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Duke Realty Corporation (NYSE:DRE)

Q3 2009 Earnings Call

October 29, 2009 03:00 PM ET

Executives

Randy Henry - Assistant Vice President, Investor Relations

Dennis D. Oklak - Chairman and Chief Executive Officer

Christie Kelly - Executive Vice President and Chief Financial Officer

Robert M. Chapman - Chief Operating Officer

Analysts

Jamie Feldman - Bank of America

Sloan Bohlen - Goldman Sachs

Brendan Maiorana - Wells Fargo

Paul Adornato - BMO Capital Markets

Michael Knott - Green Street Advisors

Operator

Ladies and gentlemen, thank you for standing by and welcome to Duke Realty Quarterly Earnings Conference Call.

At this time all participants are in a listen-only mode and later we will conduct the question-and-answer session with instructions being given at that time.

(Operator Instructions)

As a remainder, today's conference is being recorded. And I would now like to turn the conference over to your host Mr. Randy Henry, Assistant Vice President of Investor Relations.

Please go ahead, sir.

Randy Henry

Thank you. Good afternoon everyone and welcome to our quarterly conference call.

Joining me today are Denny Oklak, Chairman and Chief Executive Officer; Christie Kelly; Executive Vice President and Chief Financial Officer; Bob Chapman, Chief Operating Officer; and Mark Denine, Chief Accounting Officer.

Before we make our prepared remarks today, let me again remind you that statements we make today are subject to certain risk and uncertainties that could cause actual results to differ materially from expectations.

Some of those factors include our continued qualification as a re-general business and economic conditions, competition, increases in real estate construction costs and interest rates.

For more information about these risks, we refer you to our 10-K that we have on file with the SEC, dated February 25, 2009.

For our prepared remarks, I'll turn it over to Denny Oklak.

Dennis D. Oklak

Thank you, Randy. Good afternoon everyone and welcome to Duke Realty's third quarter earnings call.

During third quarter, we continue to make significant progress to address near term debt maturities, our overall leverage. We've been able to take advantage of opportunities in the capital markets when they arise, which is a testament to our finance and legal team and the strength of our company.

On today's call, I want to provide some thoughts on the current real state cycle and how we are aligning our business strategy for future growth. We'll also provide an overview of the third quarter performance.

Christie Kelly will provide an update on our financial performance, capital markets and financing activities as well as our real state valuation results.

Then Bob Chapman will provide some views on the overall industrial and office markets, highlight activity in three of our major markets, and then discuss our portfolio occupancy and significant transactions during the quarter.

And finally, I'll summarize our performance outlook for the rest of 2009. Things were certainly more positive during the third quarter. REITs are successfully accessing the public capital markets, GDP forecasts are improving versus previous months. Inventories have been at historic lows and it appears that inventory levels may need to restock sooner even with flatter marginal retail sales increases.

There have also been improvements in recent estimates of shipping and trucking volumes, which are further indicators that we are moving in the right direction. The eventual side of our business historically has rebounded more quickly than office from cyclical downturns.

We are seeing similar trends in our portfolio this cycle too. As Bob will touch on later, we have recently began to see activity in some of our industrial markets and we are benefited from consolidation into some our larger distribution facilities.

On the office side of our business, we anticipate a slower comeback than industrial as unemployment rates are forecasted to be in the 10% plus range and are expected to remain there well into 2010.

Uncertainty remains as to when the stimulus towers will take affect into what degree, we are seeing our office tenants looking to renew and extend leases with rent concessions in early years, but with less capital requirements from us in return.

We evaluate the economics of these blend extend and don't spend transaction on a deal-by-deal basis to maximize profit ability ensure alignment with our long-term business and asset strategy.

With respect to the third quarter, results were inline with our expectations. Same property NOI that three month period was down by 5.6% compared with the same period last year.

Same property NOI was down by 0.5% when compared with the 12 month a period ended September 2009 and 2008. Specifically approximately 2% of the overall 5.6% decrease in our three month same property performance is attributable to the blend extend and don't spend renewals I mentioned. We still project year end same property will be a decrease of 2 to 3% year-over-year inline with our original expectations.

Third quarter activity picked up significantly in September at several major transactions in our industrial portfolio were signed.

As a result of our solid September, our overall occupancy only decreased by 41 basis points during the quarter from 87.44 to 87.03%.

Occupancy and our same property portfolio held up well on the industrial side at 90.8%, but we experienced some stress on the office side as same property occupancy decreased to 86.5%.

While our occupancy has dropped since last year and last quarter, performance was inline with expectations. The impact of recently developed assets, which have been in service for over one year, but have not yet leased up to stabilize occupancy at 90% are dragged on the overall stabilized occupancy.

On the positive side, these assets were generated approximately 50 million of future earnings from lease up to stabilization.

These assets with one of the earnings growth drivers we look to in 2010 and beyond. This embedded NOI growth will contribute to our goals of driving for income growth while further improving our debt coverage and other leverage ratios.

Christie will be providing color on the details of our impairment charges recognized in the third quarter. But I want to address the strategic refinements we've made, which ultimately triggered the majority of these charges.

We are now to planning to more aggressively market per sales certain of our undeveloped planned inventory inline of lower anticipated development by, because we are significantly reducing our focus on merchant building. We will also have targeted non strategic property dispositions, further aligning our focus on high growth markets with an emphasis on industrial and medical office. Our decisions caused the change in the intended use of some of our land and buildings were evaluated them accordingly and recognized impairment charges were appropriate.

Moving forward, we remain focus on deleveraging our balance sheet, leasing our recently placed and service development projects and executing our operating strategy in order to drive core operating income and continuing to offer our customers and investors quality services and returns.

I will now turn our call over to Christie.

Christie Kelly

Thanks, Denny and good afternoon everyone.

As Denny mentioned, I would like to provide an update on our financial performance, discuss our valuation results including impairment and other non-cash charges recognized in the third quarter and give an overview of our capital markets and financing activities including an update on the renewal of our credit facility.

Now I'd like to spend a few minutes on third quarter operating results. Reported FFO per share for the quarter was a loss of $1.2, which includes the loss of a $1.28 per share from $297.1 million of impairment and other non-cash charges as well as a loss $0.06 per share from 13.6 million of losses on debt transaction completed during the quarter.

Excluding these items, FFO from operations was $0.32 per share inline with our expectations and above consensus estimates of $0.31 per share. This quarter as I mentioned previously as we reported last evening, we've recognized 297 million of impairment and other non-cash charges, primarily as a result the changes in our operating strategy as Denny mentioned. For assets we intended to sell given refinance in our strategy, we evaluate from impairment using estimated create value.

If assets were intended to be how longer term in alignment with our strategic objectives, we analyze through impairment by comparing our cost basis to the undiscounted cash flows over the entire holding period including our disposition values.

We completed a comprehensive review our land conditions. We identified non strategic -- for disposition with the carrying value of 385 million and recognize an impairment charge of $132 million or 35% of the carrying value of the land was identified for disposition.

There were no impairment charges taken from land positions that we intend to develop based upon development models using undiscounted cash flow. Also, we intend to sell, we've taken an impairment charge of $70.7 million. As part of the review of both our holding out in joint venture real estate assets, we reviewed our investments in unconsolidated entities.

During this review, we determined that the carrying value of our investment and 3630 Peachtree office project in Atlanta was impaired and a charge of $14.4 million was recorded to write-off our entire investment to gain in this project.

We now anticipate an increase in the total estimated project cost as a result of extensively sub periods with higher concessions. As a result of these higher costs, we also recorded a contingent liability and related impairment charge of $36.3 million related to our guarantee obligation to the lender on the project.

While impairment charges have been recorded, we are working diligently with perspective tenants to lease the space and still believe this is an excellent project and will be successful in the long-term.

We also recognized $31.4 million of charges for the write-off of other real estate investments and for pursue cost and development projects, which we no longer plans to start.

We also established the $12.3 million valuation allowance against differed tax assets in our taxable subsidiary. As a result of our strategic decision to asset our merchant building business.

Now, I'd like to summarize our capital liquidity achievements during the quarter. In August, we successfully completed by 500 million unsecured bond offering consisting of 250 million 7.5 notes due 2015 and 250 million of 8.38 notes due 2019.

We are pleased with the timing in the execution of this transaction and the excessive by our investors in the market, today are expected to come in about 50 to 75 basis points since the offering. On a secured side in July, we closed 114 million ten year loan interest only at 7.75%. We have executed 279 of secured deals in 2009 at very attractive rate.

We currently do not intend to pursue any additional secured loans in the near term. Upon the closing of the unsecured offerings, we have about 535 million of cash on hand to retire near term debt. In late August, we repurchased on the 207 million of 2011 convertible bonds and the open market is 2.2% discount. We then successfully executed 145 million tender offer for a portion of our 2009, 2010 and 2011 bonds.

All of 2009 and 2010 bonds will be retired with the remaining cash we have on hand. As a result of our unsecured and secured financing activities, we recognize that 13.6 million loss for the quarter. 6.5 million of this amount was related to a great uptick on the 280 million secured loans that we are working on.

The remaining losses of $7.1 million or a combination of premium pricing paid on the bonds purchase is the tender offer and GAAP losses associated with the repurchase of our convertible notes.

With disposition market continued to be slow, with all 96 acres of undeveloped non-strategic lands for proceeds of 13.6 million and no buildings. Although, we didn't execute the building sales during the quarter, we anticipate closing on about 150 million of additional dispositions during the fourth quarter.

We also have the strong backlog of projects that will close in 2010. We remain focused on our goal as 300 million of asset disposition this year and our fleets with the progress our disposition team has made.

Today, we have raised in 1.5 billion of capital and the balance on our 1.3 billion credit facility is now zero. We are making progress on the renewal of our credit facility. We've met with all of our partner banks at the beginning of October and two days have we seen FERC commitments from our lead bankers for over 80% of the projected capacity of our facility.

In summary, our terms include an 840 million projected facility, a ray of LIBOR plus 275 with a 50 basis point facility team, no LIBOR floor and I'm happy to report 39 months to February 2013. We expect to close mid-November and are very pleased with the support we are receiving from our banks and with the progress we have made to get the renewal completed before the end of the year.

And now, I'd like to turn it over to Bob Chapman for an update on our market and third quarter occupancy and leasing activities.

Robert M. Chapman

Thanks, Christie.

I'd first like to give some highlights on what we are seeing nationally with respect to the fundamentals and demand in the industry and office markets. Then discuss specific thoughts on our Atlanta, Dallas and Indianapolis markets and finally talk about our quarter end results.

Overall, operating fundamentals on both the office and industrial side remain difficult; or on the industrial side, we have seen some pick up in activity across the system during the past couple of months.

As Denny mentioned earlier, increases in shipping and trucking volumes from the previous flows, our initial positive, but we believe we still have long way to go in the recovery process.

As you look at suburban office from a national perspective, operating fundamentals continue to be quite impacted by job losses and moderate supply still coming online. Vacancy rates have risen with further negative absorption expect to be continue in the 2010.

At Duke, we've successfully perused early renewal opportunities and extended least terms as Denny mentioned. Our strong balance sheet is keeping us involved in deals as the brokerage community recognizes our ability to raise capital.

Now to give you a better idea of what's happening in our markets, I wanted to briefly discuss Dallas, Atlanta and Indianapolis as I believe these three give a good view of what we are seeing across our different geographic locations and different product types. I'll also show some highlight from our medical office activities.

First, let's look at Dallas. On the both distribution site, the Duke portfolio consists of approximately 12 million square feet in service, that's about 75% leased as of September 30. I'd like to point out that the occupancy is somewhat skewed by the fact that we have nearly 3.6 million square feet of product, representing six new buildings that have been serviced for over one year and are currently 50% leased.

These assets are located in four different sub markets across the Dallas, Fort Worth area and we developed over the past three years. Year-to-date, net absorption in Dallas industrial market is a negative 5.5 million square feet and overall vacancy is 12.7%.

This market has experienced over building and supply is definitely driving pricing downward. Rents are down 20 to 30% year-over-year, and it's not unusual to see free REIT of upto 12 months for long-term credit tenants. Deals have been getting done in the 250 to 600,000 square foot range.

At Duke, we signed leases -- we signed 800,000 square feet in September including a 400,000 square foot and a 260,000 square foot lease both with quality credit tenants. Additionally, we've seen a pick up in activity since August and signed 850,000 feet in September.

On the office side in Dallas, we have 645,000 square feet in service that are approximately 75% of leased as of September 30th. Year-to-date net absorption for the overall Dallas market has been only 160,000 square feet and overall vacancy has increased to around 20%.

From a rental rate standpoint, the office markets actually held up better than industrial with rent reduction of only 10 to 15%, but we see more recent deals carry short for rent reductions. Our Duke team has executed over 300,000 square feet of office leasing this year in Dallas.

Now turning to Indianapolis, where we have over 19 million square feet and service stabilize bulk industrial product, which is almost 95% leased at the end of the quarter. This is one of our strongest industrial markets as overall vacancy for the Indianapolis industrial market is around 8%.

Despite overall negative absorption in 2009 year-to-date of 2.4 million square feet, Duke has been able to hold our occupancy and execute over 700,000 square feet of new leasing and 1.7 million square feet of renewals.

New product rents have dropped 10 to 15%. On the office side in Indianapolis, we do catch approximately 3.1 million square feet of end service stabilized product, which is 89% leased as of September, 30. From a rent standpoint, office rents have held up better than industrial with the year-to-date absorption and negative 287,000 square feet on suburban office product.

Most two deal start was six months pre-ramp. Our office team has done a good deal activity this year with several leases in the 20 to 35,000 square foot ranged sign in 2009.

Finally moving south from Indy, the Atlanta market is one of our largest office and bulk distribution markets. Looking at bulk distribution product first, Duke has over 8.5 million square feet of stabilizing service product that's nearly 86% leased as of September 30th.

Absorption year-to-date for the overall market has been a negative 4.4 million square feet, but there was positive absorption of 143,000 square feet in this last quarter, the first positive absorption since the first quarter of '08. Vacancy rates are around 13%. We have noticed that activity in the big blocks market has begun to pick up since last year with several potential deals over 200,000 square feet currently in the market.

Duke's strong balance sheet is keeping us involved in the deals as a brokerage community recognizes our access to capital that we had in 2009. On the office side in Atlanta, Duke has a 4.1 million square foot in service stabilized portfolio with 86.5% leased. The office markets have been particularly hard hit in this cycle with negative absorption for all three quarters this year and occurred overall vacancy rate of about 19%.

As Christie mentioned, we reflected the top marketing conditions in our impairment charges taken on the 3630 Peachtree joint venture. In our suburban market, rents are down 10 to 15% with free rent of one month per year common concession.

Duke's team has completed more transactions this year-to-date than in all of 2008 and we have very few large stocks of vacancy in the portfolio.

Also I want to address our medical office product for a moment. We currently have a portfolio consisting of 17 in service building totaling 1.7 million square feet that are 80% leased as of September 30th and seven buildings totaling 1 million square feet under development, which are 85% pre-leased.

We are pleased with the performance of this portfolio and believe we are well positioned to grow this business. Specifically, our existing product is well leased. We have an excellent team with strong relationships, with leading hospital systems. Our focus on on-campus medical office has high entry in our main competitors and private developers, we're finding capital skills and are having difficulty competing for new development projects.

In terms of the overall total business highlights, I am pleased to report that our renewal percentage was 85% during the quarter. Our blend and extend and don't-spend approach Denny has mentioned has been well received as we work with tenants to provide rental leave more practical and at the same time, limit our capital expenditures.

An example during the quarter is in Hawaii (ph) where we are able to renegotiate and extend over 500,000 square feet of office space leases covering two large existing tenants. While we did reduce the rent slightly during the next 12 or so month, we were able to be extend for another approximately 10 years with little or no CapEx.

In doing so, we've added significant value to the portfolio in the process. At quarter end, the wholly-owned development pipeline overall consisted of only 10 properties comprising 1.4 million square feet, which were 92% pre-leased with an anticipated yield of 8.5%.

These projects required an approximately $71.1 million of additional complete, which we factored into our liquidity analysis, which is included in our supplemental package. We also have three joint venture projects under development. We're in ownership interest of 50%. The estimated project cost for these properties is $338 million with nearly $95 million yet to be incurred.

With that I'll turn it back over the Denny.

Dennis D. Oklak

Thanks Bob.

The third quarter was another successful quarter for us in terms of raising capital and improving our balance sheet. On the property operations side, we continue to focus on renewing and extending our existing tenants and funding new tenants to fill our recently developed assets.

We are reaffirming our 2009 guidance for FFO per share in a range of a $1.42 to $1.64 as adjusted for the additional shares issued in the April 2009 common stock offering. As previously discussed in the second quarter, this is anticipated that FFO per share will be at the lower end of the guidance based upon current expectations of leasing volumes and timing of potential fourth quarter transactions.

Furthermore, as we look to the fourth quarter, in 2010, it's going to remain tough, but we are beginning to see signs of recovery, the impact of the recession is still being felt by our industry and still filtering to our portfolio.

I'd also like to again remind you there are guidance includes a deduction for severance cost, but assumes no gains for the sale of development properties or land. This includes no-income or loses recognized on the debt transactions and also does not include the affects of impairment or other non-cash charges.

So with that, I will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from line of Michael Bilerman of Citi. Please go ahead.

Unidentified Analyst

Hi, it's Josh Adie (ph) with Michael. Could you tell us a little bit more about the land that was impaired in terms of its location and the year it was acquired? And then also kind of tell us about the lends you're keeping and those characteristics for lends are keeping?

Robert Chapman

Yes. Josh, I think you're familiar with our land portfolio, and we really have land on both the office side and the industrial side in all of our markets. And we went through and took a look at all of that land and decided what we really wanted to hold lost term for development and what we didn't.

And the land that we identified for sale is really all over the board. I mean it's in all of our markets. It's for example in a market we have two or three industrial developments. We might have decided to sell one and focus on the other two.

So -- and again, I would say that the land that we've identified for sale has also been acquired again across 10 years plus. So some of its newer lands, some of its older land, a good chunk of it is where we have very small parcels left, we just want to get those parcels move, so we are looking at today's market price, just to clean that up.

Unidentified Analyst

What's the basis of the land that was impaired versus the land that you held?

Robert Chapman

As we said in the remarks, the basis of the land that we evaluated for impairment was about 385 million. So that's the land that we intend to try to move here as quickly as we can. And then the rest of our land that we're going to hold for development, so that is about 400 to 500 million on the wholly owned side and about 200 million on the joint venture side.

Unidentified Analyst

Christie, just walk through the Peachtree impairment relative to, I guess, what you've taken, what you've invested in the venture. At least looking at the supplemental on page 31, 50% interest in 85 million I guess you're partly taking a per vision for future spend, does that not only writing off what you have, but a future amount?

Christie Kelly

That's right. What we did is we wrote off what we had in the project today for $14.1 million as we communicated. And then as a result of you know what we are seeing on the project and the future economy, we also incurred 36.3 million of charges based on what we think will be putting into the projects going forward and also based on our obligations to our lender on the project.

Unidentified Analyst

Yeah. You know when to walk away from it.

Robert Chapman

The 36 million is guarantee that we have of the construction loans.

Unidentified Analyst

And then after that point, if there's another dollar to put in you are going to walk away?

Robert Chapman

No, not necessarily. We just -- we know that we are obligated to put in whole amount and when you look at the projects and what we now think is going to cost and what we think the value will be upon the project completion. We just felt like that money that we are going to have some put in and have already put in and potentially have to put in through the guarantee is impaired today.

Christie Kelly

And I think the other things too, I'd like to stress, which we were really trying to reiterate in our previous remarks is that we've got a great team there focused on this project and working really diligently to lease the space up. We believe in the project gets a excellent building. And we think it's going to be successful in the long term.

Unidentified Analyst

Thanks and just one more question separately: how are the bad debts trending? Remember those, I think the last quarter that you were concerned about? How's that trending versus last quarter?

Christie Kelly

Yes, the bad debt -- I'm happy to say we're seeing trending down. Historically we've had average run rate of about 25 basis points, which increase in after second quarter to about 150 basis points. And we've seen a significant decline in third quarter and expecting that to be around 75 basis points this year.

Unidentified Analyst

Thank you.

Operator

Thank you. And next to the line of Chris Keaton (ph) with Morgan Stanley. Please go ahead.

Unidentified Analyst

Hi good afternoon. My questions on the disposition plan, you've been in the market and I wanted to hear what the recent trends you're seeing, how that kind of shapes how you look at 2010 specifically if that's your interest on office versus industrial sort of things.

Christie Kelly

Sure, Chris this is Christie. First, I'd mentioned previously that for third quarter we didn't close any buildings sales for the quarter, but we did have some positive experience on landed positions. The other thing I'd just like to report is as of the month of October we closed another 15 million in proceeds for another deal. And we're working on closing another 120 million by December. And a majority of those transactions are under contract. And we have buyers that are very anxious to sell for various products to buy purchase for various reasons by this year, by the end of this year.

The other thing I'd like to say is our team has just been doing a phenomenal job. Because of the focus on these the sales of these non strategic assets. We also have a number of transactions that are lined up for 2010 to close, and so we are on track for a 300 million of disposition for this year and are also comfortable with 300 million for our next year based on the statistics that we have in front of us today.

And the kind to get those -- the composition dispositions, a number of those are the properties that we originally developed and intended to sell. There is a couple of building suite projects that are being sold into our CBRT joint venture and then again our strategic focus on disposition is really to downsize sort of our Midwest office markets, where we have some older assets and we are working our ways through those also.

Unidentified Analyst

So it sound like and then there is a portion of land in there that the remaining value after the impairment something I guess in the mid-200 is that right? And that wouldn't be yielding anything, just thinking about the yield on or your dispositions in 2010?

Robert Chapman

That's correct.

Unidentified Analyst

And last follow-up question here: has the tenure of your discussions and negotiations with buyers, how's that involved over the last few months; has the debt markets have opened up somewhat, is that improved in your mind?

Robert Chapman

Yeah, I would and it's definitely improved. When you look back through the first part of this year, I would say the first half of this year, things were very, very slow on a disposition side, Now, it's picked up, but I will say of all the dispositions that we have wind up and basically all of that we've executed this year -- basically none of the buyers are using debt. They're all cash transactions, because again when you look at our dispositions, these are one-off dispositions anywhere in 10 to $30 million range. And the bank debt for single asset of financing is still just not available out there today. So substantially everything we're selling is all cash buyers of one form or another.

Unidentified Analyst

Thank you.

Operator

Is that it?

Unidentified Analyst

Yeah, that's it. Thank you.

Christie Kelly

Thank you.

Operator

We'll now go to the line of Jamie Feldman and Bank of America. Please go ahead.

Jamie Feldman - Bank of America

Thank you very much. Denny, I was just hoping you could give us a little bit more color on the strategy. I mean is it beyond selling none core land, I mean are we thinking in terms of new markets or how should we think about the company two or three years out?

Dennis Oklak

Jamie, we really are thinking about any new markets right now. We're really focused on a market's that we are in and operating in today, which is about 90 or 20 markets today. And we're very pleased with the profiles that markets we are in. Again looking forward on the strategy as I mentioned -- we're looking to downsize the overall land position, because we just don't really see us getting involved to the extent we were on the merchant building business. I think that's going to change in my opinion anyway for publicly traded REITs and then end and our development by who is going to down, because a lot of that land we're reducing within the merchant building business.

So we are keeping the land that we see as good developed land that we want to build products on as hold for the long term and we've identified those parts in each of our cities. We want to do that, and that's the land we're holding for both obviously. I think in the near term on build the suite projects that we will chase on the land and a long-term just inventory developed product, but which is obviously much further out.

Then as far as the asset strategy, we are focused on reducing our overall suburban office in definite again because primarily that most of that is target disposition in that area are older, less functional product and a lot of that is located in our Midwest markets. As you know, we still have some assets to sell in Cleveland, which is the market we've really executed.

But we've still got a few assets there. Long term, we're focused -- as Bob said, very focused on increasing our investment in the medical office portfolio. We're seeing some good opportunities there. There continued to be some good development opportunities that we are working on and as you know we have several projects under development right now.

And then we are going continue to focus and grow our bulk industrial. When you look at our targeted disposition, a list that we have out there today others almost know industrial product on that less, because we have really excellent bulk industrial portfolio over that.

Jamie Feldman - Bank of America

Thank you. And then in terms of and your comment at the begin of the call about inventories being low. When you talked to your tenant base and potential tenants in the market. Were they thinking in terms of where inventories need to recover due to see real new demand, and this will kind a growth?

I mean we are starting from a very low base, so the question is what kind of growth do we really need before all the slack and warehouse gets taken out and you do need there is incremental demand? I am just trying to get my head around that.

Dennis Oklak

Well, let me answer that first and than Bob can chime in also. But we're not seeing, I don't think there is a lot of slack in the industrial portfolio today. In others words, vacancies are up a little bit for their historic norms. Normally, the bulk industrial product run somewhere between five and 8% vacancy at the most, it's a very high occupancy product type, and today that occupancy not just in our portfolio, but I think if you look across the board is more -- the roughly 10% range in most of our markets.

But that 90% that is leased, the tenants are really using that space. Say, what we've seen is people are actually shopping more products into the space that they have and then just either downsizing their space, but keeping the same of amount inventory there. So, I think the space that is leased today for is pretty well occupied, so as those inventories pick up, I believe that will translate relatively quickly some increased occupancy in all of the markets.

Bob, your thoughts?

Robert Chapman

Well, I'd just add that kicking the tires in various markets like the ones I mentioned, Dallas, Atlanta, Indianapolis, I just echo the usage of the space on the industrial side is strong. Not only on the bulk side, but also the light industrial, the 50 to 100,000 square foot users. It seems like its higher space utilization then as an example on the office side, where you actually kick the tires on that, you can see what people aren't using as much space.

Dennis Oklak

Jamie, the other thing I would add on the industrial side that our strategy has been to go to the larger bulk industrial buildings over the last few years, and our new development has been in larger buildings I would say from 500,000 square feet and up above that. We have benefited in this most recent cycle here from having those larger warehouses, because we've had several tenants that have consolidated several smaller warehouses into one of our larger bulk distribution facilities. But again the efficiencies and generally speaking, the larger spaces on a per-square foot basis you have lower rent. So, we benefited from that and several instances I know as 12 months.

Jamie Feldman - Bank of America

Okay. Thank you.

Operator

Thank you. And next we go to the line of Sloan Bohlen of Goldman Sachs. Please go ahead.

Sloan Bohlen - Goldman Sachs

Hey, good afternoon. A question for Denny and probably Bob as well. Just on the leasing environment, couple of the -- we've heard from this year so far, I've spoken about stabilization in rents probably mid-next year at some point. What kind of sign push we look for in your market growth and the industrial and office, will that be a shortening of concessions or are there any markets we already seeing that today?

Dennis Oklak

Bob, I'll let you.

Robert Chapman

Yeah. Sloan, its use of -- the concessions are usually the first indicator and a lot of times the page rents are good indicator, but there are several of our compotators that are out there dropping face rates at historic lows. So I wouldn't consider that to be the best indicator. I think the indicator like I mentioned in Dallas with the free rent also at Atlanta. I think that's probably going to be the better indicator than phase rates.

Dennis Oklak

Right. And I think my perspective would be that I think in most of our markets especially I would say most of the Midwest markets the industrial business is held up really pretty well, because there was just not lot of both building, polled by that with the possible exception of Chicago.

I think all the larger cities that we operate in being Chicago, Atlanta and Dallas, there is -- in all three of those cities, there has been some amount of over building on the industrial side. But the rest of the Midwest markets have held up pretty well.

And there hasn't been a whole tremendous pressure on rents. There's always some in the down cycle. And slightly that you could easy see stabilization on rents by early to mid next year, because they haven't fallen terribly far already. I think probably in some of the largest cities, I think we probably have to pick out two or three 100 basis points of additional occupancy before we see those rents starts stabilizing. But again I think that could happen pretty quickly if the inventories start to build a little bit.

Now on the office side, I think it's going to take us a while longer, again I think the rents. We see more the concessions and probably more pressure on rents in the suburban office portfolio today. And that again I think is just really going to be dependent on what the unemployment rate does.

Again it's now picking up close to 10%. For the most recent forecast, we've looked at say it's going to stay there, probably until mid next year. So, I don't think that we'll see maybe a floor on office rents until we start to see in unemployment rates start to go back down.

Sloan Bohlen - Goldman Sachs

Okay, thank you. And then a just quick question for Christie: just on the write-down on the land that's held for sale; one, maybe I missed it, but did you get the carrying value of what land that's held for sale was written down to the $71 million.

Christie Kelly

If I am understanding your question, we looked at 382 million of lands that we are looking to dispose. We've acquired impairment charges of 132 million on that land for a $0.35 charge to basis. And we had remaining $440 million of land that we intend to develop.

Sloan Bohlen - Goldman Sachs

Right, but you provided a write down for assets down for sale, and I was just wondering whether you provided the basis for those assets.

Christie Kelly

Okay. On the assets, no I didn't, I am sorry -- on the assets, we look to add a prepared basis if you will of 305 million and took a write down of 71 million or 70.7 million for 23% impairment percentage of basis review.

Unidentified Analyst

Okay. So is it fair to say if we look at the liquidity announcements in your supplemental looking out years, I think you have 300 that you are planning to sell next year. The past what we continue to see impairments as those come up of sale.

Christie Kelly

Yeah, it is possible.

Sloan Bohlen - Goldman Sachs

Okay, all right. Thank you.

Operator

Thank you. Next we'll go line Brendan Maiorana of Wells Fargo. Please go ahead.

Brendan Maiorana - Wells Fargo

Thanks and good afternoon. Denny, I hear your comments about the markets that, hopefully it sounds like they're starting to bottom. And I look at your leasing activity during the quarter, and it was pretty strong especially on the renewal side. But as it relates to leasing up the vacancy that you have in your recently completed development projects that's lagged a bit. And I know some of your competitors have been very aggressive in terms of price. Do you think that the leasing vacancy leas has lagged, because some of your competitors are being more aggressive on price or is it just at the markets are still too soft to absorb a new face?

Dennis Oklak

Well, first of all, I'd say we have made some progress on that. And we have some deals out there that I think will hopefully will make some good progress on that, the unstabilized portfolio in the fourth quarter. For example, Bob mentioned that we've signed about 660,000 square feet in two leases in Dallas in September that we are built in our unstabilized buildings. So that was a good pick up there.

As far as pricing goes, I don't think we will miss in deals because of price, generally speaking, we know where the deals are. But having said that, I think there is some people doing Bob said alluded to doing some crazy things out there, and rather then do something on a long-term basis, and rents way below what we think there be work -- we'd rather wait, because we think in 12 to 18 months we are going to see particularly on the industrial side, the market pick take up hopefully pretty significantly.

Brendan Maiorana - Wells Fargo

So, can you give us a sense of where you're thinking relative to where some of those deals maybe covering the market today, where you think those rents would be, 12 to 18 months to make that calculation such on it's more beneficial to you to wait.

Dennis Oklak

I think if you look at that if your rents can go up somewhere let's say and Brendan, just we do this analysis on our lease when we are valuating in lease proposal, we look at and taken the lease today versus when we think we might lease it or have another opportunity of leas it in that what rate, so we look at that constantly. And I would say generally speaking if your rents are picking up, if you think rents are going to go up in the 15 to 25% range in the next 12 to 18 months again of some of the very low rates we might be seeing in the market today, then your -- usually that calculation says you're better up way.

Brendan Maiorana - Wells Fargo

Okay, it's helpful. And then just going back to the land, the 440 million that's left that's not in the bucket to sale, what do you think your developments starts can be on a longer term basis as you think about your organization right now and where it stands and where you'd like to be from development start to annually?

Dennis Oklak

Well, I think we believe that as we get back to a normal market if you will. We can be in the 3 to $500 million range of new developments starts. Today, I think we believe that we can do 150 million to 200 million of medical office developments, healthcare related developments starts the year. And then if you look at the other 300 million or so, 2 to 300 million in our 20 markets, that's not an unreachable target at all for us, I think, in any kind of normalized environment.

Brendan Maiorana - Wells Fargo

It is your land, as it's said today have a significant portion that suitable for medical office or would that be more that would have to be land that would be acquired and that developed?

Dennis Oklak

Well, generally speaking, the bulk of our medical office development is done on launch or ground leases with the hospitals. Over 80% of our medical office developments is on hospital campuses and generally attached to the hospital. And the hospitals generally don't like to sell that land. So we'll get somewhere between a 50 and 100 year ground lease on that land, which is very typical in the medical office business. So we don't have not a lot of our land is due towards the medical office business.

Brendan Maiorana - Wells Fargo

So, out of the remaining starts, the non-medical office, call it, 200 to 300 per year on a normalize basis. That you have land like the 440 million roughly of land for 200 to 300 million of development starts per year, what do you think your land is I guess roughly unimproved as a portion of the overall cost of your development?

Dennis Oklak

Well, it varies a little bit Brendan. If you are talking kind of Midwest industrial it's probably 10 to 15% of our overall cost. If you're talking Washington D.C. office, which we own some Washington D.C. office land, still it's probably 25 to 30% of our total project costs.

Brendan Maiorana - Wells Fargo

I am reading through that. It sounds like you've got still probably 10 years worth of land bank on 200 to 300 million of annual start.

Robert Chapman

Well, Brendan, one thing I'd add is in our business model, there are thee different types of developments. They are partially pre-leased buildings, they're building the that own. And then is also a third-party construction that the client will own, we'll rebuild the building for them and they will take on our land. So, there's some of that going on now.

Brendan Maiorana - Wells Fargo

Okay. So that's not included in kind of the...

Dennis Oklak

No, that's right, Brendan. That's probably running another 150 million to 200 million a year for us. And I am not sure how exactly you did that calculation. But I would tell you, it's probably more of a four to five year supply of land for development at those levels.

Christie Kelly

That's right, Brendan. And this is Christie and I just want to reiterate that we took a look at our strategic focus here refined has been really begun to both land and our non-strategic building set. We are selling I also wanted to say we notched that land based on our knees and branded through the development models using and discounted cash fund now and incurred zero impairment charges.

The other thing I wanted to circle back on is on the pricing on buildings, we also have tested for impairment based on the over 1.5 billion non-strategic assets that we steed up for sale. For the first test, if you will over 875 million of building. And with that over 575 number of basis that we tested to be sold in the next three year, we did not incur any impairment on. So I just wanted to circle back on the question, I think that Chris asked.

Brendan Maiorana - Wells Fargo

Okay, great. Thank you.

Operator

Thank you. Our next question comes from the line of Paul Adornato at BMO Capital Markets. Please go ahead.

Paul Adornato - BMO Capital Markets

Hi, thanks. Just a quick follow up. With respect to the merchant buildings, does your exit from that business cause you to revaluate your presence in any of those 19 or 20 markets that you currently operate in?

Dennis Oklak

Paul, as I said before, we're pretty happy with all the markets we're in. There I think we there are some markets that will likely adjust our strategy within that market. Again for example I think you'll see us more focused on the bulk industrial product in the Midwest that we traditionally been. So as we downsize that suburban office, I think that would be sort of a permanent downsize. We're office, suburban office and some of the Midwest markets. But all the markets that we are in today are performing pretty well and we really like, the other thing I would say about our market is we like our position in the markets.

If you look across the Midwest cities, again particularly without excluding Chicago from this, we are dominant player in all those markets and that help us, we believe get better pricing and do better in those market. So we like being there. And Chicago, we are one of the top players; it's hard to be dominant in these big markets. But although, I would tell you I think on the industrial side, we are pretty dominant in Dallas. And so, again we like all the markets of we are in.

Paul Adornato - BMO Capital Markets

Okay. And finally with respect to merchant building, so we see any additional G&A benefit or has that already filled through the numbers?

Dennis Oklak

When you look at our G&A, we're up a little bit this year from our serve historical last couple of years run rate primarily because the severance cost that we incurred this year in downsizing our business. So going forward, we really anticipate today we tell you that we anticipate that G&A to run at roughly the same level that we've been seeing.

Paul Adornato - BMO Capital Markets

Okay, thank you.

Operator

Thank you. And our next question comes from line of Michael Knott of Green Street Advisors. Please go ahead.

Michael Knott - Green Street Advisors

Hey guys.

Christie Kelly

Hi there, Michael. How are you doing?

Michael Knott - Green Street Advisors

Hi, doing well; thank you. I have a question on the land as well, Christie, can you just give us maybe a number in terms of what the value for FAR -- is for the written down land seeking some of the versus the 440 million intend to keep.

Christie Kelly

I can take a second.

Dennis Oklak

You know what? I don't think we've really calculated that. And it's going to vary a little bit, because you got both office and industrial land in there.

Michael Knott - Green Street Advisors

Right.

Dennis Oklak

So, I am not sure that's going to be a role, but number in total that I don't have it by product type here. So, I am not sure I can really give you that right now.

Christie Kelly

We'll get back to you on that.

Michael Knott - Green Street Advisors

Okay. What's the market for land sales like right now my perception is it's not very deep, and so I am wondering how long you think it will take to sell that 250 million if I am thinking about that right 250 million, and so price, which is a -- yeah maybe I don't need to sell, but the pricing comes worse than you expected. I guess I am curious how you -- what about the valuation of that land given the capacity of deals out there?

Dennis Oklak

Well, we -- let me answer the first part.

Christie Kelly

I'll answer the second.

Dennis Oklak

Yeah, then I'll let Christie answer the second.

Yeah, I think it's slow out there, there is no question about it. But there is a couple of things that I would say is there is a lot of our land to be used for multiple types of commercial development. For example, over the years and we continue to be able to sale some say office land for potential residential development apartments, town homes. And we still are seeing some activity on that side. And then we -- as Bob mentioned, a lot of times we are able to sell land to users, who want to build their own building. Many times that ends up being some of our third party business.

So the interest is still moving, but it's slow. We'd like to think we could -- in the good years, we were selling 100 to 150 million a year in sort of 2005, '06, '07. Now we are down in the closer to the 50 million, $60 million range, but we think we can maintain that range even in this market.

And then the other thing that I would say is we have gone through all of our land in terms of -- and set what we think would be a minimum acceptable price for that land and communicate it that out to the field, so they have their marking orders and know what we'd be willing to take.

And then I'll turn it over to Christie to talk a little bit about how we came up with the value for the accounting valuation.

Christie Kelly

Thanks. Well, Michael, what we did is, is that you know I had mentioned that we had first of all taken our land and really put it into two baskets to be developed and to be disposed based on our strategic focus. And on this to be disposed bucket, we then went out and went through in a extremely expensive process using external resources, very defined, if you will feedback data gathering on broker's opinion a value, got that back from the market with the help of our brokers and external experts out there, especially given today's market environment.

And then brought that back in house and validate audited data to make sure that it was reasonable and that we didn't -- we didn't have information that was there A, written by crayon or B, that we thought was not valid. And then ran it through our models, and then also worked with KPFG and our valuation expert to come up with our valuation. So, it was the lot of work by, by our finance and external accounting team together with the focus and the very simple market to come up with our best estimate of value in today's environment.

Michael Knott - Green Street Advisors

That's helpful, thanks. Denine or Bob, given the roll down on rent of some years suburban peers as reported this quarter, I found your finance 1% to be encouraging. Are you surprised that number hasn't been more negative and what do you expect going forward or maybe alternatively what do you think you're overall portfolio mark to market is today and where do you expect it to go?

Dennis Oklak

Well, first I'll give you my thoughts on that and Bob can also chime in, but in a lot of our markets, we don't get the real run up and run during the really good time like some of the markets do and we don't get the tremendous decrease as some markets do. So, I think generally speaking today, our rents in place are probably a little bit, underneath overall, I mean our rent place are probably a little bit above the market. But I don't think there is a huge gap today.

Robert Chapman

All right, Danny, I got cut off.

Michael Knott - Green Street Advisors

Okay. Denny, thanks for that. Bob I'm sorry, did you have anything else?

Robert Chapman

I am sorry, I got cut off. I didn't hear the first part of it. Go ahead. I just want to let you know I was back on the call.

Dennis Oklak

Okay, thanks Bob.

Michael Knott - Green Street Advisors

So, Denny, do you expect that number may not get much worse for industrial speaking to the comparison of in-place rents and market, but maybe it keep getting worse, a little worse for office, depending on what happens employment, is that fair way to think about it?

Robert Chapman

Yeah, I think that's right, and but I also think that sometimes those statistics can lag what's going on in the market. So, I think in 2010, what we will likely see in our portfolio, on most of our renewals would be a negative trend and both the office in the industrial side. And again I just, it's so dependent on the mix of leases you renew, when those leases were signed, how that affects. Now the good news for us is we've only got about 9% of our leases rolling in 2010. So, I think we are in pretty good shape on that side and as you've seen, we've done a very, very good job of renewing our tenants, this year.

Michael Knott - Green Street Advisors

All right. Then last question: so when going back to what Jamie was asking about what do you want to do to look like it fears out, I'd be happy with any other comments you have on that in terms of what you'd like people to say about to do 50 years from now. And then also maybe if you just get up is maybe target your preferred or ideal mix of NOI between bulk office and healthcare?

Robert Chapman

Sure, Michael. I guess that first of all I would like to say people to say about Duke, which I would like for them to say today about what a great bulk industrial portfolio we have, because we do. I firmly believe we've got one of the top bulk industrial portfolios in the country. And then I think we will have an extremely solid medical office portfolio located really throughout the country, and the focus there is on the major hospital systems that we have as customers and that we are a very preferred developer with all those folks.

And then on the suburban office side, that portfolio will be smaller than it is today, but it's also going to be a very solid portfolio located in what we believe are higher growth markets than we are in today, where we have a good monitoring trend of rental rate increases. And then if you just going back to where we think that will ultimately trend and where we're targeting is today we're a 56%, 55, 56% office, we'd like to get that down in the 25% to 30% of our overall portfolio growth the industrial from which is there about 35 to 40% give that up into 60% range? And then the rest of which 10 or 15% or so in the medical office piece of the business.

Michael Knott - Green Street Advisors

Okay, and you think you can accomplish that mostly through the sales that you are contemplating? And maybe incremental development on the healthcare side over the next couple of years.

Dennis Oklak

Yeah, I think it's going to be a combination of lot of things. It's clearly going to be executing on the targeted dispositions that we have. It's going to be the focus on that land that we are holding developing projects. We'll hold on balance sheet on that land, and I think we will do some targeted acquisitions at the right time, assuming the capital markets stay favorable for us. We'll look at some targeted acquisitions to help us get there.

Michael Knott - Green Street Advisors

Okay, thank you.

Dennis Oklak

Thanks Michael.

Operator

Thank you. And at this time, speakers, there are no further questions in queue. I'll turn it back to you for any closing remarks.

Dennis Oklak

Okay, thanks a lot everyone. Our next call will be our fourth quarter Earnings Call in January '10. We will send something out in late December with the time and date. Thanks again.

Operator

Thank you. And ladies and gentlemen, that concludes for your conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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Source: Duke Realty Q3 2009 Earnings Call Transcript
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