will continue to be a challenge for us.

Overall, we have a solid tenant base anchored by the U.S. government and related companies. Most of the challenge tenants are concentrated in our Baltimore sub markets. We have over 600 tenants with no single tenant other than the U.S. government accounting for more than 4% of our revenue, which insulates us from any one major tenant or industry impacting our overall portfolio.

We remain confident in our market mix with First Potomac’s positioning in the greater Washington D.C. area. While our markets have been challenged along with the rest of the country, the D.C. region remains more stable than most other regions in the country. In fact, the recent CNBC poll ranks Virginia as the best state in the country to do business in. Government expansion associated with the stimulus measures will have a positive impact on our core market, but we don’t believe we'll see the impact on this spending until 2010.

Turning to our balance sheet and liquidity, we continue to de-lever in three key ways during the quarter. First, we sold stock; second, we repurchased and retired additional convertible debt, and third, we were relieved of a lease guarantee at our RiversPark joint venture, which allows us to deconsolidate RiversPark II. While these actions will reduce our per share FFO, it put us in a stronger position going forward.

During the second quarter and in early July, we sold common shares to our controlled equity offering program for net proceeds of $8.7 million at a weighted average price of $10.44 a share. We used the proceeds to retire a portion of our exchangeable senior notes at a weighted average discount of 20% and to pay down a portion of the outstanding balance on our unsecured credit facility. We don’t have any meaningful maturities until 2011, and as we previously stated, we’re already exploring our options of making progress on refinancing this debt.

As Barry will discuss later in the call, we narrowed our guidance for the balance of the year due to our lowered expectation for NOI from our Baltimore properties and higher non-cash G&A expenses.

I just want to note that our non-cash G&A charge results from accelerated expensing of performance vesting share grants issued earlier this year. The expense level is a result from a complicated Monte Carlo simulation calculation and we don’t think they reflect the true cost of these grants as a company. However, we’ll take the expense over the next few quarters.

G&A overall is very much under control. Cash G&A is less than 7% of our revenues. When we went public, our goal is to get G&A below 9% of revenues, so we believe we're operating the company efficiently. Non-cash G&A, however, now represents about 25% of our overall G&A expense. We will work over the next few quarters to bring this non-cash number down.

In summary, we’re confident of our strategic direction and our well-positioned assets in attractive markets. We have a compelling asset class that have shown resiliency through market cycles. As a lower cost alternatives to multi-storey office space, the flex space has historically been less impacted by a difficult economy, and we’re seeing this now, especially in our key markets.

The State of Virginia and Metro Washington D.C. are among the strongest markets in the country and they contribute more than 95% of our rental income. Our Baltimore properties are more challenged and while we’re focused on improving the results there, they are non-core. Our operations outside of Baltimore are performing well, and we remain keenly focused on our aggressive leasing efforts, controlling our costs, monitoring our struggling tenants, and improving our financial flexibility to help us navigate this cycle.

I’ll now turn the call over to Skip Dawson, our Chief Operating Officer. Skip?

Skip Dawson

Thanks, Doug. We continue with our active leasing agenda in the second quarter and have generally maintained our occupancy levels since the beginning of the year. We have also increased our focus on capital costs associated with our leasing and have successfully reduced our capital costs during the second quarter.

At the end of the second quarter, our consolidated portfolio was 87% leased and 86.5% occupied, which is in line with our guidance for the year. During the quarter, we executed 51 new and renewal transactions filling 395,000 square feet.

We completed 15 new leases totaling 108,000 square feet. Some of the notable new leases in the quarter were in our Southern Virginia region, including 45,000 square feet at 1400 Cavalier Boulevard, and 22,000 square feet at Greenbrier Business Center.

The new leases represented an 8% increase in base rent on a cash basis and a 14% increase on a GAAP basis. As perspective tenants are shopping around more for deals, we have given minor concessions on new leases, but even in this environment we have still realized increase in rent. What is interesting in this quarter is once you get past the two larger leases, the balance of new leasing averaged about 3,000 square feet per lease. Even during these tough times, we’re still seeing rental rate increases on smaller suites.

Additionally, as we expected and communicated last quarter, our average capital cost per square foot was down to $10.19 compared to more than $26 in the first quarter, and we seem to be tracking down toward the cost we experienced in 2008, which was around $16 per square foot. In terms of renewal activity, we renewed 288,000 square feet in the quarter on 36 transactions. These include 65,000 square feet at Norfolk Commerce Park, 21,000 square feet at Reston Business Campus, and 20,000 square feet at 1400 Cavalier Boulevard. The renewal represented a solid 88% retention rate as a result of our efforts during the year to reach out to tenants and proactively work on their current leasing needs. We did give up our rental rate on these renewals this quarter with base rents down 4% on a cash basis and basically flat on the GAAP basis. Looking at the first six months, we’re down 1% on the cash basis, but up 8% on the GAAP basis.

Additionally, our average capital cost per the square foot was down to $1.78 from $5.75 in the previous quarter. As we move to the balance of the year, we are projecting that our capital cost renewals will be closer to $3 per square foot range that we experienced in 2008.

As we discussed last quarter, we have taken care of our largest lease expirations in 2009 and 2010. But because of this, we do anticipate that our retention rate will be lower as the year progresses, since we have pulled forward some renewals and future expirations.

Now let me briefly touch on the status of tenant build-outs we have underway. During the quarter, we delivered approximately 240,000 square feet of tenant build-outs. This included 54,000 square feet of development and redevelopment, with the balance on existing end service space. At the end of the second quarter, we have roughly 95,000 square feet of tenant build-outs scheduled to deliver in the third quarter of this year. These deliveries should help migrate the challenges that we could face as we move to the second half of the year.

From a regional perspective, Northern and Southern Virginia markets, which represents 34% and 45% respectively of our portfolio by square footage, are more active than our Maryland markets. Leasing traffic is slower compared to last year. There has been some improvements especially in the Virginia markets. While many prospective tenants seem to be taking more time to make decisions, there are still tenants out there seeking space. We still believe that being a public company in this environment gives us the competitive advantage over private owners in our markets.

With that, I’d like to turn this call over to Barry Bass, our Chief Financial Officer.

Barry Bass

Thank you, Skip. Good morning, everyone. Our FFO for the quarter was $11.6 million or $0.42 per diluted share compared to $11.8 million or $0.47 per diluted share in the second quarter of 2008. Our results included $0.05 per share of gains realized from repurchasing $9 million of our exchangeable notes at an average 20% discount. Excluding these gains, our FFO was $0.37 per share compared to $0.41 in the second quarter of 2008. Our AFFO for the quarter was $0.19 per share compared to $0.27 last year.

Our Same-Property NOI was essentially flat on a cash basis and declined less than 1% on a GAAP basis. As expected, based on when leases went into effect, our Same-Property NOI growth is moderating as the year progresses. Broken down regionally, our Southern Virginia region’s Same-Property NOI was up 8% for the quarter. Northern Virginia was up 5% for the quarter, and our Maryland region was down almost 15%, primarily as a result of taking significant reserves at some of our Baltimore area assets.

Our reserves for the overall portfolio came in at $980,000 for the quarter. As we’ve mentioned previously, we anticipated pressure on this line item during 2009 as the economic downturn continues. Reducing our accounts receivable risk and pursuing delinquencies is a top focus for us. Even with this increase in reserves, we anticipate that our bad debt will be less than 3% of our overall revenue for the year. As appropriate, we’re working with tenants to restructure their leases and mitigate our exposure.

As mentioned last quarter, in March we began using joint venture accounting for our RiversPark II asset in Columbia, Maryland, after we renewed a major tenant and thereby eliminated our guarantee associated with the renewal of that lease. As a result, approximately $600,000 of revenue and $500,000 of NOI was removed from our P&L for the quarter compared to the first quarter and is being treated as an investment in affiliate.

We continue to make incremental progress on our balance sheet and liquidity position during the quarter. During the second quarter and early July, we sold 852,400 common shares at a weighted average offering price of $10.44 per share for net proceeds of approximately $8.7 million. We used the proceeds to retire the $9 million in exchangeable notes that I previously mentioned. And additionally, in May, we repaid an $8 million mortgage loan, encumbering Glendale Business Center with a $6 million draw on our unsecured revolving credit facility and available cash.

We now have only 5% of our debt or $30 million maturing prior to January 2011, with most of that debt maturing in late 2010. We continue to explore options for our 2011 maturities, which are comprised primarily of bank debt, including our line of credit, as well as the balance on our exchangeable notes. We continue to reduce our absolute level of debt and intend to drive that level down further.

As for our guidance, we brought the high end down to reflect lower expectations for other income, including termination fees and construction management fees, which we brought down by $2 million; higher anticipated non-cash G&A; as well as a higher number of shares outstanding from our second quarter equity issuances. We also took into account higher anticipated bad debt reserves on a tenant-by-tenant basis and assumed that if we haven’t yet signed a lease, it’s unlikely we will get a new tenant in prior to the end of the year.

The non-cash G&A expense, which will affect our results for the next couple of quarters, is the result of a share grant that was designed to be shareholder-friendly by including investing criteria tied to total shareholder returns. However, due to the accounting treatment, we’ll have to recognize roughly $600,000 in non-cash charges over the next couple of quarters. We remain keenly focused on our expense controls, and excluding non-cash charges, we expect our G&A to be flat compared to last year.

Thank you for your time, and we’ll now take some questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we’ll take our first question from Paul Adornato with BMO Capital Markets. Please go ahead, sir.

Paul Adornato - BMO Capital Markets

Could you tell us about the bad debt, how many tenants does that relate to and what businesses they’re involved in?

Skip Dawson

Sure. The current pool of tenants that we’re actually reserving for, it’s about 47. And as we talked earlier on the call, the majority of those are going to be the Maryland, specifically as far as dollar value in the Baltimore properties we discussed earlier. The size of the tenants, they vary. We’ve got about a dozen of them over 10,000 square feet, half a dozen of those between 5 and 10 and in the balance under 5,000. So each of one of these tenants that we are in reserve for today, we’re working with, we’ll try and do formulate a plan that makes sense going forward in realizing the challenges that they’re facing, but …

Paul Adornato - BMO Capital Markets

Okay. Have all of the tenants stopped paying rent or are these the ones that you feel are just in trouble?

Doug Donatelli

No, they haven’t stopped. Just to step back for a second on how take we take a look at reserves, we reserve for tenants that are in the space currently that have balances above their security deposits. And in some cases, tenants moving around in that bucket, we look at the obligation, we look at what they are telling us as far as their history in the past and what they see going forward. But nonetheless, bad debt we actually believe is not going to sponge off the system. Its tenants that are currently [challenged] that we’re working through right now.

Skip Dawson

Most of those tenants have stopped paying their rent, excuse me. So they’ve either stopped paying their rent or we just know something about their business and have decided to reserve for them, because they have approached us and told us that they have issues with their business, and we are concerned about the ability to collect those rents going forward.

Paul Adornato - BMO Capital Markets

Okay. And what businesses are they involved in?

Doug Donatelli

I mean it’s a mixture. We’ve got tenants that are specifically in a service related industry. None of its government related or contracts specific to government work. It’s, as we said before, concentrated in more some of the Baltimore properties we have, which is the service part of it.

Paul Adornato - BMO Capital Markets

Okay.

Skip Dawson

It is hard to say. There is one industry in particular, I mean we have some health clubs, we have some mortgage brokers. So those are the types of tenants that you’d expect would be suffering in this type of downturn.

Paul Adornato - BMO Capital Markets

Okay. And with respect to new leases, you say you’ve signed quite a number of smaller leases as well. I was wondering if you could just go over your tenant underwriting criteria and how that might have changed given the environment.

Doug Donatelli

For each time, we take last year’s financials. We review those. We go through the (inaudible) report. We look at the sustainability of the previous rental stream and the opportunity that we see going forward. We take a really strong look at those tenants coming online. And from there, we make a decision of how much of the security pass will take letter of credits in case as personal guarantees. And once we get comfortable, then we’ll bring them online.

Paul Adornato - BMO Capital Markets

Okay. And just looking at acquisitions and dispositions, does it makes sense to try to lower your exposure to Baltimore and Maryland through a joint venture or outright sale at this point?

Doug Donatelli

Yeah, we’ll explore all opportunities that might come that way. I mean the [Baltimore] properties that we own, particularly the ones that are having some trouble, can do us through the suburban Maryland portfolio that we acquired a few years ago. So they weren’t properties that we targeted for acquisition. And like I said, the Baltimore market is really not a core market for us per se. But we’ll explore opportunities as they come along.

Paul Adornato - BMO Capital Markets

And on the flip side, any opportunities coming from distressed owners in your region?

Skip Dawson

Not quite yet. We anticipate some opportunities coming may be in the fourth quarter, certainly in 2010. But right now, the market from an acquisition standpoint is pretty quiet.

Paul Adornato - BMO Capital Markets

And can you point to any examples for cap rate confirmation?

Skip Dawson

No, not really. There is just not that much data out there. Some…

Barry Bass

There are some pending acquisitions and pending deals out there that haven’t closed yet. We might start to give some clarity as to cap rate, and there’re some whispers about what those cap rates are coming in at.

Skip Dawson

But in this market, we’d like to see them close first, so we can get a much more accurate reading on where the market is.

Operator

We’ll go next to Brendan Maiorana with Wells Fargo Securities.

Brendan Maiorana - Wells Fargo Securities

Just a follow-up on that, the deals that are out there in the market. How would you characterize the level of activity on the buyers’ side for those deals? Is it active market or are there just a couple of buyers out there?

Skip Dawson

Well, interestingly, I mean there are a few opportunities out in the marketplace, some of it industrial, some of it suburban office. And the interest in those opportunities is quite high. They haven’t closed yet. So we’re not quite sure where the pricing is going to settle down. But the number of viewings, the number of offers and the interest has been higher than, I think, most people would expect.

Brendan Maiorana - Wells Fargo Securities

And is there a difference between the level of activity on the suburban office side versus the industrial side in terms of the number of buyers that are sniffing around out there?

Skip Dawson

No, I wouldn’t say there is much of a difference. I think there is a difference however in regions. I think that there is a difference between Washington and some other markets around the country. I think the people are really focusing on Washington as a good place to invest money going forward, and I think we’re seeing a lot more activity than other places.

Brendan Maiorana - Wells Fargo Securities

Right, okay. Thanks. In terms of leasing, it seems like obviously the retention ratio has stayed up pretty high, but then level of new leasing dropped off a little bit. Is that just because tenants are being a little bit more careful in terms of making decisions or is that something that you guys are doing just keeping in mind that you’ve had some problems with some of your tenant base. In terms of reserves, are you being a little bit more conservative in your underwriting or is it just tenants that are being more conservative in terms of making decisions?

Doug Donatelli

I think tenants are taking a little bit longer to make decisions in the market on new space also in the same [velocity] compared to last year is much less than what we expected. So it takes a while. There is a number of options out in the market for tenants. They’re not only looking at the spaces, but they’re looking at the quality of the landlords too. That’s a huge driver right now in the market, and we feel pretty comfortable that we’re in good position there. So it’s just a combination of tenants taking their time and really scaling the market before making commitment.

Brendan Maiorana - Wells Fargo Securities

Given, Skip, that you’ve got more pressure in your Maryland portfolio in terms of your existing tenant base and that’s where you also have the most lease up to do, is that more of a challenge for you just trying to underwrite tenants there or do you feel like it’s the underwriting of tenants, there is no real difference among regions, it just happens to be that you’ve got a pocket in your Maryland region today?

Skip Dawson

Well, every lease that comes in, we take a strong look at the underwriting component. We understand and we’re seeing Maryland as a little more challenge, and we want to make sure when a tenant does come to the portfolio to take a look at the space, what’s the real reason behind it, are they moving from a landlord that they’re having trouble with or they’re actually a viable tenant in the market with business that’s sustainable. And that’s how we take a look at it.

Brendan Maiorana - Wells Fargo Securities

Okay. I know this is a little bit of a ways away, but you got a significant amount of leases rolling over in 2011. Do you have any indications in terms of whether or not there are some large tenants that will renew or if there are some who don’t move out?

Skip Dawson

We’re having discussions with tenants in the 2011 expiration, but I don’t really have any color right now to share with you on that.

Brendan Maiorana - Wells Fargo Securities

Okay. And then just lastly for Barry in terms of the capital that you raised on the CEO program. Can you just gives us a sense of the amount that was done, the decision making behind that and then do you have plans to increase the CEO program or think about an equity issuance, how do you guys view that given where your current capital plan is?

Barry Bass

Sure in terms of the amount that was done, I mean we tried to match up pretty well kind of how much we raised to how much we were buying back in terms of our notes, so. And then it also does come down to being able to sell at prices that we deemed reasonable and that worked well frankly with the return that we were getting when buying back those notes. So there is a little bit of an art to it in terms of matching it up. In terms of going forward, to the extent that we find that there are more exchangeable notes out there, we would look to issue additional equity under the CEO to try to take advantage of that. In terms of a larger equity offering, that’s not something I’m going to discuss. We’ll look at all of our different capital sources available to us and we will make a judgment as we go forward.

Brendan Maiorana - Wells Fargo Securities

You'd like to reduce your debt a little bit further, given that the guidance is down a little bit. Your FAD was down a little bit this quarter, although I guess that’s going to move back up like CapEx lines?

Barry Bass

That’s correct.

Brendan Maiorana - Wells Fargo Securities

I mean there is some retained cash flow, do you feel like that’s enough to get you to where you want to be or should we expect some combination of asset sales, equity issuances or some other means to bring that down?

Barry Bass

Yeah, I mean overtime I think you should expect some combination of all of those things.

Operator

We’ll go next to Jordan Sadler with KeyBanc Capital Markets.

Jordan Sadler - KeyBanc Capital Markets

I just wanted to follow-up a little bit more on the leasing. Skip, the pace of leasing that you are seeing so far in the third quarter, you mentioned, you used the words maybe pulled forward that you’ve pulled forward some of the leasing I suspect, may be in 2008 you and earlier this year. You’ve pulled forward some of the stuff, it did some of the sort of quest on a low hanging fruit in terms of leasing and I’m just curious if you think that pace is going to remain in sort of the level that you are able to do this quarter or will that continue to sort of moderate a little bit?

Skip Dawson

Our renewals.

Jordan Sadler - KeyBanc Capital Markets

Yeah, well renewals and new leasing altogether because both seem to....

Skip Dawson

We did reach out in at the end of last we’re assuring to the 2009 2010 large expirations it kind of mitigate our exposure over the next few quarters and I think that was in four side smart thing to do. We are talking with tenants, we are working with them on their needs, their current needs today which you may have seen in renewals is shorter term renewals for people to understand what their business is going to look like after we come through the challenges we are facing, but if the tenant is currently operating is in this space and their business is relatively stable. There has to be a big event for them to consider moving out of the space with all the costs associated with the move today.

Along with that we’re going to even move with the to a landlord is going be a challenge. Or you can say with the landlord that’s got some sustainability to observe. Those factors are in play here today. So we see that as somewhat of a competitive advantage with tenants we currently have, and I do believe that as we go to second half of the year, we talked about our retention rate, it would come down, I mean 88 for the second quarter and mid 80s for the years. It’s pretty strong right now, but we do see some stress in the second half of the year for that. We land in the mid 70s, we talk about throughout the year. That’s a fine number for the entire year.

Jordan Sadler - KeyBanc Capital Markets

Mid 70s. And on the new leasing?

Skip Dawson

Well, we’re seeing activity in Virginia. I mean it’s nice we’re getting some enquiries or there is some couple of yields out there right now that we’re chasing. I’m not quite sure if they are going to land or but it was a lot different that we experienced in the first quarter. We’ll just have to wait and see it’s combination of demand for contract driven or a consolidation from a number of locations into to one facility. So we are actively in the market, we are talking with the brokers, our space looks good and we are prepared for any enquiries to come through our system?

Jordan Sadler - KeyBanc Capital Markets

Okay. It’s helpful. And then on the guidance Barry just I may have miss this, did you update the same-store expectation for the full year?

Barry Bass

Not specifically, you know same-store basically what we provided would translate into kind of 1% down to 1% up kind of in that range. So essentially flat same-stores kind of what we are looking at for the entire year.

Jordan Sadler - KeyBanc Capital Markets

Flat same-store, and that’s on a cash basis?

Barry Bass

That’s actually on a GAAP basis.

Jordan Sadler - KeyBanc Capital Markets

Okay. That will give the original guidance on a GAAP basis?

Barry Bass

That was the intent, yes, I believe.

Operator

We’ll go next to Dan Donlan with Janney Montgomery Scott. Please go ahead, sir.

Dan Donlan - Janney Montgomery Scott

Good morning. Just had a question as to the bad debt expense and tenants there. What’s the thought process behind possibly just going to the eviction process versus keeping them in the current buildings?

Skip Dawson

Well, any time the tenants in reserve, naturally the first thing, let me step back for a second. Just give you a normal month and then how we go through our process. Tenant pays first pay on the 5, between the 5th and 10th of the month, we make sure everything is posted. What is not posted or comes to locked box. We’re on the phone with the tenant between the 10th and 15th checking exactly what the story is. If we’re not paid by the 15 to the 20th, we go through and we automatically issue a default notice, and they have five days to cure. And during that after that default notice we go through the process all the way up through and including if necessary an eviction of the space. So that can take anywhere from 60 to 90 days depending on what area, what group we’re dealing with there so.

All the way during that time we’re trying to work on a scenario that, by possibly keep the tenant in. We’ll keep the tenant in and work on a plan to pay us back. If we’re forced to go all the way through eviction, we will evict the tenant and in that time that space goes into our vacancy. And the obligation we go and chase.

And the only way that we take a look at any type of money is coming back into the system is that once we get it paid from an outstanding obligation or a reserve. That’s when we take that reserve back, but going forward until we receive something, it’s still in the reserve column. So we do chase these guys, we do work hard with them to try to understand what’s causing this problem and try to work with them to solve it. But we find in some cases you go all the way up to the day before eviction to get paid.

Operator

We will go to next to John Guinee with Stifel Nicolaus.

John Guinee - Stifel Nicolaus

Hi, John Guinee here. Barry or Doug, it looks to us is if you are going to be at a $0.32 run rate for FFO in the third and fourth quarter based on the mid points. Didn’t accurate where to look at this?

Barry Bass

Yeah, I mean basically what we did is for our guidance assumed that high end we basically from an operation standpoint repeat what happened in Q2. So we had $0.37 of core operations in Q2, but we are going to have about $0.02 of additional non-cash G&A in Q3 and 4 and also about a $0.01 of dilution in each quarter as a result of having more shares outstanding. So that kind of gets you down to about $0.34. And then we provided some cushion to, just in case there’s another wave of tenant issues that we have to deal with over the next couple of quarters.

Operator

We’ll go next to Dave Rodgers with RBC Capital Markets.

Dave Rodgers - RBC Capital Markets

Hi, good morning, guys. I wanted to follow-up on the acquisitions in the market. Just a question are you guys participating or have you bid on any assets up late?

Doug Donatelli

We’ve been looking at acquisition opportunities as they come long, yes.

Dave Rodgers - RBC Capital Markets

And anything that gone into to bid? Were there enough interest on your part?

Doug Donatelli

Yeah, I think there is still a bid ask GAAP, at least from our standpoint. So nothing come to past yet.

Dave Rodgers - RBC Capital Markets

Okay. On the tenants side in terms of just broader rent release question maybe even aside from where you reserved, have you felt that giving rent relief to this point has maybe been able to stabilize some tenants. What are you views on that and what you are seeing today?

Barry Bass

It does help the tenants during these challenged times, and it’s one other things that we look at and determine what makes some sense so we also get to take a look what’s behind the tenants, is there space or demand for the space that they are currently occupying, and we feel once we get through this we’ll have tenants are much stronger and more committed to our company.

Doug Donatelli

We’ve been through times like this before, and we deal with each tenant on case by case basis try to just figure out why it has get the before wide. They are having a difficult times paying their rent obligations and seeing if giving them some relief make sense for us as a company and I think that in many cases it does, then we will work with tenants and try to get them back on track and then that leads to a recovery of any reserves we have for them. And then the idea is to how to help tenants, so we think can may get through these tougher times. And when they do, they’re loyal tenant for many, many years and we’ve seen that in many cases in the past.

Dave Rodgers - RBC Capital Markets

In the rent relief you are considering largely contained within that 3% or so of revenues in the reserve category.

Barry Bass

That’s correct.

Dave Rodgers - RBC Capital Markets

Okay. And I guess, I guess Barry last question for you on the equity offering. Obviously, the pursuit of an acquisition or something along those lines would that change your view on how you might pursue the use of the controlled versus a larger offering and as well as potentially, then offering larger assets up for sale, to pay for that. I mean, how do you balance that, with looking at these acquisitions today?

Barry Bass

Yeah, I mean we don’t have a whole lot of larger properties that we could offer for sale frankly. So yeah, I mean, to the extent that we do see opportunities and we feel like we’ve gotten our balance sheet into a position where it makes sense pursue those opportunities, we could do a number of different things. If we could find a joint venture partner then we could probably find, we could probably get enough equity through the controlled equity offering program to match up with the joint venture partner. If we wanted to buy it on balance sheet we would needed to do a larger offering.

But again, I mean we do definitely have to weigh kind of the pursuit of acquisitions with taking down our leverage. And so all of that would kind of come into play, and then kind of the cost of that equity versus the benefits that we receive from that acquisition.

Operator

(Operator Instructions) And we will go next to Bill Crow with Raymond James.

Bill Crow - Raymond James

Good morning guys. Just a couple of follow-up questions here on the bad debt – no need to beat the horse here, but what percentage of the incremental reserves was related to companies that are not paying debt versus that percentage that is anticipatory of future problems?

Barry Bass

Yeah, as I said most of the bad debt reserves that we take relate to tenants who are currently not paying their rents, so....

Bill Crow - Raymond James

So, 80%, 90%...

Barry Bass

It’s 80 to 90%. That’s correct.

Bill Crow - Raymond James

Okay. And Doug, there was a time where you were talking about whisper cap rates and I think you are going to offer some color on that, got cut off. Would you like to -can you give us some color on the cap rates on deals that are out there?

Doug Donatelli

Yeah, there’s high eights to high 11 depending on where the product is located, tenancy, et cetera and so on. It’s a wide range right now.

Bill Crow - Raymond James

All right, and then Barry one last question here. On the exchangeable note repurchases, are you finding that tougher to uncover those opportunities, are the investors just getting to a point where, okay, we’ve come back from the break, maybe there’s no need to sell, we can hold on until the put date and come out whole or you still, you’re still obviously recovered $9 million worth. But did they get tougher as the quarter went on?

Barry Bass

Well, as there are fewer and fewer notes outstanding those notes are generally going to be held in stickier and stickier hands. So yes, I mean it will become more difficult. We think we know where several of the notes are and believe that there are still some sellers out there and we will be chatting with them.

Operator

We will take our next question from Christ Lucas with Robert W. Baird.

Christ Lucas - Robert W. Baird

Skip, on the renewals for 2010, can you gives us a little bit of color what your expectations are at this point with what’s left and then just sort of how you go through the process of negotiating with the existing tenants versus marketing that space for potential reuse?

Skip Dawson

Sure. In 2010 we’ve got a little over million square feet to said to expire. There are guys who are actively in the market talking with these tenants to determine what their lease are currently and it is some type of idea going forward what they are looking for. It’s a challenged market regarding, what’s out there we try to get a good understanding of what their space looks like, their cost for them to move, that’s the direction they go and look at.

Our costs for re-tenanting are on where we look at and look at from a case-by-case basis and make a determination. It’s tough to peg right now today, if you were looking for retention rate with our 2010 expirations, what they would look like. But we are actively working with them. Just the market overall is a story of lot of can stay input. It’s a challenge for us then to generate new tenants in the market, but we are not the only landlords in the area seeing strong retention rates right now.

Christ Lucas - Robert W. Baird

And then Barry, just on the balance sheet, can you give us any sort of sense or update in terms of your discussions with your 2011 maturities in terms of any extensions or certainly with the line of the term loans that you are working through right now?

Barry Bass

I can’t give you anything specific other than we do continue to talk to the lending group we continue to run numbers and try to get a sense from where the general market is headed from a lending perspective. And a lot of internal discussion about when the right time is to extend those versus the cost of extending those.

Christ Lucas - Robert W. Baird

What’s the trend been in your discussions in terms of just the pricing that you are getting back form your lenders?

Barry Bass

I would say the credit markets are definitely slowing a little bit better now than they were earlier in the year. So but in terms of pricing, we are talking about bank debt that would be 300 to 400 basis points over, LIBOR spreads are coming down which is good so what used to be a 200 basis point LIBOR floor, this might be 100 to 150 so.

Christ Lucas - Robert W. Baird

So things have improved on that front.

Barry Bass

Correct.

Operator

And we’ll go to Paul Adornato with BMO Capital Markets for a follow-up.

Paul Adornato - BMO Capital Markets

Yeah. And just touching on the Norfolk market, I guess in this environment, one might expect that to show a little bit of weakness. I was wondering if you could provide an update on the port traffic and port infrastructure and just what’s happening in that market overall?

Skip Dawson

Well the pool has experienced some challenges over the last nine months or so the inputs are relatively flat it does cause some pressure on big block of warehouse space in that market. We are seeing that pressure that but from the office side or the support side still vibrant at the end of that market.

Barry Bass

We’ve seen from organizations that are associated with the government fair enough to growth that has mitigated any slippage that we’ve seen from the port slowing down. But the port is definitely seeing slow down in traffic.

Operator

And we’ll take a follow-up from Jordan Sadler with KeyBanc Capital Markets. Please go-ahead sir.

Craig Mailman - KeyBanc Capital Markets

Hi, it’s Craig Mailman here with Jordan. Just curious to see within your government exposure, if you have any meaningful leases out to the postal service?

Skip Dawson

We do have a lease with the postal services in our property in West Virginia and that has already been renewed.

Craig Mailman - KeyBanc Capital Markets

Okay. Because we had seen that there potentially could be some consolidation by the postal service to close some branches and other exposure, they have their real estate. Do they have any house on that renewal?

Skip Dawson

The facility that we currently have with them is a distribution facility, not an single isolated zip-code unit. So they did extend and there are no house on that in that lease.

Craig Mailman - KeyBanc Capital Markets

And I just had a follow-up on the capital plan Barry. In sort of one of your responses, I think that one of Dave’s questions. It sounds like you wanted your balance sheet to be in a particular shape before you went ahead with new investment opportunity, and I’m just curious if you could give us a sense of what kind of shape you’d want it to be in sort of metric when we look at?

Barry Bass

Yeah, I mean, I don’t want to peg a specific target. We obviously want to get leveraged down and what we would potentially do is look to kind of combine the an acquisition opportunity with the deleverging if that happen to work out that way so, there is no...

Craig Mailman - KeyBanc Capital Markets

[During objective] on leverage maybe?

Barry Bass

Yeah, I mean long-term or even in intermediate term somewhere in the seven times debt-to-EBITDA is where we would like that’s kind of step one.

Craig Mailman - KeyBanc Capital Markets

Where do you guess that you are at on your metrics, currently?

Barry Bass

About 8.5

Operator

There are no further questions at this time. I would now like to turn the call over to Doug Donatelli for closing remarks.

Doug Donatelli

All right. Well thank you everybody for participating this morning and we look forward to talking to you on our third quarter call.

Operator

That concludes today’s conference. We thank you for your participation.

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Source: First Potomac Realty Trust Q2 2009 Earnings Call Transcript
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