Liberty Property Trust Q4 2009 Earnings Call Transcript

Feb. 9.10 | About: Liberty Property (LPT)

Liberty Property Trust (LRY) Q4 2009 Earnings Call February 9, 2010 1:00 PM ET

Executives

Jeanne Leonard – Investor Relations

William Hankowsky – President, Chief Executive Officer

George Alburger – Executive Vice President, Chief Financial Officer

Michael Hagan – Chief Investment Officer

Robert Fenza – Executive Vice President, Chief Operator Officer

Analysts

Jordan Sadler – Keybanc Capital Markets

James for Alexander Goldfarb – Sandler O’Neil

[Keebin Kim – Macquarie]

Sloan Bohlen – Goldman Sachs

Paul Adornato – BMO Capital Markets

Josh for Michael Bilerman – Citigroup

Michael Bilerman – Citigroup

Brendan Maiorana – Wells Fargo

John Guinee – Stifel Nicolaus

John Stewart – Green Street

Operator

I would like to welcome everyone to the Liberty Property Trust fourth quarter earnings conference call. (Operator Instructions) Miss Jeanne Leonard, you may begin your conference.

Jeanne Leonard

Thanks everyone for tuning in today. You’re going to hear prepared remarks from Chief Executive Officer Bill Hankowsky, Chief Financial George Alburger, Chief Investment Officer Mike Hagan, and Chief Operating Officer Rob Fenza.

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 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 the Federal Securities Law. Although Liberty believes that 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, uncertainties and other factors that could cause actual results to differ materially from the expected results. These risks are 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?

William Hankowsky

Thank you Jeanne and good afternoon everyone. Liberty had a very strong fourth quarter, ending a year of significant accomplishments in the roughest economic environment we’d ever experienced. FFO for the quarter was minus $0.14 including a $94.5 million non cash impairment charge. George will walk you through those numbers in a moment.

Excluding this non cash item, FFO was $0.67 for the quarter and $2.83 for the year, consistent with the guidance we provided last year.

I want to comment on three topics; capital, operating fundamentals and investment activity. On the capital front, 2009 was a year of significant achievement. We have always had a conservative and strong balance sheet, but last year we took a series of steps to further fortify our position.

We raised $790 million in fresh capital via our continuous equity offering, secured debt and asset sales. Adding in the fourth quarter of 2008, we have raised $1 billion.

2010 will be a much quieter year on the capital front. We will be renewing our line before year end and retiring our unsecured notes in August which we could do today with the cash we have on hand. We will however, be opportunistic if it makes sense to execute a capital transaction to strengthen the company and our balance sheet long term.

In the area of operating fundamentals, the fourth quarter was our strongest quarter of the year, leasing 4.7 million square feet, our largest leasing quarter for renewals and replacements in the last two and a half years. Leasing for the year totaled 15.5 million square feet.

Occupancy held at 89.2% with another strong renewal rate of 60%. Indicative of the competitive landscape, rents were consistent with the third quarter down 13.7%.

December and January have seen a pick up in leasing prospects in the market. These eight weeks of activity are not enough to data points for us to feel there’s been an inflection point, but it does affirm our sense that the markets have bottomed out.

In 2010 we anticipate a continued competitive rent environment and renewal rates more consistent with our historic averages in the mid 50%. We also expect to see lower placement activity as the markets firm up.

As a result, we would expect to see higher total transaction costs as replacement leasing gains a greater share of our total leasing mix. Based on our current forecast, we also expect to see greater variability on our occupancy, trending down in the first half of the year and rising up in the later half.

On the investment front, acquisitions, dispositions and development, 2010 will see a transition from 2009. We sold $178 million in 2009. Our range for 2010 is $75 million to $125 million. But, should we see an opportunity to sell more consistent with our long term strategic objectives, we will take advantage of these opportunities.

We had no acquisitions in 2009 but are actively monitoring opportunities to acquire in 2010. With our cash on hand and line capacity, we have over $700 million available to take advantage of potential opportunities. Mike will provide some further color on this current environment.

On the development front, we continue to see build to suit prospects in the market and anticipate commencing a few of these in 2010.

In summary, 2009, as difficult as it was, allowed Liberty based on our performance last year to be well poised for 2010. Our leasing operation continues to significantly outperform our markets by 400 basis points and nationally by 470 basis points. Each percentage point of occupancy we can gain is worth approximately $0.07 of FFO.

Our development expertise and financial strength are bringing us potential build to suit opportunities and our financial strength and platform is beginning to expose us to potential acquisition opportunities.

With that, let me turn it over to George.

George Alburger

Thank you Bill. FFO for the fourth quarter of 2009 was a loss of $0.14 per share. The operating results for the quarter include a $94.5 million non cash impairment charge relating to our equity investment in unconsolidated joint ventures and related goodwill.

I believe most of you are aware that the methodology dictated by GAAP for valuing investments and unconsolidated joint ventures differ from the method used for consolidated real estate assets. For investments in unconsolidated joint ventures a discounted cash flow method is used. For a consolidated real estate asset, an undiscounted cash flow method is used.

The discounted cash flow method that we use in order to arrive at a valuation for investments in joint ventures involves a great deal of judgments; judgments about holding periods, about current market rents, changes in rents, exit cap rates and discount rates.

These judgments and the resulting discounted cash flow valuation yielded a $94.5 million impairment that we recorded this quarter. Approximately $80 million of the impairment relates to our Washington joint venture including its related goodwill.

The rest of the impairment was for our joint ventures in Chicago and for our Blythe Valley and Manchester, England joint ventures.

I’d like to move on now to discuss our quarterly results. Excluding the impairment charge, FFO for the quarter was $0.67 per share. During the quarter, we brought into service four development properties with an investment value of $121 million. These properties were 96% leased and have a current yield of 9.1%.

We didn’t have any development properties this quarter and development starts for the year have been modest. As of December 31, the committed investment in development properties is $244 million. For wholly owned properties it’s $83 million, and for these properties, the projected yield is 9.4%.

We didn’t have any acquisitions this quarter or for the year but we were active with dispositions. During the quarter we realized $35 million in proceeds from the sale of seven properties and 10 acres of land.

On the leasing front we were very active. During the quarter we executed 3.4 million square feet of renewal and replacement leases. For these leases, straight line rents decreased by 13.7% which is consistent with our guidance for the fourth quarter 2009 and for calendar year 2010 that rents would decrease by 10% to 15%.

For the fourth quarter operating income for the same store group of properties decreased by 2.8% on a straight line basis and decreased by 1.4% on a cash basis for the fourth quarter 2009 compared to the fourth quarter 2008. Same store performance for the year was essentially flat.

I want to make one final comment which is about the first quarter of 2010. Bill mentioned we expect a dip in occupancy in the first quarter. This dip could affect first quarter results negatively by $0.01 to $0.02 per share.

The second item that will affect first quarter results will be the accelerated vesting in the first quarter of long term incentive compensation. You may recall that in the first quarter of 2009, accelerated vesting of long term incentive compensation increased G&A expense for the first quarter by $3.8 million. There will be a similar accelerated vesting and G&A impact for the first quarter of 2010.

These comments are not meant to suggest a change in earnings guidance for 2010, but I wanted to sensitize everyone to these items and the affect they will have on first quarter and that there will be some unevenness in our quarterly earnings for 2010.

With that, I’ll turn it over to Mike.

Michael Hagan

Let me start by recapping our 2009 activity. As Bill mentioned, we made no acquisitions in 2009. On the disposition side however, we completed $178 million in sales in 19 transactions. Approximately half of these transactions were completed to users. On the investment sales we completed, the average occupancy of the property sold was 95% and the cap rate was approximately 10%.

All of these sales were consistent with Liberty’s strategy of reducing our investment in suburban office and selling assets that do not meet today’s operational efficiencies. About half of the assets sold were suburban office and approximately 50% of the square footage sold was 20 years or older.

Now let’s discuss our expectations for 2010. On the dispositions front, our guidance for the year is $75 million to $125 million at nine to 11 cap rates and we are comfortable with that range. As Bill mentioned, we are under no pressure to sell. However, we will continue to monitor the investment activity in the market and should sales opportunities arise that are consistent with our overall strategy and a pricing we find attractive, we will increase our sales volume.

On the acquisition side, 2009 was a quiet year for Liberty as well as for the market. We expect to see more activity in 2010. We feel that there is a bifurcation occurring in the market. On one hand, stabilized assets in preferred locations will command premium pricing while the expected distressed market has yet to materialize in any significant way.

Lower returns on investments have generated a great deal of frustrated capital on the sidelines. This supply of funds is looking for core assets and will act as a catalyst for cap rate compression. We expect to see prices for stabilized assets lower than the peak but not at the double digit return expectations of a year ago.

For example, we have been tracking a quality multi-tenant industrial portfolio. We understand the number of inspections of the properties to be in the 20’s and the anticipated pricing could be in the eight to nine cap rate range.

While we are clearly in a process of correcting from a period of high historical valuation, the volume of properties that have traded in a distressed manner are well below everyone’s expectations. There seems to be a great deal of forbearance in the market.

Extend and pretend strategies as well as a pick up in the debt capital markets have limited distressed opportunities. The pricing gap on many of these transactions remains large. Within the last month, we underwrote a pair of completed but vacant distribution buildings. Due to the weak fundamentals, that is the negative absorption and decreasing rental rates in the market, it is extremely difficult to forecast future cash flows.

Our valuation did not meet the seller’s expectations and with the seller under no pressure to sell, there was no transaction. We believe that with continued pressure on fundamentals, and future financial requirements in the form of debt maturities as well as capital improvements, distressed opportunities will continue to present themselves.

We will look for these opportunities and not focus on the cause of distress. We will differentiate lead market fundamentals from short term weaknesses. Where Liberty can add value through our leasing, property management and development expertise, we will be an acquirer.

Our expectation is that this revaluation process will play out over the next few years and we will invest in them in a disciplined manner.

On another investment front, Bill mentioned the activity on the build to suit is increasing. The market has recognized we have the capital and ability to execute on these transactions. We are underwriting these transactions based on factors like property type, credit of the tenant, term of the lease and location of the property.

We will proceed with these transaction where we are comfortable upon completion, we have created value.

Now, I’ll turn it over to Rob.

Robert Fenza

Good afternoon. I’m going to spend the next few minutes discussing the leasing environment, market activity, the development pipeline and some value enhancement programs in place.

As Bill mentioned, Q4 was a very solid quarter for us in terms of leasing. 209 new and renewal leases were executed for more than 4.67 million during the quarter. We maintained our occupancy and continue to outperform our competitors by a wide margin.

We are simply getting more than our fair share of the market which is a direct result of our local operating teams’ ability to provide the most valuable real estate solutions to our tenants and prospects and leveraging our strong relationships with the brokerage community.

In 2010 we expect occupancy to trend down earlier in the year and then push higher later in 2010 but on average, occupancy should remain relatively flat for the year as overall demand continues to remain soft.

Only 12% of our portfolio’s leases expire in 2010, a smaller than usual percentage. This will result in a higher percentage of leases being done in previously vacant space. This will positively impact revenues but will also contribute to higher tenant improvement costs.

The current leasing environment has improved slightly over last year. We can categorize tenants by the following; tenants are making decisions and acting upon them, tenants are pushing for longer lease terms and are looking to lock in at lower rates. Tenants are looking for the landlord to provide tenant improvements which bodes well for a well capitalized company like Liberty.

Free rent is common but varies by market. It is not prevalent on renewals but averages about one month per lease year on new leases. And tenants are still underwriting landlords and the brokers are avoiding financially challenges properties for fear of not getting paid on a deal or a deal falling apart in the eleventh hour because a lender can’t or won’t meet the terms of the tenant.

This is clearly another advantage for us because of our reputation for fair dealing and strong capabilities, financial and otherwise.

Moving to properties and markets, market conditions remains challenged and there is simply less demand than in years past. And that is consistent in just about all of our product types and in all of our markets.

One exception to this is the recent uptick in industrial activity in several of our larger industrial markets. The recent pick up in global industrial production of 8% since June, a rebound of more than 16% in container traffic at U.S. ports year over year and a year over year pick up of about 24% in air cargo all point to the beginnings of improvement in industrial demand.

Lehigh Valley, Pennsylvania which serves Northeastern United States is experiencing a solid increase in industrial activity. Houston is seeing a steady improvement and Chicago to a lesser degree, is seeing signs of a pick up in prospects.

Shifting now to the development pipeline, with no recent starts, the development pipeline is now down to five buildings. Subsequent to quarter’s end, we’ve leased the rest of our Orlando building at 2001 Summit Park Drive which means that the buildings currently under development for Liberty’s wholly owned portfolio are 100% leased.

We are seeing renewed activity from users looking for build to suit facilities and are discussing those needs with several prospects. We do expect several build to suit additions to the pipeline this year.

Earlier, I referred to a competitive advantage that Liberty enjoys in our markets due to our ability to deliver higher value to our tenants. This value extends beyond rental rates and TI packages to the true daily cost of occupancy.

At a time when competing landlords may be finding it difficult to maintain their properties, Liberty is continually investing in our portfolio to maintain both short term and long term value.

In 2009 we completed energy audits on 263 buildings and established short, medium and long term action plans to eliminate energy waste, reduce energy consumption and delivery energy savings to our customer.

In a few short months after identifying the low hanging fruit, the low cost no cost opportunities to reduce energy; Liberty reduced energy usage by nine million kilowatt hours, saving our customers over $1 million so far.

In late 2009, we surveyed 100 building highlighted from the energy audits for complete lighting retrofits, utilizing the latest technology for high efficiency lighting. The work is now being implemented and the projected first year savings on these 100 buildings is approximately $0.20 a square foot or about $2 million in energy savings.

Another energy saving step we initiated in 2009 was increasing the energy awareness of our tenants so that they can understand energy management techniques and assist in energy conservation efforts. Liberty customers now receive a monthly newsletter called Energy Savers which has been enthusiastically embraced by our customers.

Late in 2009 and ongoing this year, Liberty will be installing a building wide area network energy network monitoring system or BWAN on 130 of our office buildings. This use of technology will adapt to existing infrastructure in older buildings, producing real time energy usage data.

The BWAN network will allow us to monitor and optimize the efficiency of heating, lighting and air conditioning, producing a higher degree of creature while reducing energy costs. The savings potential of this project is over $3 million per year for those 130 buildings.

And finally, Liberty was selected to partner with Peak hill Energy and the U.S. Department of Energy in the Smart Philadelphia Smart Future initiative. Liberty will match a $2.1 million grant awarded from the Department of Energy and coordinate a 10 building R&D project to overlay advanced technology over basic building audit recommendations to develop a template to turn existing buildings into Smart buildings.

This project when completed will produce a viable stream of techniques and methodologies that can be applied to our entire portfolio in the coming years to continue to enhance its energy performance, tenant satisfaction and shareholder value.

And with that I’ll turn the call back to Bill for questions.

William Hankowsky

Thanks Rob, Mike and George. Let me close our opening comments by reaffirming our guidance for 2010 of FFO of $2.60 to $2.80 a share. And with that, we can open it up for questions and answers.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jordan Sadler – Keybanc Capital Markets.

Jordan Sadler – Keybanc Capital Markets

I wanted to clarify and get some color on the potential acquisitions or other investments. It sounds like you’re going to adding several build to suits to the pipeline. Could you give us some parameters in terms of volume surrounding potential build to suit development and/or acquisitions? I know you did have some preliminary acquisition guidance of actually up to $100 you said previously; just maybe some more on the build to suits? And what would you expect in terms of returns from each?

William Hankowsky

Let me do those separately. On the build to suit side, it could be as modest as $8 million build to suit, one or two that scale to something as big as $100 million. None of these are done deals. They could all fall out of bed but our sense right now is when we look at who we’re talking to and where we stand that one or more of these might well happen in the year.

But I think that’s the range of potential, so I wouldn’t want to put a number on it in terms of total value until there is a little bit more clarity between us and the customers that we’re talking to. In terms of returns there, as Mike said, we know what we’re doing when we build buildings so for us historically the risk we have seen with development is really lease up.

Obviously on the build to suits we’re not facing that, so I think we’d be looking at returns in the low teen’s kinds of cash on cash to make us want to do a build to suit, something like that.

When you move to the acquisition side of the world, and your recollection is correct, our range for the year is zero to $100 million, and as we said on the third quarter call when we gave guidance, and as Mike just stated a few minutes ago, we want to be disciplined here.

So if there is nothing we see that makes sense to us, it will be zero. If there are things that make sense to us, maybe its $50 million, maybe it’s $100 million. If it was more than that, we wouldn’t be afraid to acquire in numbers greater than that, but where we stand today, I think zero to $100 million is still the right number.

We might find stuff that makes sense. Mike gave you a couple of stories there about deals we’ve looked at where we just couldn’t make the numbers work for us and for the seller. So it didn’t end up getting executed. And that could be the behavior for the year and maybe the lines will cross.

Here again in terms of return levels, I hesitate to put numbers on these, but I think Mike gave you a good sense that there is a big distinction between a vacant building which might be attractive to us because it’s a value add opportunity, but given where fundamentals are, we’re going to be looking for a lot more return there to bridge the gap to get the thing leased up versus a stabilized asset.

You’re seeing some stabilized industrial stuff might trade eights to nines so good stabilized assets that could make sense.

Jordan Sadler – Keybanc Capital Markets

That multi-tenant portfolio you referenced as an example would sort of fall into that framework. Could you give us some color on the size of that portfolio that would command that kind of cap, maybe location?

William Hankowsky

I think it’s actually one million square feet and I’ll tell you one of the hardest things to deal with, it’s not about the cash flow that is in place today, it’s the cash flow that’s going to be in place two or three years from now.

Not only is there fundamentals driving vacancy or trying to project where vacancy is going to be, you start rolling over a 15% to 20% of the rents in the coming years, you can assume that there is a roll down in those rents. So I think the cap rate out of the gate might be a little misleading, but I think where we’re priced right now, I think it’s going to be somewhere between an eight and a nine cap.

Jordan Sadler – Keybanc Capital Markets

On the impairment charge, could you maybe flush out what the major changes and conditions or assumptions were at year end that caused the sizeable write down? I know you mentioned Washington as being the bigger piece.

George Alburger

This is a complicated area. There has been deterioration that’s been going on in the markets for some time. So we look at this every quarter. But it’s when do you cross this threshold in accounting literature when you consider this valuation or decline in valuation to be other than temporary which is the language they use, and that’s clearly something that’s up for judgment.

But we track this every quarter and if you look at our results for the first quarter and second quarter we were getting increases in rental rates and for the first three quarters of the year we were getting positive performance for same store.

Then in the third quarter things changed for us and we got some meaningful decreases in rents and we gave guidance that we thought rents would be down in the fourth quarter, but I think we kind of waited for another dot to be on the graph and we’ve had it now.

We’ve had two quarters now of pretty meaningful declines in rents and when you bake that into some of the other factors we laid out there which is where we think rental rates are going to go, cap rates and things like that, that’s when we kind of tripped the switch and we had the impairment that we recorded this quarter.

Operator

Your next question comes from James for Alexander Goldfarb – Sandler O’Neill.

James for Alexander Goldfarb – Sandler O’Neil

Following up on the question about the impairments, what was the discount rate you used on the JV write down?

George Alburger

We use different discount rates for different JV’s. They were below 10%.

James for Alexander Goldfarb – Sandler O’Neil

I guess that’s as much color as you want to give on the Washington?

George Alburger

I’m hesitant. This is subject to so much judgment I’m hesitant to put out one factor which is a discount rate or a cap rate or a change in market rent, because they’re all kind of within ranges and we have ranges from a variety of business literature and a variety of literature on real estate, and we were within acceptable ranges under all this.

We ran it different ways. We ran it for different holding periods. We ran them for ten year holding periods, 15 year holding periods, different cap rates, different changes in rents, different discounts rate.

James for Alexander Goldfarb – Sandler O’Neil

Looking at leasing spreads and rents right now, what do you, what’s the mark to market on the office portfolio versus the industrial portfolio and looking out given the limited role this year how you actually think that plays into the portfolio going forward?

William Hankowsky

Let me answer the last piece. We’ve got as you said, we’ve got about 12% of our leases expiring this year and obviously we also have 11% of the portfolio to lease so there’s opportunity in both cases.

I think that if you’re looking at where rents are, our sense is both in industrial and office that we’ve kind of hit the bottom. In other words the market rents are not going to decline significantly from where they are today.

There will be episodic situations and they exist. You hear about them every week where a potential landlord in a market for whatever reasons they might have, sitting on a vacancy for a long time and a lender that would like to see some cash flow, decide to make a very aggressive deal. So you can hear a story about a rent in a market.

But our sense is that on the whole, in our markets for both product types, there is a general sense that they’ve kind of stabilized where they are.

I think in terms of rent movement, it’s a kind of classic scenario. Rents don’t move in a market across the whole market all of a sudden. What will happen is, somebody needs 50,000 square feet of office space in a market and as the market begins to firm up, where they used to have 10 options, now they have four.

And suddenly landlords have a little bit more ability to move and stick with rent, so you begin to see it. And in the industrial side you can see it for example, somebody needs 600,000 square feet versus somebody that needs 100,000 square feet, they might just not have as many options and so you begin to get firmness kind of by transaction and by sizing and by market and then it begins to spread.

I think you’ll see some firmness on the industrial side episodically through the course of this year. I think you’ll see less of it on the office side because clearly the job numbers aren’t giving us the kind of demand that we’d like to see on the office side.

George do you have a sense of those mark to markets?

George Alburger

I do have a sense of mark to market for the entire portfolio. Generally I would describe it as being our rents for the portfolio would be about 10% to 15%; market rents being 10% to 15% lower than our in place rents are.

With respect to office, it’s going to be on the higher side of that range and if you went all the way to the industrial it’s probably outside the lower end of that range, not as high as 10%. But that’s the general range.

James for Alexander Goldfarb – Sandler O’Neil

You mentioned that you were going to opportunistically look at the capital markets as the year progressed. I’m just curious if that means you’re thinking more along the lines of re-launching the ATM, if you would come with a secondary offering or if you think the unsecured markets look more attractive and how that fits into your strategy.

William Hankowsky

I think that as I said in my remarks, we have some unsecured debt coming due. We could pay it off with cash. We could use the line to pay it off. We could decide we’re going to roll it into a new unsecured. I think it’s more about how events transpire looking at the various options to deal with them and thinking about where the markets at that time in terms of what tool makes sense.

Also, to the degree we were fortunate enough to find an acquisition that was particularly attractive and it required not $50 million but it required $200 million, you might want to put some more permanent capital against that acquisition and in that instance again, you might look at both equity and debt markets to make a determination as to what would make sense to do it.

So I think part of it might be driven by opportunity and part of it will be driven by viewing the markets and making a judgment.

George Alburger

That’s a pretty good summary. It’s fair to say there is a lot of activity going on in the unsecured market and we’re staying on top of that and that’s a market that’s come back tremendously in the last year and at pretty attractive rates.

James for Alexander Goldfarb – Sandler O’Neil

Is it fair to say the unsecured market looks more attractive than the secured right now?

George Alburger

I thin it all depends on what you’re trying to accomplish. If you’re just talking about a situation whereby we have some maturing debt, I think we would probably satisfy that maturing debt as Bill said with a draw down on the line and maybe a term on the line with senior notes and unsecured transaction.

If you had some types of capital transactions or capital investments, a significant amount of acquisition activities, you want to keep your balance sheet in shape and maybe that would suggest that you might need some equity.

Philosophically which you all know, we like the unsecured market in terms of generally where we like to have our debt placed fundamentally because it’s so consistent with our business model; lots of smaller assets, lots of tenants, lots of movement in the portfolio, and it just gives us maximum flexibility to do that.

Now obviously you look at what costs are and compare them. But all things being equal, I think it’s fair to say we favor the unsecured over the secured.

Operator

Your next question comes from [Keebin Kim – Macquarie]

[Keebin Kim – Macquarie]

Just to go back to your point on leases, if you had to look at the vintage year of the leases that are expiring in 2010 and maybe 2011, when were those leases on average originated?

William Hankowsky

I think our average lease term is around seven years, but that’s obviously weighted by office leases tend to be somewhat longer than industrial leases. So industrial leases are probably in the four to five range in terms of average term and office leases are probably more in the eight to ten range, and that gets you to the seven on average.

So when you’re looking back in terms of when they were originated that are expiring, the industrial ones are going to be 2005 and the office ones are going to be 2003 to 2004. So that’s generally how they would play out.

[Keebin Kim – Macquarie]

So it would be safe to assume if you’re expected 10% to 15% roll downs for 2010 leases as you’re going further out, it should need 25% negative because you’re going to 2007 leases where the rents were much higher?

William Hankowsky

No, I wouldn’t say that. You’ve got to be careful. Remember what we’re doing here. We’re blending. When we talk to you about leases going down on average 10% to 15%, we’re talking about all the lease activity for the year.

2010 happens to be a year, looking from a standpoint of how we’re forecasting the year, more of our leasing is going to be replacement leasing than it’s going to be renewal leasing. So we’re talking about the new prospects we will put into vacant space, we will put in at market rents today which are lower than the rents that were in those space for the last tenant that was in them versus what’s happening with renewal rates.

I also think as I said, that as you see movement in the markets, that is some firmness in the markets getting into ’11 and ’12, I think you’ll see some rent movement in those years that will somewhat offset what’s expiring. So I don’t see a roll down in rents in our portfolio getting into the 20’s.

[Keebin Kim – Macquarie]

On your near term debt maturities, I know you mentioned you prefer unsecured. Could you just give us a quick idea of where the spreads are on secured and unsecured.

George Alburger

For the unsecured a ten year that we could probably do a ten year 6.5% plus or minus which would put the spreads anywhere from 285 to 300 for the ten year? For secured debt it’s probably pretty much in the same number. But as Bill mentioned, we’re pretty disposed to unsecured debt.

Operator

Your next question comes from Sloan Bohlen – Goldman Sachs.

Sloan Bohlen – Goldman Sachs

I can’t remember whether you mentioned this before but you talked about redoing the line this year. Do you have an expectation as to what the capacity could be?

George Alburger

We’ve talked about a capacity. The existing line is around $600 million and we’ve talked a capacity of $450 million, maybe $500 million and we would also perhaps have [inaudible] for the facility. Where the existing facility will expire in the first quarter of 2011, we’re not going to wait until the fourth quarter to put a new one in place so let’s get the 10-K filed and start to advance our conversations with our participant lending group sometime around mid year hopefully have a new facility in place.

Sloan Bohlen – Goldman Sachs

You talked a little bit about doing more leasing of space that’s currently empty and maybe some higher incentive costs. I was wondering if you could frame that and as a follow on to that how you think about dividend coverage going forward, if that’s going to become a higher portion of your leasing?

George Alburger

We all know dividend is a Board consideration so I’ll let Bill deal with that. Rob did talk about higher leasing transaction costs, but to some extent, absolutely the leasing costs for 2009 on a square foot basis was less than 2008. We retained cash this year. Clearly we’re pushing up against it, but we clearly have the capacity to absorb what could be a little bit more in the leasing transaction costs because we’re filling vacant space or renewing existing tenants because we have less existing tenants to renew.

Of course filling vacant space and incurring more TI costs, that’s a good kind of problem to have, filling vacant space. So it shouldn’t put pressure on the dividend in the little movements at that level.

William Hankowsky

Just to add one other thought to George’s point, it isn’t as if this is an environment where TI’s are being used by landlords to buy deals. We’re not talking about that. All we’re wanting to sensitize you to is that whereas maybe 50% of the deals we did in 2009 were replacement deals, maybe it will be more like 60% to 70% would be replacement deals in 2010 and they take a little bit more dollars than a renewal, so it’s more about the composition of the mix of leasing. It’s not about replacement leasing costs are going up.

In terms of the dividend question, as George said, it’s ultimately a Board decision, but I think we’ve been very clear for years that we are big believers in the REIT model and we believe a significant component of the traditional REIT model is the dividend so we think very hard about it and we think very hard about making any changes in it. So to the degree we are comfortable where we are, we would tend to remain there.

Sloan Bohlen – Goldman Sachs

As you look at potential acquisition opportunities, you obviously need to make an assumption about how much leasing you could do or where the fundamentals are going, but mainly I’d be interested in your thoughts on what you think in terms of an exit cap rate longer term.

William Hankowsky

I’m going to let Mike answer that but I do want to pick up on your point just to give you a sense of this. Normally, for Liberty, if we bought a vacant building or build a building, we build in kind of a one year lease up. In some of this stuff we’ve been looking at, we’ve been talking 18 months, 24 months for lease up periods, so very much that extended lease up period is what’s driving the map on a vacant building.

Michael Hagan

The way we’re underwriting assets, it’s all a market by market type of a think. Clearly there is a cap rate on the D.C. building as the cap rate would be on a building our here in Great Valley, and I think we’re trying to look at historical cap rate spreads, the treasuries, and my guess is that somewhere they’re going to settle out between an 8.5 and a 10 depending on where that stuff is.

Again, D.C. being a little bit of an exception, but that’s why I think you’ve got a wide range to it right now.

Operator

Your next question comes from Paul Adornato – BMO Capital Markets.

Paul Adornato – BMO Capital Markets

I was wondering, does the impairment in Washington trigger anything in terms of the joint venture or does it trigger anything in terms of your partner’s accounting investment?

George Alburger

I hate to give you a simple one work answer, but it does not. It doesn’t affect that relationship. It doesn’t affect their bookkeeping. They’re aware of this impairment. They’re aware of the magnitude. They’re aware of what we’re booking here. We’ve had this conversation with them.

Paul Adornato – BMO Capital Markets

In terms of your attitude towards joint ventures in general going forward, do you still expect developments to be housed in joint ventures sometimes?

William Hankowsky

Not necessarily. I think the best way to think about our joint venture approach is our JV’s basically are single institutional players in a single market with a single product type. That’s Jersey, that’s Chicago, that’s Washington, that’s Birmingham, that’s Kings Hill in England.

So to the degree in those geographies and product types there is development, we have included as the activities of those JV’s everything that Liberty does. So if we buy, sell, develop, it would happen inside the JV’s.

If we were developing in any of our non JV markets, we would be doing it as Liberty. The only exception to that has been the Comcast Center which just given the scale of the asset, it made sense to have that as a one off one asset JV. But given our typical profile of development for Liberty, I think you’d be seeing that done.

Where it’s a Liberty market, it would be Liberty wholly owned. And where it’s a JV market it would be a JV development.

Paul Adornato – BMO Capital Markets

Any changes in your partners desires for liquidity or other circumstances with respect to the JV?

William Hankowsky

I understand your question totally. We are well aware that in some situations sponsors are getting a little bit of fatigue and wanting to move on. I think I’m comfortable saying that all of our joint venture partners are very comfortable with where we stand with the JV, and their structure and no, we have no issues with anybody looking for liquidity.

Operator

Your next question comes from Josh for Michael Bilerman – Citigroup.

Josh for Michael Bilerman – Citigroup

Can you give us a little more detail on the economics behind some of the build to suit projects this year? Specifically what’s the difference between the rent that you think you’ll get and the current market rent and how does this compare to what you think the construction costs might be which may have declined recently?

William Hankowsky

That’s a good question. Here’s what’s happening. The construction costs are definitely down and we see it in the TI work we’re doing. We see it in the CapEx that Rob mentioned that we’re doing in our existing portfolio.

And depending on what it is you’re doing, it can be a 10% to 15% decline, it could be a 30% to 40% decline. The aggressiveness of the contracting industry is pretty acute right now to get business and keep their people working and keep their company’s operating. So that’s to the good.

Now understand that depending on what you’re building, roughly half of it is labor and half of it materials and so where you pick up the decline isn’t necessarily uniform across every discipline if you’re building a brand new building. So you pick up a little bit. So maybe you roll it all up, new construction today, maybe it’s down 10% to 15% from where new construction was 2007.

Offsetting that, you’re right. We’re looking for returns and we think the cost of our equity and we think the cost of debt, everything is much higher today than it was then so you’re looking for returns that are higher than you might have done a build to suit in 2007.

And when you roll those two together, you end up in situations where the rents you might feel necessary to execute a build to suit are above market. And that can range 20% above market to 40% above market. They can be somewhat higher.

Mike made a point in his remarks that in addition to making sure that it all looks good in terms of return and everything, the other thing you want to make sure you’ve done is create value, that you haven’t built an asset that almost the day you complete it, it is worth less than what it cost you to build it.

So we want to be careful about the credit of who we put in these building, the term of these leases, etc. to make sure it makes sense. We probably talked to a dozen people last year about build to suit, and in a number of instance when we walked people through it, they ended up saying, wow, that’s more expensive than where the market is. And the answer is yet, it is.

So you might consider going into an existing space. In one case, somebody we worked with ended up buying a building that that made more sense for them. So these have to be fairly discrete needs that somebody has that would drive them to want to do this today, and that’s why we think we might do maybe one, maybe a couple.

But I don’t want anybody thinking we’re having an explosion of build to suits all of a sudden. But I think there will be some that will begin to happen.

Josh for Michael Bilerman – Citigroup

When you think about your turns in the low double digits are you thinking about using land that’s on your books or about buying new land?

William Hankowsky

I think in every instance but one, it’s our land and that one is a situation where somebody has control of the site so we’re more working with them. As I said, none of these might happen, so we’ll see, but basically we’re looking at using our land.

Michael Bilerman – Citigroup

When you’re talking about one or a couple, these are $20 million type deals?

William Hankowsky

They could range, we haven’t put any of these fish in the boat yet. They could range from an $8 million pretty straightforward flex kind of building for somebody, and maybe one or two of those. They could range to an office building that’s more like $20 million or $30 million or you could have something fairly significant that could get you close to $100 million.

The problem is, since they’re lumpy I can’t put a number on it. We could end up doing two $8 million and nothing else. We could end up doing one $50 million.

Michael Bilerman – Citigroup

But all the built to suit will be 100% free lease. You’re looking for a high return, and when you’re quoting those returns, that’s your land. The $220 million of land that’s on your balance sheet, that’s still at historical book. None of them have been impaired in any way?

William Hankowsky

That’s correct.

Michael Bilerman – Citigroup

So when you’re quoting these returns that’s using land at market or land at your book basis?

William Hankowsky

It’s using land at book basis but we’ll look at what land is at market in terms of just considering the transaction. But understand, the land is not a huge component of the cost of these new buildings.

Michael Bilerman – Citigroup

On D.C., is there anything, is the law suit still going on with the former Republic owners?

William Hankowsky

Not exactly. I’ll do this quickly and then maybe offline if you want more detail. There was a lawsuit in Delaware. That lawsuit is over and it has been put to bed and was appealed twice and both parties just went home. No harm. No foul. No one got anything.

There was a new lawsuit filed basically on the same issue in the District of Columbia and we’re seeking to have it dismissed. Then there are a very modest, modest in the sense of monetary issues that deal with one of the individuals that was there and that lawsuit is still pending and is depositions, but it’s modest no matter what happens.

Michael Bilerman – Citigroup

And all the costs that you’re having to fund is hitting G&A today and is being expensed.

George Alburger

It’s a little bit complicated but its been baked into our impairment calculation if you will.

Michael Bilerman – Citigroup

But part of this is still, you were able to transfer the liability into the joint venture?

George Alburger

Part of the cost of the original acquisition was an accrual for what we thought we would be the cost to settle these litigations, resolve these issues. I can tell you this, there is a thorough disclosure in the 10-Q but we’ve accrued for it if you will.

Michael Bilerman – Citigroup

I know that the impairment is totally accounting related but I didn’t know if wrapped up in that if there was any change on the lawsuit front.

William Hankowsky

No.

Operator

Your next question comes from Brendan Maiorana – Wells Fargo.

Brendan Maiorana – Wells Fargo

In terms of the industrial demand is there any differentiation between the pick up in demand for small box users versus large box users?

William Hankowsky

That’s a good question. As Rob mentioned you’ve got three markets that seem to have a little bit of pick up and to some degree it’s going to be somewhat related to the markets.

Houston is not a big box market so the activity there tends to be in the multi-tenant user nature, about 25 to 50 to 75 corporate kind of users. You go to Chicago, and I think it is probably fair to say there it’s more of a multi-tenant user pick up, so kind of 200. It’s not like there’s an explosion of people looking for million square footers in Chicago so for the Chicago market, they would call that mid range deals, and those would be big deals in Houston.

Lehigh Valley I think it’s fair to say it’s running from a 200,000 square feet to as much as some prospect activity it’s in the 700,000 to 800,000.

George Alburger

I’d say if there was a proponents, there would be most common is about 100 to 200 right now.

Brendan Maiorana – Wells Fargo

I think it’s fair to characterize that industrial pick up has been more significant than office, but are you seeing an improvement in office in the fourth quarter or in the early parts of 2010?

William Hankowsky

Here again I want to be careful. I’m nervous that people are going to take these comments to say that things are coming back. All I’m talking about is that there were more people in the market in December and in January than we’ve seen in awhile. Remember we’re seeing very few people so more going from two to four is more for us, but it’s nowhere near where it’s been historically.

On the office side, I would say it’s more market specific so there was some sense that there was a few more people in the market in Northern Virginia. I would not say there are more people in the market in Jacksonville or Richmond, maybe a few more people in the market in the Philadelphia suburbs. So it is not consistent across all markets.

Brendan Maiorana – Wells Fargo

Thinking back to your comments at mid year ’09 where I think you made a comment that you don’t want any of your folks to fall in love with their space and just get deals done at market if you could. Is that still the mind set today or do you feel like you’re going to be, you’re not going to do a deal that’s below, you’ll kind of go at market. But if there are below market deals out there you’d rather be a little more patient and wait for the market to come back.

William Hankowsky

That’s an interesting question. I think this is very market, and it can get as granular as space specific. Rob and I spent two weeks going every budget assumption in every budget for every city. So that’s 858 spaces.

People have a very good sense of how to think about those. It was the collective wisdom of the group. So for example, there could be a space that’s a 2,500 square foot suite in a very tough office market and there’s 50 options in the market and there’s maybe 10 in the sub market, and there aren’t a whole lot of prospects.

So we’re going to meet the market. If there’s somebody alive out there we want to be able to see if we can get them in our space. We’re not going to make the market in terms of cutting rents, but we’re going to meet the market.

There could be a space that we look at and say, you know, that is a terrific space. It’s in an A building. We’re not going to get the rent we got in 2007, but the fact that somebody down the road is desperate and is willing to be 20% lower, we’re not meeting that rent even though that might be the market.

We think there will be enough deal flow that we want to get what we think is appropriate for the space in this market which is less than it’s been historically. So we will be patient. There are buildings we have told our folks, unless you can get this set of parameters, you have permission to sit on it because it’s not worth long term cutting the value of that building by making some aggressive deals today.

It’s very granular and it will vary but I would say we range from meet the market to be patient.

Brendan Maiorana – Wells Fargo

The building where you’re patient, is that somewhat of a shift from mid last year?

William Hankowsky

I would say yes. But I want to say again, it’s not every space across the board that there’s a shift, but there is a sense of we could be a little patient here on some of the spaces.

Brendan Maiorana – Wells Fargo

It looked like the CapEx really spiked up in the quarter and that caused the coverage shortfall in the dividend just modestly in the quarter. Should we expect that number to resume back to more normalized levels as we look at 2010?

George Alburger

Non reimbursed CapEx spike up. That’s not untypical of what happens every year. There is always a lot more CapEx that’s spent in the fourth quarter. The average for the year was about $2.3 million a quarter and that’s less than what the quarterly average was in 2008. And it probably will spike up a tad in 2010.

Operator

Your next question comes from John Guinee – Stifel Nicolaus.

John Guinee – Stifel Nicolaus

You have some preferred’s that I think are redeemable in August of ’09 at about 7.5%. I think it’s about $95 million out there. Until recently that seemed like a really bad idea to call those. What’s your thought process on that today?

George Alburger

I wouldn’t categorize it as a good idea to call them now so I think we’re comfortable with that. I totally agree with your notion that it had to be the furthest thing away from your mind in all of 2009. I think for right now we’re content with that.

John Guinee – Stifel Nicolaus

It looks like you $237 million of cash and cash equivalents on the balance sheet as of year end and a fairly consistent $140 million out on the credit facility. Is there a reason you’re got $140 million drawn on it given the cash and cash equivalents?

William Hankowsky

Yes, a reason that I’d rather not get into right now but I can tell you that those numbers have both changed somewhat meaningfully since December 31. So we have less cash on our balance sheet and less outstanding on the credit facility.

John Guinee – Stifel Nicolaus

You’re one of the few companies out there that quotes mark to market on a net basis. Can you give us an estimate on what the mark to market is on a gross basis and then also talk about what you think broad based is going to happen to your operating expenses year over year 2010 to 2009.

William Hankowsky

Operating expenses in the sense that we think they’re going up or down?

John Guinee – Stifel Nicolaus

Exactly.

William Hankowsky

I’m going to go back to George on the gross net question in a second but let me just deal with the operating expense question. If you take the big pieces, and Rob spent a few minutes talking about the electricity utilization, electric rates.

You have an interesting phenomenon where in a number of our markets, not all, you’re going through this deregulation process. It happened in Maryland. It’s happening now in Pennsylvania. So forget where oil prices are. That’s not the issue that’s going to drive electric rates.

What’s driving electric rates is going to the fact that a number of big utilities are coming off these deals that were struck 10 years ago. So I think electric rates are going up, hence why we’re being extremely aggressive trying to control those costs on behalf of our tenants.

Taxes are, I think we all know where local government is which is that local government has real struggles with revenue so you expect governments, local governments perhaps to raise property taxes or to try to do something like that.

Offsetting that, just like we’re offsetting the utilities by being thoughtful about retrofits and energy conservation measures, offsetting that is we have a systematic approach we’re taking this year to the appealing of property taxes on our assets.

You’ve got general costs like janitorial, landscaping etc. In calendar 2009 we met with 750 vendors. We met with every vendor in every market and revisited the cost of every service and in some cases also revisited the specs that were involved because we thought it was important to deliver to our customers lower operating expenses. So we did a pretty good job of lowering those and I think they will remain lower.

I don’t think they’re going lower but we were able to reset them down in ’09. So you roll all that up and operating expenses might go up a tad, but I don’t thing they’re going up a lot.

And remember, most fundamentally almost all of our leases are net leases so that we pass those on. So the impact to Liberty is on that 11% of vacant space in a multi-tenant building where we still run the utilities and we have to pick that piece up. So I don’t see a dramatic movement in operating expenses.

George Alburger

When people ask us about mark to market we do that comparison on a net basis not on a gross basis. I don’t have it for the entire portfolio on a net basis, but I think I can give you some information that will be helpful.

In the third quarter on a straight line basis our rents, old rents to new rents by 13.9% and we did a calculation of what that decrease would look like if it was done on a gross basis, and it was down by about 9%. So the differential that quarter was about 4%.

Operator

Your next question comes from John Stewart – Green Street

John Stewart – Green Street

I don’t mean to be sinister but you’re a little cryptic in your remarks about the change in the cash balance since December 31. Did that go to pay off the line or did you do anything else?

George Alburger

No, primarily it was the cash balance went down and we used those funds to pay off the line.

John Stewart – Green Street

You reference a dip in occupancy in the first quarter a couple of times. Is there a specific tenant or transaction that is accounting for that?

William Hankowsky

It’s no one specific tenant. There were some leases that were in occupancy on December 31 but they’re not in occupancy January 1, and some of them are larger industrial leases that we’re just aware of and as we model the year and forecast it, we see I think Rob and I both mentioned, we see somewhat of a dip in the first quarter, picking up in the later half of the year. But it’s not something big or monumental. It’s just sort of natural movement in the portfolio.

John Stewart – Green Street

I know you reiterated guidance, but I’m curious if there has been a shift in the mix at all. Specifically are you still looking for a $0.07 to $0.11 NOI erosion?

George Alburger

Generally yes.

John Stewart – Green Street

How about potentially are you baking in fewer dispositions at higher cap rates and there’s an offset in the same store? What may have changed?

George Alburger

When I laid out those cautions about first quarter I kind of wanted to highlight we were not changing guidance so we’re still sticking with the same guidance. As Bill mentioned we continue to run budgets and things like that but the same guidance.

William Hankowsky

The basic assumptions all remain the same, but as we’ve highlighted throughout this call, things could happen. So for example, if we saw an opportunity to sell something that made sense to us, we might have more sales than we thought we were going to have and if they happen earlier in the year that could knock a cent or two off, right?

If we found something to buy and it was bigger than we thought it was going to be, that could pick up a cent or two. But at this point there is not enough clarity in anything to revise the fundamental parameters of our guidance we gave you in the third quarter.

Operator

Your next question comes from Michael Bilerman – Citigroup.

Michael Bilerman – Citigroup

In terms of the first quarter, you’re saying the effective $0.68 this quarter without the impairment goes down $0.01 to $0.02 for occupancy and then you have another $0.04 for the G&A, the $3.8 million, so you effectively get down to a $0.63 to $0.64?

George Alburger

I’m not trying to give you an exact number but that’s correct. We had $0.67 this quarter and that included $1.7 million of a term fee which is a little higher than our normal term fee in a quarter. You’re going to have a number similar to the $3.8 million which is around $0.03 and as Bill mentioned, a little dip in occupancy that could cost you $0.01 or $0.02. But you are directionally right.

Michael Bilerman – Citigroup

Does that occupancy dip, when does that start to recover in terms of picking up the pennies that you’re losing?

George Alburger

As we’ve said, it picks up basically in the later half of the year.

Operator

There are no further questions at this time.

William Hankowsky

Thanks everybody for listening in and we all look forward to a much better 2010 than 2009. Thanks.

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