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Executives

Jeanne A. Leonard – Vice President Investor Relations

William P. Hankowsky – Chairman of the Board of Trustees, President & Chief Executive Officer

George J. Alburger, Jr. – Chief Financial Officer, Executive Vice President & Treasurer

Michael T. Hagan – Chief Investment Officer

Robert E. Fenza – Chief Operating Officer & Executive Vice President

Analysts

Paul Adornato – BMO Capital Markets

[Jon Petersen – Macquarie]

Jordan Sadler – Key Bank

Sloan Bohlen – Goldman Sachs

Alexander Goldfarb – Sandler O’Neill

Michael Bilerman – Citigroup

Brendan Maiorana – Wells Fargo Securities

John Guinee – Stifel Nicolaus

John Stewart – Green Street Advisors, Inc.

Dan Donlan – Janney Montgomery Scott

Liberty Property Trust (LRY) Q1 2010 Earnings Call April 26, 2010 1:00 PM ET

Operator

At this time I would like to welcome everyone to the Liberty Property Trust first quarter earnings call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer session. (Operator Instructions) Ms. Leonard you may begin your conference.

Jeanne A. Leonard

You’re going to hear prepared remarks from Chief Executive Officer Bill Hankowsky, Chief Financial Officer George Alburger, Chief Investment Officer Mike Hagan and Chief Operating Officer Rob Fenza. During the 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 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 the expectations reflected in such forward-looking statements are based on reasonable assumptions, we can give no assurances 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, risk that were detailed in the issued press release and from time-to-time in the company’s with the Securities 7 Exchange Commission. The company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events.

William P. Hankowsky

Liberty had a very solid first quarter with FFO coming in at $0.64 a share. Our performance this quarter was very consistent with our business plan for the year and consistent with our projected view of market behavior. We leased over 3.9 million square feet this quarter, slightly above our quarterly average for 2009. Occupancy declined 1%. This decline is mainly due to timing and we anticipate occupancy tracking up in the second half of the year. Our renewal rate was 55%. Rental rates declined 9.2% on a straight line basis. This is less than the over 13% decline we saw in the third and fourth quarters of last year.

So what are we seeing market fundamentals currently? Prospect activity is up generally with more activity in the industrial area than the office space. However, this is not consistent with each of our markets. When we say that activity is up, we’re comparing it to 2009. The activity is well below historic norms as the economy slowly works its way forward. Rents have bottomed out but are flat bouncing along the bottom. Concessions have also leveled out save for the idiosyncratic desperate deal down by a besieged landlord.

So in summary, on the operational front, we’re on track with our business plans for the year and continue to outperform both our markets and the nation by 270 and 390 basis points respectively. Another way to look at our performance is comparing Liberty’s share of our markets which is 1.2% and our share of first quarter leasing activity which is over 10% of all leases done in the first quarter in Liberty’s markets.

Let me turn to the investments side. We sold two buildings for $6.4 million this quarter. Our guidance for the year is $75 to $125 million in sales but, as we indicated last quarter, should we see an opportunity to sell more consistent with our long term strategic objectives, we will take advantage of these opportunities. On the acquisition front, we continue to look for opportunities. We have a strong interest in growing the portfolio but there is not a lot of product in the market and even less at pricing that makes sense to us. Our focus is on value added opportunities, something that has been a strong suit of Liberty’s since our IPO in 1994.

With our extremely strong balance sheet as of March 31st, we have over $700 million in capacity between cash and line availability to pursue acquisitions. Mike will provide you with some additional color on the investment environment in a moment. We are also continuing to explore build to suit opportunities with a number of clients and we would anticipate commencing one or more in 2010.

To sum up, the first quarter was a solid quarter for Liberty in a continued rugged market. We’re on track for the year and we affirm our guidance of $2.60 to $2.80 a share. With that, let me turn it over to George.

George J. Alburger, Jr.

FFO for the first quarter 2010 was $0.64 per share. The operating results for the quarter include $1.8 million in lease termination fees which is in line with our guidance that lease termination fees would be in the $0.04 to $0.06 per share range for the year. On our February earnings call we mentioned that the accelerated vesting of long term incentive compensation would affect general and administrative expenses for the first quarter of 2010. You may recall we had a similar situation in the first quarter of 2009.

G&A for the first quarter of 2010 includes $1.7 million of additional expense because of the vesting schedule is accelerated for certain individuals because of their ages or years of service. The overall cost associated with incentive compensation hasn’t increased, the amortization time frame is just compressed. This will be a continuing first quarter anomaly for us every year unless we figure out how to get younger, which is one of my goals.

During the quarter, we brought in to service one development property with an investment value of $24.8 million. This property is 100% occupied and has a yield of 11.7%. We didn’t start any development properties this quarter. As of March 31st the committed investment in development properties is $218 million. For wholly owned properties it is $58 million and for these properties the projected yield is 8.5%.

We didn’t have any acquisitions this quarter but sold two properties for $6.4 million. For the core portfolio, during the quarter we executed 3.7 million square feet of renewal and replacement leases. For these leases rent decreased by 9.2% which is generally in line with our guidance that rents would decrease by 10% to 15% for the year. For the same store group of properties, operating income decreased by 3.6% on a straight line basis and decreased by 2.3% on a cash basis for the first quarter of 2010 compared to first quarter 2009.

The decrease is primarily due to a decrease in occupancy and it was expected. We mentioned this during our February call. What wasn’t expected was the tremendous amount of snow we had in the first quarter. Snow removal costs were up substantially. Most of our leases are net leases so these costs are passed on to tenants but our first quarter results include approximately $400,000 in snow removal costs which was not recoverable.

Finally, on the capital front our balance sheet is in good shape. We added a new ratio to page five which is a net debt to EBTIDA calculation. This number has generally been in the low to mid five times range for us. As of March 31st it’s slightly under five times. One item we are working on is our credit facility. It expires in January 2011. We hope to have a new credit facility in place by early in the third quarter. Our present facility is a $600 million facility. We’ll probably replace it with a facility in the $450 million range.

With that, I’ll pass it on to Mike.

Michael T. Hagan

Let me start by adding some color to our first quarter sales activity. We sold two flex buildings to users during the quarter. In one instance, a user purchased an empty 31,000 square foot building. In the second sale, a tenant exercised a purchase option. The cap rate on the leased building was in the mid nines. Our guidance for sales activity for the year is to be in the $75 to $125 million range. However, as we have previously stated, we will continue to monitor the investment activity in the market and should opportunities arise that are consistent with our strategy of decreasing our suburban office portfolio, we will increase our sales volume.

On the acquisitions side, while we have not acquired any assets, we are actively seeking acquisition opportunities. We have underwritten dozens of deals. It is clear that there is a bifurcation in the market. There is a great deal of capital looking for well leased Class A properties in first tier markets. With lenders actively looking to place financing on these assets as well, the result is premium pricing.

The amount of capital chasing these core transactions throughout our markets is surprising. It seems as if 2009 never happened. In other cases, buildings that have been marketed and then pulled from the market due to pricing that does not meet the sellers’ expectations. We believe that more of these deals trade it will create a broader market and with that may come value added opportunities. We will look for these opportunities and where we can add value through our leasing, property management or development skills, we will be an acquirer.

Our guidance for the year was $0 to $100 million of acquisitions with yields in the 10% to 15% range. While we are comfortable with the dollar range of investment, we now believe that the stabilized yields will be in the 8% to 10% range. With that, I’ll turn it over to Rob.

Robert E. Fenza

I’m going to take just a few minutes to discuss operations and the marketplace. As Bill mentioned, leasing in the first quarter was solid and according to budgeted projections. 223 new and renewal leases were executed for nearly four million square feet during the quarter consistent with typical and historic first quarter market activity.

Last quarter we told you we expected occupancy to trend down early in the year and it has done just that as scheduled and expected move outs occurred. We continued to outperform our competitors by a wide margin and our occupancy continues to outperform the national average by nearly 400 basis points. As we also mentioned last quarter, we have a relatively light year for expirations and after the first quarter activity, we now have only five million square feet of 2010 expirations remaining.

The current leasing environment continues to be an improvement over most of last year with more prospect activity and more showings. Tenants are also more confident in making long term real estate decisions. This confidence tends to be among larger tenants as economic clarity has not yet made its way to mid and smaller companies who continue to struggle with decision making. As Bill mentioned, it will take time for the pickup in prospect activity and the decision making to translate in to pricing power.

During the first quarter we experienced an uptick in transaction costs driven by two factors. First, as we stated last quarter in 2010 we are projecting a higher percentage of replacement leases versus renewals. Replacement leases historically utilize more capital than renewals and secondly, the willingness of larger companies to make long term lease decisions has driven that number as well.

In the first quarter the increased transaction costs were primarily due to a small number of long term lease transactions. For example, we executed a 15 year office lease for 51,000 square feet with a high credit tenant in southern New Jersey. The tenant was attracted to our property for a number of reasons including capital improvements made to the property in the prior year which upgraded the lobby, refreshed the landscaping and enhanced the building’s energy efficiency. In a market where many landlords have simply not had the capital to continue to enhance the value of their properties, our financial position is a tremendous advantage.

I’ll make another observation about this transaction, although it represents a willingness on the part of a large tenant to make a long term commitment, we have not returned completely to what we would call standard operating procedure. This transaction took many months with interaction with the tenant at multiple levels within Liberty. Companies are making decisions but the decision making period is still protracted and decisions are very carefully and deliberately made.

Turning to specific products, last quarter we reported what appeared to be the beginning of improvement in our industrial markets. Although national distribution absorption continued to weaken in the quarter, we are definitely seeing increased demand. Although, at this point Houston is the only market where we could use some additional inventory to lease.

In the first quarter, there was a 300 basis point drop in occupancy in the Lehigh Valley distribution space due to anticipated move outs. However, so far this year we’ve completed over one million square feet of new distribution leasing which will commence in the second quarter.

Shifting for a moment to development; the pipeline is rapidly shrinking. After bringing 3 Crescent Drive in to service in Q1 at 100% leased the pipeline is down to just four projects at an investment of $218 million. Subsequent to quarter’s end, we brought leasing of our Washington DC building at 1129 South 20th Street to 50% leased bringing the pipeline to over 40% leased today.

On the build to suit front, we’re seeing good activity with close to a dozen prospects for over two million square feet. These prospects are predominately office and high finish flexs. Although several are in the negotiation phase, corporate decision making is still very sensitive to movements in the economy and we have seen protracted decision making lead to projects being postponed or shelved in the 11th hour before. So our best projection at this point is that a few of these will make it to the finish line in the next few quarters.

With that, I’ll turn the call back to Bill.

William P. Hankowsky

Let me close by sharing our thoughts on the current state of the economy. Put simply, things are getting better because the rate of decline has slowed or halted but substantive growth has yet to fully materialize. The unemployment rate stays stuck at 9.7% and even with one month of positive job growth we’re still looking at 8.2 million jobs lost. The result is a continued pressure on some firms from this long high tide of recession yielding contractions and operational shut downs.

At the same time, other firms are seeing clarity and beginning to make long term space commitments. The net of these trends was negative absorption in the first quarter in both office and industrial space but, they were the smallest numbers we’ve seen in the last eight quarters. We are about to go in the right direction but it will be a long and initially slow path up.

With that, let me now open it for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Paul Adornato – BMO Capital Markets.

Paul Adornato – BMO Capital Markets

Bill, I think you said that Liberty accounts for about 1.2% of market share in your markets yet you accounted for 10% of all leasing activity. I was wondering if you could give us a little more detail on why that’s happening? Are your leases perhaps priced a little bit too attractively for your markets or are you offering shorter term leases?

William P. Hankowsky

It’s a great question Paul. I don’t think it’s either of the reasons you cite and the statistics I gave out there, what we do is we take a look at – this is on a per square basis, I just want to make clear what I am talking about. So it’s not on a transactional basis, it’s on square feet that are leased in each quarter that we track and historically we have always done more than our share which is how we end up with that occupancy rate that is greater than the market average. But, in the first quarter it happened to be about 200 basis points higher than it normally is so I just thought I would make note of it.

I think what drives it are several factors. To be blunt, one is simply the quality of the asset and the quality of the landlord. We have very good buildings, they’re well located, generally in park environments. As Rob said in his comments when he gave that example about the building in New Jersey, we have been investing in our assets which in some cases is not happening. We have absolute creditability in the market and what I mean by that is people know that if Liberty is going to make a commitment it is going to be fulfilled. We can pay the commission, pay for the TIs, we’ll keep the building up.

So that experience that has happened over the last 15 months of people going to private buildings and then finding they couldn’t perform, lender would agree to the TI package, broker didn’t get the commission the way they thought has soured the brokerage community on some landlords. Candidly, they will go to people they know can perform. I think also it’s a function of simply legacy. We’re in these markets for a long time, we have strong relationships with the brokerage community. We will see every deal in the markets we’re in or the submarkets we are in.

We have 2,400 tenants so it’s a significant amount of our activity is internally generated, people moving, growing, a company in market A having a need in market B. So I think when you kind of roll all that up, it creates the opportunity for us to outperform and I think as it continues as we’ve said in this call, to be a rugged environment, landlords that have stability and capability are just going to perform better and that’s what we’re seeing.

Paul Adornato – BMO Capital Markets

Looking at some of the macro drivers, the economists have cited inventory rebuilding as one of the drivers of the economy do you see that affecting your markets yet, your industrial markets?

William P. Hankowsky

I do think we’re seeing a bit of that Paul. When you look on the industrial side where that is obviously going to manifest itself, we’re seeing more activity in Chicago, we’re seeing more activity in the Lehigh Valley, we’re seeing more activity in Houston. So the markets I would tend to call somewhat more distribution oriented we’re seeing probably more of an uptick than for example southern New Jersey where we have industrial which is really a regional industrial market, in other words plays just to the metropolitan area.

There’s less activity in the markets where our industrial product tends to serve the metro area versus the distribution product. I think that differential is in part driven by your comment, by inventory buildup.

Paul Adornato – BMO Capital Markets

Finally, any change in the attitude of banks in terms of appetite for commercial real estate landing and also in terms of wanting to force property transactions or just enable property transactions?

William P. Hankowsky

Two very big questions, on the appetite to lend, I think the place where you’re seeing that appetite may be more up is actually with life companies more than I would say with traditional banks. There’s no question that there I debt available, it just wasn’t the way it was six to nine months ago, it is a dramatically improved environment from a debt availability perspective. But, as Mike said in his comments you have this bifurcation.

They are prepared to lend to well leased, with term, decent credit in the tenant mix, good sponsor product in what I would call historically liquid markets, i.e. where real estate has tended to trade, even if it’s not trading today. Because, that life company can sit there and say, “If something goes array and I end up owning an industrial building in Chicago or an office building in the Philadelphia suburbs, I know there will be buyers for it even if there aren’t a lot for it today.” So they will lend there.

They won’t lend to the under leased, bad credit, renewal happening problem sponsor. So you actually sort of have more capacity available against not that much demand. On the distressed side it is clearly still a scenario of the banking institutions basically if there is cash flow available to service the loan, forget all the technical defaults about covenants and loan-to-value. The simple fact is they are prepared to extend. They don’t want to deal with the asset, they don’t want to take it back. I think they also believe that things are getting moderately better across the line so maybe things will be better if everybody kind of hangs in there.

They are probably less patient where the sponsor isn’t cooperating or where there simply is no cash flow. But, in the product types we’re in you see almost no industrial in kind of the distressed category and very little office.

Operator

Your next question comes from [Jon Petersen – Macquarie].

[Jon Petersen – Macquarie]

I was wondering if you could give us an idea of what you think the current mark-to-market is on your office portfolio and then also on your industrial portfolio?

George J. Alburger, Jr.

Generally speaking, on a mark-to-market averaging the total portfolio it’s probably 10ish if you will and when I say 10ish I mean current rents are about 10% ahead of market rents. The range would be on the industrial maybe it’s closer to 5% and on the office it’s a little bit north of that 10% number.

[Jon Petersen – Macquarie]

Then you talked about how you are seeing the economy maybe rebound a little bit not with too much strength, but I guess how does that interpret in to rents? What do you expect market rents to go for I guess office and industrial again?

William P. Hankowsky

I don’t think they’re going anywhere fast. The situation is pretty simple, you had an uptick in vacancy in both office and industrial in the first quarter, nationally it was up 30 bips on the office and 20 on the industrial. We still, as I said, had negative absorption so there is still more product in the market available to be leased than there was 90 days ago. As long as the supply is outstripping the demand, I think the rents are flat. We do see the occasional very aggressive deal by somebody who is just trying to land somebody but on the whole I would say the rents are basically stabilized.

What it would take for rents to begin to move would be some tightening. As we’ve mentioned in prior calls, the way it happens is it doesn’t happen overnight across lots of markets. It will begin to happen in a sub market, it will begin to happen by a product and it probably begins to happen in a submarket, by a product, by a size. So what will happen is suddenly there’s not 10 50,000 square foot spaces, there’s only three. Landlords appreciate that and will push pricing.

You can be in the exact same market and still have 20 10,000 square foot spaces and there’s going to be no rent movement. I think you’re going to be able to see some movement by maybe some industrial rents by size as markets tighten because again, there just won’t be specific. But again, over the course of the year we’re going to see no benefit from that. We’re going to see rents that are expiring in our portfolio, as you asked about mark-to-market, are higher than where market rents are and they’re not going to catch up in 2010.

George J. Alburger, Jr.

Our guidance for 2010 is that on a straight line basis rents would be down 10% to 15% and on a cash basis we said they’d be down about 15% to 20%. Now, we weren’t quite at those levels, I mean we were underneath both of them for the quarter but that’s our guidance for the year for our portfolio.

William P. Hankowsky

I think market rents are flat which is what’s in that, no further declines.

[Jon Petersen – Macquarie]

I just want to go back to your earlier comment about the type of clients that are expanding. You said larger clients, you’re seeing a lot more activity there. Any views why? Is it related to financing availability or just underlying business drivers?

William P. Hankowsky

I think larger candidly translates to corporate. In other word, I think bigger, stable companies are comfortable that the bottom is here, can see the future, can make decisions and make long term commitments. Rob, the case you cited is a 10 year deal or a 15 year deal?

Robert E. Fenza

A 15 year deal.

William P. Hankowsky

I’m not sure anybody would have done a 15 year deal this time last year as the world was spinning out of control. People are comfortable doing that, that have candidly their own financial stability. Where we’re not seeing it is in what I would call the mom and pop, the local company who may still be feeling pressure on their business and isn’t quite ready to make that kind of long term commitment. So it tends to be brand names you would know, many of whom are in our portfolio who are comfortable making long term commitments.

[Jon Petersen – Macquarie]

One last quick question, as we’re seeing a strong recovery in global trade, at least in the costal markets and especially driven by China, how much of that recovery that is occurring is translating in to national industrial helped markets like Chicago and elsewhere in the Midwest?

William P. Hankowsky

I think where you’re seeing it is there are more [3PL] kind of players in the market who have contracts they’ve more recently received which is clearly being driven by some consumer products guy who says, “I’m bringing in more widgets,” or whatever they’re bringing in, giving out a contract and then that guy is looking for several hundred thousand square feet. So I think it is manifesting itself but again, that’s a very particular – and there tend to be a couple of hundred thousand square feet kind of users. There’s no real like million square foot users, these tend to be in the 200,000, 300,000, 400,000 kind of square foot range where the distribution demand has picked up.

Operator

Your next question comes from Jordan Sadler – Key Bank.

Jordan Sadler – Key Bank

I just need a little clarification on sort of the acquisition environment and what you’re seeing in terms of flow. It sounds like things are definitely competitive and you discussed it somewhat on the stabilized asset front but what are you seeing in terms of what you’re targeting for redevelopments? I noticed you obviously lowered your return hurdles or expectations going in so I assume you’ve gotten closer on some deals or at least missed on some deals, maybe just give us a sense of the pipeline?

Michael T. Hagan

I would tell you that we are tracking a lot more real estate that we either think is going to come to the market or is on the market right now that has some degree of vacancy to it and that we didn’t think was going to be there the beginning of the year kind of thing. I think that as it gets harder and harder to find core deals, you’ll see these opportunities become more apparent and that’s what we’re going to look after and try to acquire. I think it gets back to our ability to get them leased in places where we’re comfortable with.

Jordan Sadler – Key Bank

Where are you seeing the greatest flow market wise?

William P. Hankowsky

I will tell you what we have targeted is sort of the multitenant industrial type buildings and I think in the markets we have a preponderance of that was where we’re focusing on trying to acquire. The Carolinas is one place, Houston is another place and a few of the Florida markets.

Jordan Sadler – Key Bank

Are sellers just more comfortable with the pricing meaning the cap rates seem to be moving down a little bit?

William P. Hankowsky

I think that’s true, I think what you saw a few deals trade and/or are rumored to be trading at cap rates that are in the 7% to 8% range and I think that’s suggesting to folks hey, maybe it’s not distressed pricing out there so we’ll put more real estate on the market to see where it will trade. It think pricing will move away from a situation in which it’s not going to be in that range if it’s got some real rollover or if it’s got some vacancy to it but, it’s not going to be at the expectations everybody thought they were six months ago.

Jordan Sadler – Key Bank

Just on the disposition side, you’ve reiterated the volume but I guess we’re in May already and you’ve only done a little less than $7 million. I’m just curious on the visibility in the pipeline, how much you guys may have under contract or any other situations where users may have repurchase options?

William P. Hankowsky

We reiterated the guidance because we’re comfortable we can get to that guidance with what’s in the pipeline and I think obviously it’s probably a little more second half loaded than first half loaded from a timing perspective and as we said given what’s happened with pricing, if there’s some other stuff that makes sense for us to sell that we want to sell, we may go through that number. But, even that would probably be more sort of second half oriented.

Jordan Sadler – Key Bank

On the stuff that you guys have in the pipeline, what are cap rates looking like? Are they coming down at all or are they in the range that you originally thought they were going to be?

George J. Alburger, Jr.

I think they’re going to be at the lower end of the range that we gave.

William P. Hankowsky

And our range was $9 to $11 million?

George J. Alburger, Jr.

Correct.

Operator

Your next question comes from Sloan Bohlen – Goldman Sachs.

Sloan Bohlen – Goldman Sachs

Just a quick question on the acquisition front, it sounds like you guys are looking for lease up opportunities and you’re maybe quoting a lower yield range of 8% to 10%, is that a stabilized yield? And I guess, what’s the expectation for the amount of lease up you’d be willing to take on?

Michael T. Hagan

The only stabilized yields that we’re looking for that we gave the range that we gave, and I will tell you the lease out risk we will take on is going to depend on the building, is going to depend on the market and those kinds of conditions. I can’t tell you there is a broad brush answer to that, we’re going to deal with it on a case-by-case basis.

William P. Hankowsky

If I could just to augment that, I want to kind of refer you all back to the way we think about acquisitions historically because there’s a lot about Liberty that tends to be fairly predictable here. We basically run them through in addition to the financial filters obviously from a need to have product, number one we’re going to look at our own portfolio. So if you could take this call in its entirety, we think our occupancy will be better in the second half than the first half. As a particular market begins to move along we can obviously look out and say, “In six to nine months we’re going to be 93% leased in this market, or 94% and we’re going to start running out of product.”

We’re seeing a little better deal flow so now we’re saying, “Okay, I’m running out of product and I have no product to address deal flow so what are my expectations about how long it will take me to lease it up?” Like six months ago we would have said it would take two years to lease something up to get by that would be a value add. I think today you can feel depending on product and market and where we are, so we’re going to look at all that and then we’re going to look t the market that we’re in and if there’s adequate deal flow to feel comfortable that’s one thing. If the market still hasn’t really moved forward than even if we get leased up we’re not going to necessarily add product because there’s not enough deal flow. I just want to kind of emphasize Mike’s point, it’s going to be very Liberty product specific in markets dependent upon market conditions we experienced.

Sloan Bohlen – Goldman Sachs

Bill, maybe to kind of elaborate on your point that it will be in a particular market by size and by product, it sounded like Houston maybe is a tighter market right now where maybe you’d need more product to lease. Is it to the point that are tenants utilizing the majority of their space, particularly on the industrial side or is there some level of slack that still needs to be worked through over the course of this year before we get to that point I guess for other markets?

William P. Hankowsky

One of the things about industrial space is it tends not to be a market that has a lot of slack. I understand totally what you’re talking about. In the office space world you can have the vacant space because there was hiring freezes and there’s an implicit sort of under utilization of space. On the industrial side, lease terms tend to be somewhat shorter, people are pretty quick to adjust the size, it doesn’t take much to move out of a warehouse, right? You don’t have to lay people off, you don’t have to go through a whole process, you just move the inventory away or in fact if you sold it off you just take the racks away.

So there’s much less under utilization of industrial space among our tenants. They tend to be pretty much in the space that they’re in and if they’re not they’re probably going to contract, get efficient and when the lease expires they’re either consolidating with us or consolidating somewhere else. So that’s not a big phenomena.

Sloan Bohlen – Goldman Sachs

Then just one quick one for George if I could, George you talked about the line maybe going from $600 million to call it $450 million, is that just size for what you guys think you can do in terms of whether it is build to suit or acquisition or is that more what you’re hearing from what you think you can do at the bank?

George J. Alburger, Jr.

It’s the former, it’s the former. It’s a facility that looking out over the next two or three years would be adequate to address our needs, it’s not because there’s only so much capacity for us.

Sloan Bohlen – Goldman Sachs

Then even under the low level of leverage you guys are at was there any debate as to whether you could be opportunistic to where the credit markets are today?

George J. Alburger, Jr.

Yes, I mean the credit markets today are wide open for REITs. If we were to approach a credit market for a 10 year deal we would be low 6% and that’s an attractive number. The question is what do we do with all that cash? We have a fair amount of cash on our balance sheet and can already handle with the cash we have on our balance sheet the majority that comes due in August of this year. We’re keeping an eye on the unsecured market and there’s, like I said, a lot of capacity there.

Sloan Bohlen – Goldman Sachs

The 6%, that was for 10 year paper?

George J. Alburger, Jr.

10 year.

Operator

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

Alexander Goldfarb – Sandler O’Neill

Just going more in to the transaction market one to get a little bit of color, maybe it was lost in some of the responses earlier, but one to get a little color as to where you’re seeing more interest or more acquisition interest not from your perspective but on the part of people who want to buy real estate out there if it’s more on suburban assets, more on industrial? And then, if it’s a size issue as far as they’re looking at bigger sized buildings, smaller sized buildings? I know in industrial land it seems like the bigger the box the lower the cap rates, there’s sort of an inverse size to value relationship. I just want to get an understanding of what you’re seeing?

William P. Hankowsky

I think you might also want to comment on the nature of those buyers.

Michael T. Hagan

Alex, I would tell you I believe that there’s so much capital sitting around out there and there’s so few of the core type deals that we described earlier that you’re seeing people venture away from that and I think what will happen is it will depart more on the industrial side first, it’s clearly happening with urban office and it’s going to get in to suburban office. The drive to place those dollars is going to put positive pressure if you’re a seller on pricing. I think it’s going to sort of leak out in that order of asset class.

I think you’re right, from a bigger box poster side of distribution space is always going to get premium pricing in the markets that are known for those distribution markets. It will get in to multitenant industrial, it will get in to urban office and then it will get in to suburban office. We’re getting calls every day about people asking what we have for sale and the pricing is, as I said in the comments, it’s starting to be surprising.

William P. Hankowsky

Mike, wouldn’t you say that some of what’s being put in the market is sort of funds that finally see some capacity gets liquidity and investors may want some redemption and finally some of them are putting product out?

Michael T. Hagan

The nature of some of the sellers are, yes exactly as Bill was saying, you couldn’t sell a property six or nine months ago and now all of a sudden there may be a market at pricing that you can become attractive to it and so people are testing the market on it. Some of it still might not meet an expectation but there’s more and more product being put on to the market by various institutions.

Alexander Goldfarb – Sandler O’Neill

Just as far as the big box goes, the bombers, given that a lot of those things sort of liter the landscape and are causing a lot of the pricing pressure in some of these markets, are you suggesting that the institutions are still willing to pay up for those even though in a downturn the leasing of those could be very costly?

Michael T. Hagan

They’re leased and I’ll tell you I think some of the way people are going to start underwriting these things is that some of these things were leased at the bottom of the market and people are going to look at rental rates and say, “The rents have to go up.” There were deals done in the Chicago marketplace that were in the low twos, twos to two fifty range and you find a building that you can buy for $35 a foot, someone is going to say on a price per pound basis that’s an excellent deal and the cap rates are going to be in the six kind of thing. But, they’ll buy for more of a longer term investment thinking that they can do that thinking their rents will go back up and I’ll be happy with that return. I think it’s the pressure to put the money out that’s going to drive that as much as well.

Alexander Goldfarb – Sandler O’Neill

So we’re back to the future?

Michael T. Hagan

Exactly.

Alexander Goldfarb – Sandler O’Neill

As far as just switching gears to suburban office, I just want to get some color around northern Virginia. As far as our tax dollars being put to work, how much government leasing are you seeing through the suburban northern Virginia market? Then two, is going after government tenants, is that something that you guys would target or is the RFP process too much brain damage and just not worth the economics to get involved there?

William P. Hankowsky

It’s worth the brain damage. We would definitely pursue GSA leases, we have GSA leases in that portfolio, we have one of the two downtown DC buildings is a 100% GSA deal with multiple government agencies within it. We just renewed a GSA deal out there last quarter. We’re active in that space. But, in terms of from a demand perspective I don’t think it is particular necessarily government as government as much as it is contractors to government. So whether they’re security, defense, health related, that is more of the pickup in demand in northern Virginia, that kind of player than it is government per say. Would you say that’s fair Rob?

Robert E. Fenza

Yes. I agree.

Alexander Goldfarb – Sandler O’Neill

And you’re seeing that pick up?

William P. Hankowsky

Yes. And again, pick up from where it was, I don’t want to talk about robustness here, it’s just better than it was six months ago.

Operator

Your next question comes from Michael Bilerman – Citigroup.

Michael Bilerman – Citigroup

What is tenant pipeline look like to fill some of the occupancy that was lost in the first quarter and how quickly do you think you can get it back? Is it second quarter, is it fourth quarter?

William P. Hankowsky

On the portfolio in general?

Michael Bilerman – Citigroup

Yes, on what was lost in first quarter.

William P. Hankowsky

Well, I think Rob gave you a hint of that in some of his comments. The office portfolio actually only went down 30 basis points in occupancy, it is actually hanging in there pretty well. When you look on the industrial side that was down 110 and we already know about leases signed for example in the Lehigh Valley, the one million square feet that hasn’t commenced but has happened, but there are others where we’re in negotiations. So this is a fluid process, so as we lay out the business plan for the year and look at where we are with signed but not commenced, in negotiation but not signed and project that out our sense is that as I said that occupancy would pick up in the second half of the year.

I guess by extrapolation, it isn’t in the second quarter it’s in the second half. So remember our overall guidance, our overall guidance is plus or minus 1% for the year and if you go down where you’re going down and you’ve got to come back up to get plus or minus 1% I think you can kind of figure out how it plays.

Operator

Your next question comes from Brendan Maiorana – Wells Fargo Securities.

Brendan Maiorana – Wells Fargo Securities

This is I guess I think the second quarter in a row where the AFFO level has been below the dividend. Bill, you talked about cap ex levels that are a little bit higher now than what they had been in the first few quarters of last year but it seems like maybe we’re back to a normalized level where last year was a little bit of an outlier. So, if I look at cap ex levels that may sort of sustain from here and then your capital recycling activities that are unlikely probably to be accretive at least in the near term probably may be a little dilutive, it seems like you’ve got to get some improvement on the core performance of the portfolio to get to a positive dividend coverage. How should we kind of think about you getting to a positive dividend coverage in terms of time frame?

William P. Hankowsky

You’re right, right now we’re not covering on a cash basis and again, to reiterate the performance of the portfolio this year is a dipping of occupancy in the first quarter and in response to the last question, it will probably sustain itself as it dipped in to the second quarter and begin to come out in the second half of the year so you’re going to have I guess a negative dividend coverage for calendar 2010. But, to the degree we would be able to get the portfolio up in to the low 90s and if we could end the year that way, and I’m not saying to plug that in the model I’m just saying if we could get ourselves there and then that becomes more the run rate as we go in to 2011 and conceivably the markets are getting better, maybe even rents are getting better so everything is going in the right direction, I think it puts us in a position to say that things could be much more acceptable from a coverage perspective in 2011.

We think very hard about the dividend. We are big believers in the REIT model and we look at the dividend as part of the total return we provide to our shareholders so we think about it very seriously and we’re not going to move it up and down just because the couple quarter dip in occupancy but we will pay attention, we’re very serious about it. But, your question laid out exactly how it would have to play out at the core.

Brendan Maiorana – Wells Fargo Securities

Then beyond the core if we look at capital recycling and where your balance sheet today with what’s likely to be an improving overall fundamentals, are you comfortable increasing your leverage a little bit from current levels given all the capital raising you did last year or should we think about capital recycling kind of match funding going forward with your acquisitions, dispositions and settlements?

William P. Hankowsky

I think the way to think about it Brendan is that we want to make the right business decisions for this company when opportunities show themselves. So for example, if there was an opportunity to sell more suburban office than we had thought we could sell this year at cap rates as Mike said that might be moving in the right direction and that got us to a strategic objective sooner, we’re prepared to do that even if there isn’t an off selling buy. On the other hand, if that doesn’t make sense and there was something interesting to buy and it required more capital than the cash we had and we had to use the line and we made a decision to term it out than we would do that and get things rectified over time. We’re not trying to play this event to event, we’re trying to play this over time. Our leverage today George is like 38?

George J. Alburger, Jr.

Brendan it’s around 38% and there’s a range that we operate at and this is at the low side of that range. One might argue maybe even squeaked below the low side of that range. When we had the Comcast Center going and we had a billion dollar development pipeline, we’re probably at the higher side of that range. So right now we’ll continue to operate in a comfortable range and like I said we’re probably a little bit on the squeaky low side of that range now.

William P. Hankowsky

George, would you characterize the range as historically we’ve been between 40% and 45%?

George J. Alburger, Jr.

Yes, kind of Bill.

William P. Hankowsky

But with Comcast bumping it up.

George J. Alburger, Jr.

Well Comcast bumping it up and other things bumping it down. We had it shut there for a while, it was almost like 42% almost laser like for several quarters in a row. So that will give you some sense of our comfort zone.

Operator

Your next question comes from John Guinee – Stifel Nicolaus.

John Guinee – Stifel Nicolaus

A few things, just some minor questions, what’s your ownership position in your 20th Street JV?

William P. Hankowsky

25%.

John Guinee – Stifel Nicolaus

What’s the timing of your 2010 maturity, it’s about $170 million?

William P. Hankowsky

Yes, that’s in August.

John Guinee – Stifel Nicolaus

Any thought of repaying your series B preferred which is about $7.5?

William P. Hankowsky

Probably not right now John, probably not right now.

John Guinee – Stifel Nicolaus

Then any significant changes to any of your joint ventures?

William P. Hankowsky

No. I don’t know what’s implied in the question but our relationship with our JVs is very strong and very positive so they are where they are.

John Guinee – Stifel Nicolaus

I was actually talking about leasing and occupancy?

William P. Hankowsky

No, as I said the DC market is looking a little bit better, northern Virginia that’s doing alright. South Jersey industrial as I said is a little soft so you’ve seen that kind of pop up, we had a significant single tenant that popped that vacancy. Chicago, had drifted down but we’re seeing a little bit more activity. I think that’s probably the big ones.

John Guinee – Stifel Nicolaus

The last question is I think you mentioned that you tend to sign about 3.5 to four million square feet of new leases each quarter. Is that an accurate number?

William P. Hankowsky

In terms of replacement and renewals, this quarter we did 3.9, it was a little over the average for last year which was about I think 3.8 if I recall on a quarterly basis. Last year it was pretty rugged year so if you go way back last year we did 15.5 million square feet, the year before we did 20 million plus so it can run four to five when the cycle is going pretty good and it can run 3.5 to 4.5 in kind of a more slowed up cycle.

John Guinee – Stifel Nicolaus

If you look at the rest of this year you’ve got lease expirations of about 1.5 million square feet per quarter and then next year it’s about 1.5 million square feet per quarter. What’s the difference between the 1.5 million square feet per quarter lease expirations and the 3.5 to four million square feet of total lease signed each quarter?

William P. Hankowsky

A couple of things are happening. One thing you’re pointing out John is the average this year will be lower than the average – as Rob said in his comments, the percent of expirations is a little bit lower. So the way I always think about it is right now we’re at 88% lease so we’re looking at nine million square feet of vacant space and then we’ve got five million square feet of expirations left for the year so that’s 14 divide by three, we’re not going to get that all leased.

Then we do do some early renewals so you’ve always got the potential that for some reason the tenant wants to talk – you’re in the first quarter of ’11 but he wants today to expand, he wants to do something and we’re going to handle him today? There is a piece of every year’s lease activity that is probably another 12 to 18 months out.

Operator

Your next question comes from John Stewart – Green Street Advisors, Inc.

John Stewart – Green Street Advisors, Inc.

Just a couple of quick ones, Mike could you characterize both your acquisition and disposition pipelines buying at eight to 10 and selling at nine to 11, those assets relative to Liberty portfolio quality?

Michael T. Hagan

John, I would tell you that the stuff that we’re clearly looking at is stuff that we would intend to hold for a longer term and so things that we take very seriously are the quality of the asset, energy efficiency, there are no absolute functional obsolesce to it, we’re being very fussy in that regard. We’re clearly looking for newer assets. On the disposition side we are clearly looking for opportunities to improve the quality of the real estate.

John Stewart – Green Street Advisors, Inc.

Bill, you’ve talked a lot on previous calls about your development hurdles and it sounds today like you’re a bit more optimistic in terms of the potential to capture some built to suit activity. Obviously the world has changed quite a bit in terms of availability of capital but can you just kind of walk us through your thought process in terms of what hurdle rate make sense today?

William P. Hankowsky

For new development?

John Stewart – Green Street Advisors, Inc.

Yes.

William P. Hankowsky

Well, as you said the new development we’re thinking about is about build to suit so everything I’m about to say has nothing to do with spec which is not quite on the horizon at the moment. But, on the build to suit side, the balance here is a number of the people who have come to us are very high quality credits who are prepared for whatever set of reasons to do with their business, the space need they need and the market they need it in, it doesn’t exist.

They’re also willing to make long term commitment so if we’re looking at an A credit with a 15 year lease, that’s a pretty attractive cash flow and so the hurdle rate for that doesn’t have to be what it has to be if you’re doing spec building with mixed credits. I think we’re still in the low double digits for going in yields to make that make sense to us and it will vary. Could it break double digit with a superior credit and a super building? It’s conceivable it could be high singles but I think where’s the product, what’s the value, what value have we created?

We always say to ourselves, Mike is very good at this, at the end one of the last questions we ask ourselves is if we do this, the day we do it if we sold it have we made money? To the great answer that could be yes, then we think the yield is acceptable. I think that gives you a sense of it and it’s going to depend on the deal?

John Stewart – Green Street Advisors, Inc.

When you say going in, is that cash?

William P. Hankowsky

Yes.

John Stewart – Green Street Advisors, Inc.

Lastly, George I understand you’ve alluded to downsizing the line of credit but if you had to strike a deal today what do you think the spread would be?

George J. Alburger, Jr.

I’d rather not give out that exact spread because right now I’m talking to the lenders.

John Stewart – Green Street Advisors, Inc.

A range?

William P. Hankowsky

No, don’t give him a range.

George J. Alburger, Jr.

You can see what recent deals have recently been done at and it probably hasn’t moved much off of that plateau since those deals have been done.

Operator

Your next question comes from Dan Donlan – Janney Montgomery Scott.

Dan Donlan – Janney Montgomery Scott

First question I guess is for Bill or Rob, could you give a percentage of your industrial space that is warehouse versus more bulk distribution, the big box stuff?

William P. Hankowsky

We’ll get you the percent but here’s what I have in my head. Out of the industrial assets we own, only about 40 of the buildings are north of 350,000 square feet and we own 400 and some industrial and flex, if I throw those two together because it’s almost 300 of office. So call it 10% of the buildings. The square footage will be different obviously if they’re bigger buildings. The vast majority of the assets are multitenant industrial. Another way you can reference this is in the Q the average industrial building is 120,000 square feet I think, 110,000. So that gives you a sense, that’s a sweet spot of our portfolio.

Dan Donlan – Janney Montgomery Scott

Just as you look at acquisitions I think you mentioned Carolinas and Florida as for [inaudible] as well. I’m just kind of curious as to why you like those markets versus others?

Robert E. Fenza

Carolinas, Houston and obviously in Florida are the three that we mentioned that we’re comfortable with the fundamentals on there and comfortable, as Bill mentioned, how we look at our own portfolio and where that stacks up and that’s why we’re focusing there.

Dan Donlan – Janney Montgomery Scott

Then maybe a question for Mike, as we look at cap rates between your warehouse, your bulk distribution and the flex, if you can talk in generalities where is the delta and cap rate? Is the bulk at the lowest, then followed by warehouse and then flex? Could you maybe give where that is now and maybe where that has been historically?

Michael T. Hagan

Again, I think what’s going to drive everything is just if you have a quality real estate long term lease with credit you’ll drive a lower cap rate and I think that’s fairly consistent across the product type. I think right now the capital markets are looking for more of a Class A, and bulk distribution fits that so that will get a premium to the flex and a premium to the multitenant industrial. Where those spreads are, to be honest with you right now I’m not sure if there’s enough data points going to give you a good answer on that one.

Dan Donlan – Janney Montgomery Scott

Lastly, with long term capital gains likely going up next year is there any sense that we could see some of the private holders of real estate that have held for a couple of years no decide to sell maybe towards the end of the year? Is there any idea what might happen there?

Michael T. Hagan

I think what you’re seeing right now is a lot of private owners looking at how they’re going to recapitalize their company potentially. I think that could create as much opportunity as anything driven by a tax perspective to be honest with you?

William P. Hankowsky

We haven’t seen anything tax driven year.

Michael T. Hagan

Exactly.

Operator

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

William P. Hankowsky

Thanks everybody for listening in, we appreciate it. We’ll talk to you in 90 days.

Operator

Ladies and gentlemen this concludes today’s conference call. You may now disconnect.

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Source: Liberty Property Trust Q1 2010 Earnings Call Transcript
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