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Executives

Jeanne Leonard - Investor Relations

Bill Hankowsky - Chief Executive Officer

George Alburger - Chief Financial Officer

Rob Fenza - Chief Operating Officer

Michael Hagan - Chief Investment Officer

Analysts

Sloan Bohlen - Goldman Sachs

Jordan Sadler - KeyBanc Capital

Chris [Catten] – Morgan Stanley

Alexander Goldfarb - Sandler O'Neill

John Guinee - Stifel

Brendan Maiorana – Wells Fargo

Dave Aubuchon – Robert W. Baird

John Stewart – Green Street Advisors

Michael Bilerman – Citi Financial

Stephen Kim - Macquarie

Dan Donlan – Janney Montgomery Scott

Michael Odell – AIG

Liberty Property Trust (LRY) Q3 2009 Earnings Call October 27, 2009 1:00 PM ET

Operator

Welcome everyone to the Liberty Property Trust third quarter earnings conference call. (Operator Instructions) Ms. Leonard, you may begin your conference.

Jeanne Leonard

Thank you Kim and thank you everyone for tuning in to our third quarter results conference call coming to you live from the home of the repeating World Champion Philadelphia Phillies. Today you will hear prepared remarks from Chief Executive Officer, Bill Hankowsky; Chief Executive Officer, George Alburger and Chief Operating Officer, Rob Fenza. Our Chief Investment Officer, Mike Hagan is also present for any questions you may have.

During this call, management will be referring to our quarterly supplemental information package. You can access this package, as well as the corresponding press release on the investor’s section of Liberty’s website at www.libertyproperty.com. In this package and the press release you will also find a reconciliation of non-GAAP financial measures we reference today to GAAP measures.

I will also remind you that some of the statements made during this call will include forward-looking statements within the meaning of federal securities law. Although Liberty believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions, we can give no assurance that these expectations will be achieved. As forward-looking statements, these statements involve risks and uncertainties and other factors that could cause actual results to differ materially from the expected results; risks that were detailed in the issued press release and from time-to-time in the company’s filings with the Securities and Exchange Commission. The company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events.

Bill would you like to begin?

Bill Hankowsky

Thank you Jeanie and good afternoon everyone. I’m going to cover three topics in my opening remarks; (1) A report on the third quarter; (2) our view of where the economy and the real estate markets and where they will be in 2010; (3) provide you with our guidance for 2010.

The third quarter was another solid quarter of performance for Liberty in the toughest market we have ever seen yielding FFO of $0.72. On the capital front we completed our continuous equity offering raising the final $69 million of our $300 million program. We also raised an additional $63 million through asset sales. In the last 12 months we have accessed nearly $1 billion in fresh capital to fortify our already conservative balance sheet. We are where we want to be on the capital front and we are poised should growth opportunities arise.

On the operational front we leased 3.5 million square feet this quarter and maintained occupancy at 89.3%, a slight ten basis points decline from last quarter. Our renewal rate remains strong at 60%. The one variable that saw a pronounced change was rental rates which declined 13.9% on a straight line basis. This decline evidences the market reality we have been facing in 2009 which is finally impacting our numbers due to the lag effect between lease signings and lease commencements. We have described how competitive a market it is, and these numbers bear that out. So a solid quarter in a tough market.

How do we see the economy and the real estate markets now and into 2010? The economy has lost 7.2 million jobs since the start of this recession and the job numbers have yet to turn positive. We anticipate GDP growth this quarter which will begin the long road back but it will take several quarters to see marked improvement in real estate fundamentals. As our rental rates affirm this quarter real estate is a lagging indicator. Vacancy rates nationally reached 16.1% and 13.5% for the office and industrial sectors respectively.

Even with positive GDP growth and the complete evaporation of new supply the markets will remain challenged in 2010. We believe we have seen the bottom of rent declines but it will take most of 2010 before we seen any positive pressure on rent growth. This will happen sooner in the industrial space and lag in the office sector.

So today we are providing guidance of $2.60 to $2.80 FFO per share. This decline of approximately 4% is comprised of two components; 60% of this decline is due to dilution as a result of our $300 million in 2009 equity raising. We feel very comfortable retaining this price for strengthening our conservative balance sheet and positioning us for growth. The other 40% is a result of lower real estate fundamentals we are experiencing in this extremely competitive market. Here again, we are comfortable with this result in order to maintain occupancy in our portfolio.

We continue to outperform our markets, doing 390 basis points better in Liberty’s markets and outperforming the national markets at 440 basis points better. We had a solid quarter. We have a solid balance sheet and we have a solid franchise executing extremely well in a rugged environment.

Let me now turn it over to George to provide details on the numbers and Rob to provide some further color on the markets. George?

George Alburger

Thanks Bill. First I would like to review our performance for the third quarter and then I would like to provide earnings guidance for 2010.

FFO for the third quarter of 2009 was $0.72 per share. The operating results for the quarter include $6.2 million in lease termination fees, an impairment charge of $4.8 million and a gain on the extinguishment of debt of $500,000. During the quarter we brought into service seven development properties with an investment value of $89 million. These properties were 22% leased and in occupancy at September 30 an additional 29% of the space is leased but the tenants are not yet in occupancy. The projected stabilized yield on these properties is 6.9%.

The joint venture in which the company holds a 50% interest brought into service a 100% leased, $24 million warehouse. The yield on this investment is 11.5%. We didn’t have any development starts this quarter. As of September 30 the committed investment and development properties is $372 million. For the wholly owned properties it is $205 million and for leased properties the projected yield is 9.6%.

We didn’t have any acquisitions this quarter but were active with dispositions. During the quarter we realized $63 million in proceeds from the sale of six properties and three acres of land. For the core portfolio during the quarter we executed 3.1 million square feet of renewal and replacement leases. For these leases rents decreased by 13.9%. This decrease in rent is significant when compared with 2008 and when compared to the first half of 2009 but it is not out of line with what we see for the balance of 2009 or 2010.

For the third quarter operating income for the same store group of properties increased by 2% on a straight line basis and increased by 0.4% on a cash basis for the third quarter 2009 compared to third quarter 2008. Third quarter 2009 results benefited from a $700,000 bankruptcy settlement.

At this point let me move on to earnings guidance. The first thing I want to do is cover what we see happening in the fourth quarter, the balance of 2009. During the third quarter we sold $63 million in operating properties at a 9.5% cap rate. We anticipate an additional $30 million in sales in the fourth quarter. These dispositions will have a dilutive effect on fourth quarter earnings. The decline in real estate fundamentals, essentially the decline in rents we experienced in the third quarter, will also negatively impact fourth quarter earnings. Because of these factors we believe fourth quarter earnings will be in the $0.65 to $0.67 per share range. Earnings at the midpoint of this range, $0.66 per share will result in FFO for 2009 of $2.82.

There were some significant one-time items flowing through 2009 operating results. Lease termination fees, impairment charges, gains on extinguishment of debt, but the plusses and minuses from these one-time items offset so we are comfortable using $2.82 estimate for 2009 as a starting point from which to build 2010 earnings guidance.

A big factor impacting earnings performance on a per share basis for 2010 compared to 2009 is the dilutive effect of our 2009 equity issuance. The 2009 continuous equity offering program raised significant capital and increased our outstanding shares by 12%. This together with other capital activity will diluted 2010 FFO per share by $0.06 to $0.07. As Bill mentioned we consider the trade off of this dilution compared to the additional strength it provided to an already solid balance sheet is to be well worth it.

Let me move on to other items impacting earnings for 2010 and I will start with acquisitions, dispositions, development, kind of the real estate capital activity. To date in 2009 we have not purchased any properties and we only purchased one property in 2008. We are hopeful there will be attractive acquisition opportunities in 2010 but it is unclear to what extent there will be. Consequently, acquisition investment for 2010 could range anywhere from zero to $100 million.

With respect to dispositions, for 2009 through the end of the third quarter we have sold $145 million in assets. We think the total for the year will be approximately $175 million. We see less activity for us in the sales area in 2010. We anticipate sales activity in 2010 to be in the $75-125 million range. The cap rate on these sales will be in the 9-11% range so acquisition/disposition activity for 2010 will decrease FFO by $0.03 to $0.07 per share.

Moving on to development we expect to bring into service in 2010 $75-100 million in deliveries from our development pipeline. This follows 2009 development deliveries of approximately $300 million. This 2009/2010 development activity will increase FFO by $0.03 to $0.05 per share.

We believe G&A expense for 2009 will be $4 million less than it was in 2008 but we need to hold the line on G&A costs but we also need to remain competitive. We see G&A costs increasing by $0.02 to $0.03 in 2010. This increase includes $0.01 of expense for acquisition related costs which under previous accounting rules would have been capitalized.

For the last two years we have suggested that lease termination fees would be in the $0.04 to $0.06 per share range. For 2008 lease termination fees were $0.04, the bottom end of the range. For 2009 it looks like we will total $0.07. For 2010 we will stick with our historical range of $0.04 to $0.06 per share.

Earnings from unconsolidated joint ventures and other miscellaneous items should increase earnings by $0.01 to $0.02 per share in 2010. A final item to discuss, the most significant, what do we expect for the same store group of properties which represent over 90% of our revenue? For the first six months of 2009 rents for renewal and replacement leases increased by 2.8%. For the third quarter they decreased by 13.9%. We expect this third quarter experience to repeat itself for the balance of 2009 and for 2010. We are projecting rents for 2010 will decrease by 10-15% on a straight line basis.

We expect average occupancy for 2010 will vary by 1% up or down compared to 2009 so the combination of the 10-15% decrease in rents and a 1% increase or decrease in occupancy will result in a decrease in FFO of $0.07 to $0.11 per share. All of the above items result in an FFO estimate of $2.62 per share to $2.77 per share. We will round off this estimate and provide FFO earnings guidance for 2009 of $2.60 to $2.80 per share.

One final note about capital activity. For 2009 we were very active on the capital front 2010 should be much quieter. We only need $35 million to complete the development pipeline and our debt maturities are only $180 million so our capital needs are very manageable. We have exercised the one-year renewal option of our credit facility extending the maturity to January 2011 and we intend to renew this facility some time in 2010.

With that I will turn it over to Rob.

Rob Fenza

Thank you George. Good afternoon. In the second quarter we reported a pickup in activity, more prospects and more tenants willing to make decisions; decisions which included taking advantage of the weak real estate markets to lock in leases at more advantageous rates.

This trend continued in the third quarter where we signed leases for 3.5 million square feet of new, renewal and development pipeline space in 207 transactions. While there are deals in the market there is clearly a bifurcation among landlords between the haves and the have not’s in terms of capital. Prospects and brokers are increasingly more concerned about a landlord’s ability to deliver on its promises and Liberty has gained an upper hand because of our solid footing. Couple our financial strength with our reputation for crafting solutions that provide more value for our tenant’s rental dollars and the result is a clear competitive advantage.

Tenants are vetting landlords closely and landlords are doing the same. Although the troubled tenant phenomenon has significantly abated, leasing space is very much a deal-by-deal balancing act combining scrutiny of a tenant’s credit, their business prospects, lease terms and competition. The reality of the market is the downward rental pressure is the norm. Most leases today are being signed at 10-15% below expiring rates. Pressure is more acute on new leases than on renewals. Concessions are primarily free rent and lower base rent and tenant improvements are lower on renewals than replacement leases but overall credit drives tenant improvement dollars.

On the whole, market demand is well below that of a year ago. Most tenants are renewing and are either staying the same size or downsizing. Very few are expanding. In our markets, the average size of a new office and industrial lease is smaller by about 13%. In spite of weaker demand and lower rents, 85% of renewals and 90% of new leases contain contractual rent bumps of 2-3% per year.

Moving on now to the development pipeline, seven wholly owned projects and one joint venture project were put into service during the quarter. Although the commenced leasing at September 30th for the wholly owned completed development properties was only 22%, total leasing of this group which includes both signed and commenced leases was 51% and 75% including the joint venture property. In addition we have active prospects for another 10% of the space.

The development pipeline is now down to ten projects for 2.4 million square feet and is 63% leased. Scheduled development deliveries for the next two quarters are already approximately 95% leased. Although we do not plan any new inventory development for the balance of 2009 or for 2010 the possibility exists for build to suit activity.

There are some build to suit opportunities in the market and the number of developers financially capable of engaging in these discussions is significantly smaller than in years past. With that I will turn it back over to Bill.

Bill Hankowsky

Thanks Rob and thanks George. With that we are prepared to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Sloan Bohlen - Goldman Sachs.

Sloan Bohlen - Goldman Sachs

A question for George on the guidance. I was wondering if you could talk a bit about it looks like the expenses were down a bit in the third quarter and whether we should expect kind of that base assumption going forward in 2010 or will you expect that to tick back up a little bit?

George Alburger

When you say expenses are down, in terms of operating expenses for the same store group or in general?

Sloan Bohlen - Goldman Sachs

I was looking at the same store data but even in general, just some commentary there.

George Alburger

One aside, I did mention same store was a beneficiary of around $700,000 in a bankruptcy settlement. That resides as a credit in operating expenses so that is one element of the decrease. The other element of the decrease is primarily from electric costs. There are some, Rob could talk about it a little bit more, but some initiatives we are putting in place here to kind of control utility costs. The other is probably somewhat weather related.

Sloan Bohlen - Goldman Sachs

A question on the capital markets. It sounds like you will kind of crossed the bridge on the credit facility when you get to it but has there been any thought about tapping the unsecured market in between?

George Alburger

It is no secret the unsecured market has opened up quite a bit and there have been some REITs who have accessed the unsecured market and I guess that is an ongoing process even today and they are getting it at some pretty improved rates compared to where they were a few months ago. That hasn’t escaped our attention so we do stay on top of what is going on in the unsecured market. But to some extent we already have a couple of hundred million sitting on our balance sheet. If we raise that money what do we do with it. We have kind of the high class problem we can’t really redeem our earlier maturities at discounts to face. They are already trading at premiums and we would have to pay premiums to those premiums to kind of tender those bonds. So it is something we are keeping an eye on but no near-term notion to tap the unsecured markets.

Sloan Bohlen - Goldman Sachs

Rob, on leasing strategy or what you are seeing out in the market it looks like everyone is pretty much trying to retain occupancy but is there any difference at all in being able to provide whether it be tenant improvements or are you seeing differences in concessions? It sounds pretty uniform but rents are down fairly substantially.

Rob Fenza

Rents are down. There is less demand. In some instances there is one or two prospects for a space and in some instances there is less than that. You really have to look at the deal in front of you and it is a balancing act. You are trying to make the best deal you can without letting go of the prospect. Renewals for sure we are doing a great job of renewing existing customers and we have maintained this 60% level for several quarters and that is a pure percentage. Those tenants that are in that space get renewed in that space. There is increased free rent in the market. People are also just lowering the base rent as opposed to buying deals with TI. I think the TI we are putting in the deals is evaluated based on the credit of the tenant and evaluated space-by-space on the needs of the tenant in the space. So primarily the pressure is on the rent and the free rents.

Operator

The next question comes from the line of Jordan Sadler - KeyBanc Capital.

Jordan Sadler - KeyBanc Capital

I just had a question circling back to the releasing spreads. It sounds like you expect the fourth quarter and next year to be pretty much at the same level we saw in the third quarter and the velocity of the decline just looking back over the course of the past five quarters or so seems to have accelerated. I am curious what gives you the conviction or the confidence given that rate of change we have bottomed and that going forward we will actually recover from the releasing spreads we saw this quarter?

George Alburger

I think I mentioned in my opening that I think one of the things we all need to be very conscious of in this environment is the real lag effect of what is happening and then when it gets reported. As you all know, the supplemental in our report is based on commenced leases. So what we have been seeing candidly since the beginning of the year and maybe even as far back as the fourth quarter of last year but it clearly picked up this year, was a decline in rents in the market real-time. As our earnings are coming out in the prior two quarters this year you really didn’t see it manifest itself as markedly because candidly we were reporting our commencements that had signed third quarter last year, fourth quarter last year so that lag effect to some extent was masking what was really happening with rents in the market.

I think we were in our calls trying to point that out by talking about how ugly and rugged the markets were. So from our perspective what this quarter is showing is sort of the effect of leases we have signed this year finally commencing and you have seen what has happened to the rents. What you are seeing today is the effect of the decline in rents over the first three quarters of the year and as we look going forward, and we do an exhaustive annual budget process, space by space and leasing assumption by leasing assumption, we have looked at where we think we are going to be for the rest of this year and into next year.

We think that decline has bottomed out. In fact the markets are kind of where they are at given how dramatically they have declined and what you are going to begin to see is some degree of stabilization at this point and then probably by product and by sub-market you will see things firm up and maybe even make some positive movement. As we indicated we think that is going to happen earlier with industrial and later with office because the office will only get driven by some positive employment numbers that create some new demand in the space.

You can add to that analysis if you look nationally the negative absorption in both office and industrial was less this quarter than it had been in the prior two quarters so just like the job losses it feels like the valve getting turned off. We are also seeing the valve getting turned off on negative absorption and on rent declines.

Jordan Sadler - KeyBanc Capital

On acquisitions, you talked about it and you penciled in a small piece. Can you talk about what you might be looking for in terms of acquisitions whether by asset or market or return expectations?

Bill Hankowsky

We have been following this fairly closely in a variety of ways and it is pretty clear to us what is happening in the market right now is the lending world, the banks, are dealing with an inflow of troubled real estate loans. What they are dealing with most immediately are condo projects, hotel projects and a smattering of retail. There has been limited amount of office and industrial product that has gotten totally into the distressed category and where the banks are taking it over.

We think though that might happen, that some product may get to that point and may get recycled. I think candidly it is the same lag effect we were just talking about a moment ago with rents you have a lag effect with the distress on these properties. These lenders are only gearing up sort of right now. There was one, somebody we talked to that had 10 people in a workout unit and they are now up to 100 so they are kind of getting their arms around it. From our perspective our acquisition target next year is to some extent a place hold and what we are telling you is we have an interest if there are assets available that make sense to us to acquire them.

But it could be either zero in that range, it could be 100 or north of 100 if there is a lot of it. What would it look like? We would want to buy in the markets we are in I think is the focus. We have platforms in place. The economy of scale is so apparent so it is fairly easy for us to add a building, a portfolio, a park to one of our teams in one of our markets. We would want to do it consistent with our long-term strategy to that generally has an interest in multi-tenant industrial. It would have an interest in what we might call Metro Office, so that could be CDD DC, it could be on a train stop, it could be projects like the Navy yard in Philadelphia. It would probably not include going further out in most suburban areas, further out than from the center of the metropolitan area.

We have historically been comfortable taking on under-utilized, even vacant assets, and I know that might sound a little strange given we have our own vacancy in the portfolio but I think the best value-add opportunities for us and our shareholders might be where we bring something to the equation. I think it would have characteristics like that. I think the pricing will vary. I don’t think there is a single price for each of the product types nor a single price that would cover the various metropolitan areas. The cost for us to fix something up in downtown Washington might be very different than what it would cost us to pick up an industrial building in the Carolinas. So I think it will vary over the map. It is where we think there is a value add proposition that we would be interested in.

Jordan Sadler - KeyBanc Capital

Is there a threshold or minimum return on your invested capital?

Bill Hankowsky

I’m not going to put a number out there and I know that is where you want me to go but that is okay because as I said I don’t think one number makes sense for every product in every market. We have worked very hard over a decade to have a strong balance sheet and we worked very hard this year to maintain the strength of that balance sheet so we have a fairly high value that we place on our capital. We would expect that if we invested we would get a return commensurate with that value. We are helped, to an earlier question, you heard about the debt markets and debt is looking a little less expensive, but we think the cost of our equity is a double digit number and when you think about blending together the value of our equity with our debt, I think you are probably looking at returns that should have double digits.

Operator

The next question comes from the line of Chris [Catten] – Morgan Stanley.

Chris [Catten] – Morgan Stanley

I would follow-up on kind of the same line of questioning. Just a little more color on the transaction market. Are you seeing a stronger bid for office or industrial right now or in any of your particular markets? Then thinking of your 2010 disposition targets how are you kind of balancing the goal of keeping a good quality portfolio along with delivering to the sales market what they might be looking for?

The last thought was I heard you say and I have heard it said that the debt markets have improved and I am wondering if you have seen that translate into a little bit stronger bid in the transaction markets.

Bill Hankowsky

Let me do the sales part of it first, the second half. As George indicated, on two fronts, number one is it is a fairly quiet year for us from a capital perspective. So we have compared to where we were in the beginning of this year much more modest capital needs and as George pointed out we are sitting on a couple of hundred million in cash. We have lots of capacity on the line, etc. So from a capital raising perspective candidly we don’t really have to sell anything next year. So when we put out the sales number we really are looking at it more strategically from the perspective of assets that over time we would prefer to move on and have in the portfolio.

I may ask Mike in a minute to add some further color but this year we have sold I think about 1/3 of our sales were to owners, users of the asset. I think there may be opportunities like that which would manifest themselves in 2010 and maybe the percentage will be higher. Maybe half of them will go to users. Maybe the other half will be assets that candidly we don’t have a whole lot of interest in. Since we have candidly no need to sell them we can be a little bit picky about the pricing we are willing to accept for them. That is sort of our philosophy going into it. It will be a much more modest program. We won’t put as much out in the market to attract sales, nowhere near what we did this year. It will be much more, I would use the term almost surgical in what we sell.

In what is happening in the buy world, we are not seeing a whole big uptick. I don’t think it has changed significantly and I still think smaller transactions move and big ones don’t. Even though there is more debt, Rob mentioned in his comments the leasing world there are haves and have not’s, well there is the same role in buyers; haves and have not’s. Mike, I don’t know if you want to say…the spread has…Do you want to come in?

Michael Hagan

The only observation I would make is I think where you are today in the marketplace versus where you were six or nine months ago if there is something out there you have more people looking at it. So by that, someone might infer you could get better pricing on it but we just haven’t seen any evidence that the pricing has changed all that significantly. There is still not a lot of deal flow in the marketplace.

Operator

The next question comes from the line of Alexander Goldfarb - Sandler O'Neill.

Alexander Goldfarb - Sandler O'Neill

I just want to go to the debt side. I just want to get a sense given how spreads have really tightened where you do you think you would price a 10-year if you came out to the market?

George Alburger

They have tightened. They have tightened somewhat meaningfully. We can probably have spreads, they would clearly be under 400. Would they get into the 375 range? I think so, and at that type of number you are talking maybe 7.25 for 10-year.

Alexander Goldfarb - Sandler O'Neill

Even based on where we are seeing one of your peers price today? You still think you would be 7.25? Not inside of that?

George Alburger

I’m trying to be a little conservative here. I know who is doing a deal today and I am on top of what their deal is and I know what their number was and I think I have some idea how that deal was a pretty big blowout of a deal. So it probably came in tighter than where they were originally even talking about. Yeah, I think we could probably be inside of 7.25.

Alexander Goldfarb - Sandler O'Neill

On the front page of the press release there was some color saying anticipating sort of stronger office before industrial. Just in going to some of your markets I got the sense that it was a bit of the reverse and maybe that was just specific to the markets we were visiting. I just want to hear more on what is driving your viewpoint that office will rebound…I mean sorry, industrial will rebound quicker. Sorry if I mixed it up before.

Bill Hankowsky

Our thinking here is pretty straight forward. The industrial space is going to respond to somewhat better consumer confidence. It is going to respond to increased trade activity. It is going to respond to any degree of stabilization in the housing market generally. So as the economy gets better the easiest thing you can do and you can do it very quickly is put material back on racks in the warehouse and build up inventories. It takes employment increases to be able to put new bodies in seats in offices. Given that the September job number still was a negative 263,000, that is to say we have yet to see a positive monthly job number, it just feels like that hiring aspect is a ways off. Once it starts, and we talked a ;little bit about this in some prior calls, we think there is some amount of shadow space in the market that is really manifesting itself in sort of every fifth desk in an office building is empty because of hiring freezes and job cuts over the last year and a half.

So even when companies begin to hire we think they are going to first fill that desk before they need new space. I think you really see the evidence of that, the shadow space, when you look at the average size of an office renewal in the markets we are in and I’m not talking about Liberty’s performance, I am talking about what is happening in the markets. The average size of leases is down which I think represents the fact as leases expire and people come into the market even to renew or take a new space, they are taking less space than they had. Hence, the very significant negative absorption numbers we have seen in office. We think the way this plays out is materials back on racks and warehouses. We also think that is why we are seeing some activity in the flex space which can pick up because again that could be a smaller distribution play in a market. It could also be amore of a tech company or a biotech kind of company. The classic office worker will be the last piece of this puzzle to come back into focus.

Alexander Goldfarb - Sandler O'Neill

The lease term fees seemed to spike in the third quarter. I just wanted to get a little color as to what is driving this and if this was sort of a surprise or you had sort of forecasted this originally when you were doing your 2009 budget.

George Alburger

No. We did the 2009 budget we went with more of our historical pattern of $0.04 to $0.06. I said in 2008 we were on the low side of that at $0.04 and in 2009 we will be higher than the high side of that range. We had $6.2 million of lease termination fees this quarter. I think $4.5 million was from one tenant and that was a negotiation with that one particular tenant on its space.

Alexander Goldfarb - Sandler O'Neill

Is that office or industrial?

George Alburger

It is office.

Bill Hankowsky

The color it was an office building the tenant had a long-term lease on. They were kind of stuck with it. We actually found somebody who was interested in buying it so we were actually able to do a pretty nice real estate transaction. Free up an asset, taking a fee and selling it.

George Alburger

This was a double score. We got a termination fee from the tenant and sold the asset at a gain. An empty building.

Operator

The next question comes from the line of John Guinee – Stifel.

John Guinee - Stifel

First, I am assuming George your taxable income is going to come down, your [FAS] is going to come down a little bit. Any chance we will see a dividend cut in 2010?

George Alburger

Let me answer one part of it and I will turn the dividend cut piece of it over to Bill. One piece of it, historically our dividend has never included return of capital. It always has been 100% taxable income. 2009 isn’t closed. It is tough enough to forecast FFO. It is even more difficult to forecast taxable income. I don’t know whether we will have a no return of capital situation in 2009 but if we did have any return of capital it would be modest.

It is fair to say we don’t go through complicated tax planning so we have a foundation or support for lowering the dividend but that will just give you a little bit of a backdrop. Furthermore, even with our projected decrease in earnings if you will we are still covering the dividend and we will have retained capital, albeit modest. So I will give you that piece of it.

Bill Hankowsky

In terms of dividend philosophy, as you know the board makes that decision an when we talk about it frequently and in depth. I think you do know that from a philosophy perspective we are huge believers in the REIT model and we think the dividend is a very significant piece of that. We think very hard and very deliberately and thoughtfully on dividend policy. We made an adjustment to it roughly a year ago about this time. We will keep track of it but understanding where our philosophy is I think maybe that helps you think about it.

John Guinee - Stifel

You have about 6.2 in lease term fee. Also you have four and change on impairment charges. Where do those show up on your income statement?

George Alburger

The lease termination fee is in two spots. $1.6 is in rental revenue and another $4.6 million is in discontinued operations. With me so far?

John Guinee - Stifel

Impairment charge?

George Alburger

The impairment charge is also in two spots. There is about $300,000 that is in gain or loss on property dispositions and $4.5 million that is in the discontinued operations.

John Guinee - Stifel

The third question it looks like you are going to be delivering Boca Raton at about $281 a square foot and your two Phoenix office buildings at $250 to $270 a square foot. Is that what it would cost you today or do you have a sense for what would be the cost for those buildings if you started them today? Those are awfully big numbers.

Bill Hankowsky

I think there are two pieces to that answer. One is land cost. So in both of those instances there were pretty decent land costs reflective of where the market was at the time. We acquired the land and then of course there is the construction cost. It is clear construction costs would come in lower today than they were in 2007 and 2008, probably 10-15% all in and would depend a little on the market and the nature of the building. The land costs are probably lower. So what I am saying is you sort of have to decide if I own the land and I am building a building in which case it would come in at 10-15% or am I going to the market to buy a piece of land and then putting a building on it and could I pick up a piece of land at somewhat lower basis than we had picked up this land historically.

Mike answered earlier and talked a little bit about the asset transactions. There are like no land transactions in the market so it is a little less clear what land pricing is right now but they would be less.

Operator

The next question comes from the line of Brendan Maiorana – Wells Fargo.

Brendan Maiorana – Wells Fargo

Just to follow-up on the pipeline there were some deliveries during the quarter but it seemed like on a stable basis the yields increased a little bit. I am just wondering what drove those numbers up?

Bill Hankowsky

The yields on what is still in the pipeline did go up and one of the factors as to why they went up is what was delivered at lower yields. So you basically had a numerator/denominator effect in what was remaining yield it went up. That is fundamentally what happened.

Brendan Maiorana – Wells Fargo

So there was no real adjustment in terms of the existing projects that were made in there? The yields held steady?

Bill Hankowsky

Yes. Fundamentally they held steady though just to remind you we do review them every quarter by cost and by where we think rent assumptions are and everything. So if we thought there was a need to adjust it we would. We don’t just keep them static. In this you are accurate in your conclusion which is in this quarter they basically stayed the same.

Brendan Maiorana – Wells Fargo

It sounds like for guidance next year you are not assuming any development starts. If you were to get a build to suit what would be the yield that you would look to do to kick start a build to suit next year?

Bill Hankowsky

That’s a good question. There again I am going to give you a thought process again but I am probably not going to give you a single number. As Rob indicated, we clearly have had people come to us with some interest in build to suits. We have told people that they might be surprised when we quote them a rent and we have gone through analysis and in fact quoted them a rent. A number of them have simply gone away or I can think of 3-4 instances in some cases bought an existing building or leased something.

Having said that though there continues to be this stream of requests to take a look at one. I think one way to think about it is to look at it as a standalone transaction with its own capital stack. So there was a question earlier about where is our debt today. So if our debt somewhere between 7-8 and would you do it 60% levered and would you do it for 40% equity? And where is our equity today? 14 or 15? Throw a number out there. So do a blended rate and you are 12-ish or something. What happens is you run the numbers. This is the part that I think may not come to you intuitively. You are going to come up with a rent and you are going to look at that rent and realize that rent is significantly over market and you realize if you went to a lender with that transaction and in fact tried to put a mortgage on it they are going to discount that over market rent.

So we need to be careful that what we are building is a value add proposition the day we finish putting the last brick on and the last piece of steel on. So in effect what you end up doing is redoing the capital stack and you are going to have more equity and less debt. Therefore that is going to push up your yield. So I think you are in the low teens is the kind of number I think you need to make sense. Now longer term, more credit tenant you might be lower double digits but I think it is going to be generally in the low teens.

Brendan Maiorana – Wells Fargo

I am assuming the rent required for a new build is probably somewhere around 20% or so above market. Is that sort of a fair ballpark?

Bill Hankowsky

It is really going to depend on what product in what market you are talking about. So an industrial building in one of the markets where the rents have held up better, yes maybe it is 15%. You could have an urban market where the market is a little tight and you might not find the spread as dramatic but yes there is going to be a definite spread. A double digit spread.

Brendan Maiorana – Wells Fargo

Bill, you have had turnover going back over the last couple of year’s turnover in the portfolio to kind of get that where you want it to be. Obviously in the past year or so there has been an adjustment of balance sheets across the sector overall. Do you feel like now you have your portfolio roughly at an equilibrium state kind of where you want it and where there will be some natural capital recycling that happens every year but nothing major and the balance sheet is where you want it? So as we kind of look at Liberty looking out growth will be based on overall market growth and then some development opportunities and some other external opportunities? Or are there some other major initiatives that maybe need to happen that would adjust that growth factor from the normalized level?

Bill Hankowsky

That’s a fair question but a big question so let me take a minute on it. You are right that our significant portfolio repositioning is behind us. Exiting Detroit and getting out of Charleston. We have talked in the past that there is some fine tuning of this portfolio we would like to do over time. We don’t feel in any way compelled to do this quickly. When I say that we probably would like to somewhat lower our percent of invested capital that is in suburban office. I am not saying we are getting out of it. I am just talking if we have 45% of our capital in it now maybe we would like to be at 35% but the way that can happen is candidly you have a denominator effect that as the portfolio grows otherwise and we don’t invest in suburban office; it simply shrinks.

We do think that as a prudent asset manager we probably should sell $200 million a year. Now we put out a lower number next year because we don’t need to sell next year and it ain’t the best environment to be selling in. In a normalized world you would be wanting to prune and take out assets that were obsolescent, in the long sub-market, that kind of thing. That is just going to have some natural number. You are right, it would have a run rate that wouldn’t be that consequential from the big picture.

Then from an investment side, and again I am talking longer term than 2010, but from an investment side we would like to have a little bit more invested capital in multi-tenant industrial and what we call metro office. I think you would see some subtle adjustment of the portfolio over time. From a balance sheet perspective we worked very hard and I give lots of people credit for this, over a period of time to have a great balance sheet going into this problem over the last year and a half. It clearly served us very well so we always believe in a conservative balance sheet and this environment has only proven to us more the value of watching that balance sheet. We look at a variety of metrics. We look at gross assets to debt. Leverage ratios. We look at coverage. We look at debt to EBITDA and a variety of metrics but I would say we like where we are at today. Sometimes we have put up 40% is not a bad number. If you think on leverage. That is not the only metric you should think of.

We are actually below that today. Our coverage ratios are higher. All those factors in the supplemental are very strong. Could we do a little bit more and stay within our tolerance? Yes. But as George mentioned earlier in the call what is the point of borrowing some money today and just putting it in the bank. So until we see needs for it and use for it, we think it is fine where we are right now. As I said, from that perspective our capital action is behind us and we have very modest activity next year.

Operator

The next question comes from the line of Dave Aubuchon – Robert W. Baird.

Dave Aubuchon – Robert W. Baird

What sort of job growth assumptions are implicit in your occupancy target for next year? As you mentioned we are still bleeding jobs. If we add zero net jobs in the U.S. next year do you think you would hit your occupancy target?

Bill Hankowsky

There are two questions there so let me first talk about the job assumption number and then the question about what do we think about the occupancy. Our opinion on this is that unfortunately we are going to see pretty timid job numbers. I think it is even conceivable we have one or two more months of job losses. I think earlier this year, not that I am an economist and I don’t get paid to do that, but our guess earlier this year was we might have 8 million jobs lost. We are at 7.3 I think so far. So conceivably we still have a couple of quarters of job losses.

Jobs might not go positive until the beginning of next year and I think you are going to see modest job numbers, the kind of numbers that don’t even keep up with population growth. There is sort of this theory of a natural job number just to stay even. As I said and this is important in our thinking, we do believe there is some amount of shadow space out there that will eat up demand even when it begins to happen. I think there is a quarter or two of lag in the office, even when the job numbers get better before you start seeing it turn into positive absorption.

So all of that net is we are assuming that we are not looking for job growth to significantly affect our occupancy next year. We are looking at this plus or minus 1% as a number that is consistent with where we see the world. If things got better sooner than it would obviously lift that.

Dave Aubuchon – Robert W. Baird

Is it fair to say then that any weakness you see in the office side would be made up on the industrial side?

Bill Hankowsky

Let me be clear. What we think happens on the office side is there will be some shrinkage. As Rob mentioned we have had a very good batting average on renewal rates so we think many people stay in place. We think the troubled tenant problem is behind us. We are not looking for blow outs. We think most people are going to hang around and renew. They are going to renew generally where they are. Sort of embedded in that is kind of a floor to your office occupancy. You are right though to the degree that trends down a tad as it has this quarter the office and flex would be the ones tending to offset it.

In fact, again to be candid it is one of the things we like about our model which is with the multiple product types we get this diversification that allows us to have a much more stable portfolio going forward and as various pieces of it kind of go through the cycle in different timing.

Dave Aubuchon – Robert W. Baird

On the development that you brought into service you mentioned in the press release there was 29% of this space signed. I am assuming post quarter end, is that correct?

Bill Hankowsky

No. This is the mechanics of the supplemental. The development pipeline page is on 18 I think. This shows you where the pipeline is on a signed basis. Page 17 which is showing you the developments that are coming into the portfolio are showing you on a commenced basis. So if those properties were actually in the pipeline still they would actually be at 51% signed but because they are going in and the portfolio is reported on a commenced basis we are showing you the impact it is going to have on our portfolio which is 22% commenced, another 29% signed, 51% overall committed.

Dave Aubuchon – Robert W. Baird

Any interest in reloading on the CEO program, the continuous equity offering program, just to have capital available if you happen to see opportunities or anything else?

Bill Hankowsky

I think the simple answer is that we are currently in a position where every capital source that might be tappable by Liberty is available. Could we do equity? Sure. Could we do unsecured? Sure. Could we do more secured mortgages? Sure. Could we sell some more assets than we talked about? Sure.

So we don’t feel compelled to stockpile cash for opportunities because we think if the opportunities arise we already have $200 million in cash, we have $460 million on the line. We have plenty of ammunition and we can reload that ammunition fairly quickly from one of those capital sources.

Dave Aubuchon – Robert W. Baird

Presumably you don’t want to have a higher debt level than you have right now, is that correct?

Bill Hankowsky

I didn’t say that. What I said was we are comfortable with where we are now but from the standpoint we run 2.5 coverage and we are at 2.7 now or something. We are at 38%. We have generally been between 40-45%.

George Alburger

We have generally been 41-42%.

Bill Hankowsky

We are a little bit below where we generally are but we don’t feel compelled to go get to that number just to put the money in the bank.

Operator

The next question comes from the line of John Stewart – Green Street Advisors.

John Stewart – Green Street Advisors

I think you referenced that the bankruptcy settlement ran through the P&L as an operating expense credit. Did that run through the same store expense accrual as well?

George Alburger

Yes.

John Stewart – Green Street Advisors

What was the 13.9% rent roll down you gave on a GAAP number. What would that have been on a cash basis?

George Alburger

19.

John Stewart – Green Street Advisors

You laid out about $200 million worth of cash uses next year between development and debt maturities. I presume most of that will probably be funded with cash on the balance sheet but I don’t think you really referenced what your forecast or guidance for next year is in terms of interest rates. I understand the balance on the line of credit is pretty small but what are you anticipating on the interest expense front?

George Alburger

That has changed. Right now I told you our credit facility we know it matures in January 2011. We said we wouldn’t wait until the end of the year to address it. So for purposes of modeling you have to put something in there and we put something in there with respect to modeling it. Right now our credit facility all in with spreads and facility fees is 80 basis points over. Nobody is doing facilities 80 basis points over anymore. They are 300 basis points over. That 300 basis points over is probably tighter than it was six months ago. Facility fees are going up. Spreads are going up. So you have those combinations. I mean we have a number that is less than 5% is what we are forecasting that we think all in will come in our number.

Operator

The next question comes from the line of Michael Bilerman – Citi Financial.

Michael Bilerman – Citi Financial

I am just wondering if you can talk about the tone of your conversations with your existing tenants? Any tenants coming back to you looking for some rent relief saying look the rents are down 15% in the market and I want to renegotiate my rents?

Bill Hankowsky

I think the simple answer is no. Not really. There was a flurry first quarter into second quarter this phenomenon you heard a lot where the buzz was blend and extend where people would come in and talk about a lease that was expiring in 2010, 2011 and 2012 and say I will give you a couple of years return but give me today’s rent today. There were instances where we took a look at that and some of those we did. Generally on leases that were in 2010. We weren’t going to speculate where the world was going to be in 2011 and 2012 and go that far out.

There is basically none of that activity right now. We really aren’t having people knock on our door and say hey the world has changed, cut me a break. In general we probably wouldn’t be particularly responsive because we doubt they would be receptive to us coming in when rents go up and say let’s renegotiate and give us more rent. So we think that is sort of the fairness of a business transaction.

Michael Bilerman – Citi Financial

Are you sort of hesitant to sign longer term leases now just given the lower rent?

Bill Hankowsky

Not necessarily to be candid. I think you make judgments about the quality your tenants. Rob mentioned in his remarks if it is a renewal there is very little TI and we can get somebody to sign for three years in industrial and five in an office. We are not particularly hung up about that because candidly we did it this year and we think 2010 is a rough year. And, to be blunt, there is 800,000 square feet of vacant space in the existing development pipeline and about 8 million in the core so we have a lot of opportunity to make money in the future on better rents with the existing portfolio vacancy and candidly we have 10-12% of the portfolio rolls every year. So when it is rolling in the good years we are going to enjoy the benefit of that. I would be hesitant to just park space on the sidelines for an extended period of time and pay the [OEs] to wait for better rent.

Michael Bilerman – Citi Financial

Looking beyond 2010 at what point do these rents finally turn?

Bill Hankowsky

I think you might see some industrial rents turn in some markets in 2010.

Michael Bilerman – Citi Financial

How about office?

Bill Hankowsky

I think office is late 2010 or 2011. It is out there somewhere. I think they are stabilized but I don’t think they are turning soon.

Operator

The next question comes from the line of Stephen Kim – Macquarie.

Stephen Kim - Macquarie

To follow-up on a previous question regarding your credit facility are you assuming that if you refinance your credit facility or renew it, I should say, that you are going to swap it out?

George Alburger

Not necessarily. No. We have very little in the way of floating rate debt. To some extent our credit facility has fulfilled if you will the floating rate debt component of kind of a debt balance sheet.

Stephen Kim - Macquarie

In terms of your guidance you quoted I think 10-15% decrease in 2010 rent rollovers. Implicit in that guidance what are you projecting in terms of market rents? Are you projecting an increase in market rents?

Bill Hankowsky

You mean cash rents?

Stephen Kim - Macquarie

Not what actually rolls over but the average market rent.

Bill Hankowsky

This quarter is showing you what we have been talking about all year which is rents are down in the market and here they are now you see it manifests itself in commenced leases this quarter. They are down markedly. We think they stay down. We don’t think they go down more in 2010, materially more. So what you are seeing in the guidance is that those market rents as they roughly are today would be the rent we would be experiencing as we do replacement leasing. It is somewhat better on renewals because you have a tenant in place and there is sort of a tradeoff in them not having to move, etc. Fundamentally we are sort of in an L phenomenon. We came down and now we are in the stabilized lower level going forward.

Stephen Kim - Macquarie

But isn’t it correct to assume if market rents don’t change going one year forward the mark to market on these rollovers gets worse in 2010 because you are coming off of higher lease rents from 2006 and 2007?

George Alburger

That is what we gave you in the guidance. That is already baked into the spread numbers we gave you. In other words as Bill mentioned earlier that we do a pretty exhaustive space by space analysis so the rents that are rolling out is kind of baked into the numbers we are giving you.

Operator

The next question comes from the line of Jordan Sadler - KeyBanc Capital.

Jordan Sadler - KeyBanc Capital

Can you give us a breakdown of what the impairment was on? Was that more the assets or the land piece of the sales?

George Alburger

The modest $300,000 was land related and the rest of it was for buildings. That is in discontinued ops.

Jordan Sadler - KeyBanc Capital

Was there any more of a tilt towards one asset type or another or is it just…?

George Alburger

It was primarily one asset.

Jordan Sadler - KeyBanc Capital

Industrial, flex?

George Alburger

It was in industrial. It was a little bit of a quirky situation. I wouldn’t take it as anything much about pricing of industrial real estate.

Jordan Sadler - KeyBanc Capital

You gave obviously your rent decline guidance but what are you expecting for cash same store NOI for 2010?

George Alburger

Cash and straight line they are generally, I know there is a spread this quarter but sometimes they are right on top of each other because the cash NOI has the benefit of rent bumps.

Jordan Sadler - KeyBanc Capital

So it is going to be pretty similar to the down benefit?

George Alburger

Yes. It is never the exact same number. It bounces around.

Jordan Sadler - KeyBanc Capital

Just to clarify, the 10-15% lower that was your GAAP same store NOI projection?

George Alburger

10-15% lower in rents was a straight line to straight line comparison, yes GAAP.

Jordan Sadler - KeyBanc Capital

Looking at your expirations for 2010 could you give us a sense of some of the talks you have been having on the office side. Particularly in the Northeast I think you have that 1.5 million to 2.7 million expiring in that market.

Bill Hankowsky

Out of the very large expiring leases next year we are in discussions with everybody. A number of them are very close to being wrapped up and renewing. So out of the top 20 size leases and this includes office and industrial, I am just talking size of transaction for next year 17 of them are currently in the will-renew column. They are not all documented and done but they are proceeding fairly well.

Jordan Sadler - KeyBanc Capital

In terms of timing, on the office ones, are those more front half loaded or are they pretty spread throughout the year?

Bill Hankowsky

They are spread throughout the year. In some cases what happens is you get into dialogue and you actually don’t wrap it up until closer to when it actually expires. Sometimes people are happy to document it all and do it. Some have internal processes which there is one I am aware of which is on that list that we basically have a full done deal and it is just going through those internal approvals but those internal approvals take about 60 days.

Jordan Sadler - KeyBanc Capital

On the potential line renewal are you assuming mid-year in your guidance?

George Alburger

Generally mid-year. Yes.

Operator

The next question comes from the line of Dan Donlan – Janney Montgomery Scott.

Dan Donlan – Janney Montgomery Scott

I am curious what you are seeing in the markets. I know in the past you had mentioned that Jacksonville and Richmond were kind of weaker because of their back office exposure. I was just curious if you have any additional color on some of your markets.

Bill Hankowsky

I think in terms of color I would make a distinction between industrial and office. I think on the industrial side for example we are seeing somewhat higher activity in the Lehigh Valley market third quarter versus beginning of the year, really if we just look at showings and prospects, etc. Chicago feels like it has picked up in terms of activity although it has had a really rugged year so it has got a fair ways to come back but I do think activity level has picked up there.

This kind of goes to the comments about industrial coming sooner. I don’t want you to think it is all back. If we track showings, prospects, proposals out there is somewhat of an uptick there. If you look at the office side I think what we are seeing is what we talked about earlier this year which is Richmond remains rugged with Jacksonville, I would put those together. I think for example Virginia Beach is doing better, seeing a decent uptick in activity. I think Minnesota has seen somewhat of an uptick. So maybe that is helpful.

Operator

The next question comes from the line of Michael Odell – AIG.

Michael Odell – AIG

Just a follow-up of the line renewal. Just curious what the capacity of the new line would be.

George Alburger

It is not fully baked yet. We presently have a $600 million line facility and that line facility was what we used when we had a $1 billion development pipeline and were pretty active on the acquisition front. So I don’t think we need a line quite that big. By the same token it was perhaps a little bit more easily refreshed over the last couple of years. So we are looking at a line maybe in the $400-450 million range.

Operator

There are no further questions at this time. I turn the call back over to you.

Bill Hankowsky

Thanks Kim. I want to thank everyone for listening in and all your thoughtful questions and I hope everybody enjoys the World Series. We will be watching closely. Thanks.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: Liberty Property Trust Q3 2009 Earnings Call Transcript
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