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Executives

Tim Bonang – VP, IR

Adam Portnoy – President and Managing Trustee

David Blackman – Treasurer and CFO

Analysts

Yanku [ph] – Wells Fargo

Dave Rodgers – RBC Capital Markets

Jimmy Feldman – Bank of America/Merrill Lynch

Tayo Okusanya – Jefferies

Government Properties Income Trust (GOV) Q1 2010 Earnings Call Transcript May 5, 2010 1:00 PM ET

Operator

Good day, and welcome to the Government Properties Income Trust first quarter 2010 financial results conference call. Today's conference is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to the Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

Tim Bonang

Thank you and good afternoon. Joining me on today's call are Adam Portnoy, President and Managing Trustee and David Blackman, Treasurer and Chief Financial Officer. The agenda for today's call includes a presentation by management followed by a question-and-answer session. I would note that the recording and retransmission of today's conference call is strictly prohibited without prior written consent of the company.

Before I begin today's call, I would like to read our Safe Harbor Statement. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Federal Securities Laws. These forward-looking statements are based on GOV's present beliefs and expectations as of today, May 5, 2010. The company undertakes no obligations to revise or publicly release the results of any revisions to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission regarding this reporting period.

In addition, this call may contain non-GAAP numbers including funds from operations or FFO. A reconciliation of FFO to net income, as well as components to calculate AFFO, CAD, or FAD are available in our Q1 supplemental operating and financial data package filed in the Investor Relations section of the company's website at www.govreit.com. Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our Form 10-Q, which will be filed with the Securities and Exchange Commission and in our Supplemental Operating and Financial Data package found on our website. Investors are cautioned not to place undue reliance upon any forward-looking statements.

And now, I would like to turn the call over to Adam Portnoy.

Adam Portnoy

Thank you, Tim, and good afternoon, everyone. We are pleased to announce another active quarter for Government Properties Income Trust. During the first quarter of 2010, we successfully raised $210 million in gross proceeds from a public offering common shares and acquired two previously announced properties of $72.4 million. After quarter end, we closed on the acquisition of two additional properties and placed a third property under agreement.

Since the completion of our IPO in June 2009, we have acquired eight properties and we have one additional property currently under agreement for an aggregate purchase price of approximately $233 million. These nine properties included approximately 1.3 million square feet in our 100% lease but the weighted average remain lease term with 7.3 years.

We also continue to remain well positioned for our future growth. Our portfolio properties are 100% leased. We have no material lease maturities until the fourth quarter of 2011. We have no debt maturities until April 2012 and our $250 million revolving credit facility which currently undrawn in fully available for us to acquire properties, majority leased to government tenants and cap rates materially above historical averages.

For the first quarter of 2010, we are reporting FFO of $0.43 per share based on a weighted share count of $29.1 million shares. We have no outstanding shares during the first quarter of 2009. We closed our IPO on June 8, 2009, so our financial reporting prior to that date was consolidated with our former parent company, HRPT Properties Trust.

At March 31, 2010, our portfolio statistics and balance sheet remained rock solid, approximately 94% of our rental income was paid by the U.S. government and four state governments. As a result of our recent equity offering, our ratio of debt-to-gross real estates was less than 6% and our interest coverage ratio was almost nine times.

During the first quarter, we had a very modest amount of leasing activity with only 4000 square feet of lease assigned. For the remainder of 2010, approximately 2% of our annualized rental income is expiring.

60% of this 2010 lease rollover was concentrated at one property with the U.S. department – one property leased to U.S. department of energy in Germantown, Maryland and lease renewal negotiations for this property are closed to being finalize.

Since January 1, 2010, we have acquired four properties and we have entered into an agreement to purchase one property for an aggregate purchase prices of approximately $144 million.

Our first acquisition was previously announced during our year end earnings call and its an office property located in Lakewood, Colorado with approximately 167,000 square feet. The property is 100% leased to the U.S. government and it serves as the Intermountain Regional Headquarters for the National Park Service. The purchase price was $28.7 million and included the assumption of a $10.4 million mortgage loan. We acquired this property in January 2010 and the going in cap rate was 10.2%.

Our second acquisition, which was also previously announced during our year end earnings call, is an office property located in Landover, Maryland for 266,000 square feet. It is 100% leased in U.S. government and is occupied by the Defense Intelligence Agency. Purchase price was $43.7 million and include the assumption of a $24.8 million mortgage loan. We acquired this property in February 2010 and the going in cap rate was 9%.

Our third acquisition is an office property with $27,000 square feet located in Burlington, Vermont. This property is a newly contracted Build to Suit that is 100% leased to the U.S. government and is occupied by the office of security and integrity. The purchase price was $9.7 million. We acquired this property in April 2010 and the going in cap rate was 8.6%.

Our fourth acquisition is an office property located in Detroit, Michigan with 56,000 square feet. This property is also a newly constructed Build to Suit that is 100% leased to the U.S. government and occupied by the U.S. citizenship and emigration services. The purchase price is $21.3 million. We acquired this property in April 2010 and the going in cap rate was 8.7%.

We have one property currently in agreement that we expect to acquire before the end of the second quarter which is an office property located in Malden, Massachusetts with 117,000 square feet. It is leased to the Commonwealth of Massachusetts and is occupied as the headquarters for the Department of Education. The contracted purchase price is $40.5 million. This acquisition is subject to diligence and customer closing conditions and as a result, there is no assurance that we will acquire this property.

We remain encouraged by the strength of our acquisition pipeline as we are evaluating a number of high quality opportunities for relatively new properties with long remaining lease terms. The opportunities include properties leased to both the U.S. government and state governments and the acquisition cap rates fall within our targeted range of 8% to 10%.

Turning to our capital access, on January 14, 2010, we priced a $9.8 million common share offering at $21.50 per share. The offering closed on January 21 and we raised gross proceeds of over $210 million. The funds were used to repay amounts outstanding on our secured revolving credit facility and to fund acquisitions.

We believe the results of our first quarter 2010 activity continue to support our business goal providing shareholders a safe dividend, supported by a stable rental revenue coupled with the opportunity to grow the acquisitions and cap rates above, the historical average for government leased properties.

I'll now turn the call over to David Blackman, our Treasurer and Chief Financial Officer to provide more detail on our financial results.

David Blackman

Thank you, Adam. First, let's review the results of first quarter operations. Operating income decreased 1.8% as a result of total expenses increasing by 39.8% compared to a 21.3% increase in rental income. We acquired six properties from our initial public offering to March 31, 2010. As a result the primary reason for our year-over-year change in rental income and property operating expenses is our acquisition activity.

Our non-property level operating expenses of acquisition cost, depreciation expense and general and administrative expense for G&A were the primary drivers in our year-over-year drop in operating income. We recorded $844,000 in acquisition cost during the first quarter of 2010 compared to no acquisition cost in the first quarter of 2009. Depreciation expense increased 37% as a result of acquisition that also is a result of $2.2 million with capitalized improvement at four of our properties.

Finally, our G&A expense is a comparison of receive an allocation from HRPT Properties Trust in 2009 and the actual cost associated with operating a separate public company in 2010.

A portion of G&A expenses, our fixed costs and will decrease as a percentage of revenue in real estate investments, as we continue to gain scale. If you compare to our first quarter of 2010 G&A expense to our G&A expense from the fourth quarter of 2009, the increase is substantially the result of property acquisitions, which helps to exhibit that our G&A expense is beginning to normalize.

Property operating – property net operating income increased by 21.3% year-over-year and our consolidated net operating income margins were consistent at 66.6%, for both the first quarter 2009 and 2010. EBITDA increased in the first quarter 2010 by 10% compared to last year, primarily as a result of acquisition activity and in spite of our $844,000 of acquisition cost and our increase in G&A expense.

Interest expense was $1.5 million in 2010, an increase by the same amount as we had no outstanding debt in the first quarter of 2009. Included within our interest expense for 2010 is $532,000 and amortization of the deferred financing fees, associated with the entering and amending our $250 million revolving credit facility and the assumption of two mortgage loans, for properties acquired in the first quarter of 2010.

Net income for the first quarter of 2010 was $6.9 million compared to $8.5 million for the first quarter of 2009. The decrease reflects the net result of a $1.5 million increase in interest expense, $844,000 in acquisition costs, a $729,000 increase in G&A expense and a $1.4 million net increased in rental income over operating expenses.

FFO was $0.43 per share for the first quarter of 2010, based upon weighted average share count of $29.1 million shares. We declared our first quarter dividend on April 8, equal to $0.40 per common share. The dividend will be paid on May 24 to common shareholders of record, as of the close of trading on April 23.

During the quarter, we spent $234,000 on tenant improvements and leasing costs and $46,000 for building improvements which included parking lot improvements, the completion of a garage renovation, life safety enhancements and energy upgrades.

Turning to the balance sheet. On March 31, we held $27.6 million of unrestricted cash and $1.1 million of restricted cash, associated with our two assumed mortgage loans.

Deferred financing costs of $5.6 million of fees and expenses, associated with establishing and amending our $250 million revolving credit facility and the assumption of two mortgage loans during the quarter, all of which amortized on a straight line basis.

Rents receivable includes $2.1 million of accumulated straight line rents as of quarter end. Other assets of $9 million include $3 million held in Escrow for our two property acquisitions that closed in April and our $5.1 million investment in affiliates insurance company.

As of today and at quarter end, we had zero outstanding on our revolving credit facility. During the quarter, we removed our property in Buffalo, New York at collateral from our credit facility and amended it to remove it for vision that established a minimum LIBOR rate of 2%, reducing our borrowing costs from 5% to 3.25% based upon current LIBOR rates.

Our credit facility matures in April 2012 and we have a right to extend it for an additional year to April 2013. We believe we are complying with our terms and conditions of our credit facility and are operating well within the established covenants.

During the quarter, we assumed two fixed rate mortgage loans for $35.2 million, with maturities of 2016 and 2021. Those mortgage loans are non-recourse and structured without financial covenants to the company. But neither mortgage loan has currently opened a prepayment, including our assumed mortgage debt, our ratio of debt to gross book value of real estate, with 5.6% at quarter end.

GOV remains a well capitalized company, without material lease maturities or any debt maturities in 2010. Our properties are 100% leased and approximately 94% of our rental income is paid by the U.S. Government and Four State Governments. As a result, our cash flow is incredibly stable to pay a consistent dividend.

In addition to our stable base, we continue to have strong acquisition momentum, with both quality acquisition pipeline and significant access to capital as evidenced by our successful equity offering in January and our fully available $250 million revolving credit facility.

We are both excited and confident with our ability to have success during the remainder of 2010. That concludes our prepared remarks. Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we will go first to Brendan Maiorana with Wells Fargo.

Yanku – Wells Fargo

Good afternoon. This is Yanku [ph] here for Brendan. My first question in regards to our operating portfolio, it looks like the same-store was actually down 2.5%, the lease rate was essentially 100%, fully leased. What was actually driving the rents to go down a little bit?

David Blackman

We had really the primary driver, Yanku, was we had increased in variable [ph] cost for our properties in Washington DC area. That was really the primary driver behind that.

Adam Portnoy

It wasn't a drop in rents as much as was an increase in expenses.

Yanku – Wells Fargo

Okay. It looks like, I mean, it's a small amount. It looks like rent dropped about $200,000. But you are saying that the most of the decrease was variable cost. Okay. Got you. And you guys provide a cap rate for the Malden, Machs [ph] acquisition?

Adam Portnoy

We haven't and we'd like to hold off on these closing cap rates, until we complete the acquisition. But it's within – it's in line with what we said between 8% and 10%.

Yanku – Wells Fargo

Okay. That sounds good. And just a question regarding the California portfolio? Not sure, what the bidding process is, whether that's ended or not? I think it did. And it sounds like the pricing is going to be pretty steep with potential for sub seven cap rate. Just – I was wondering if we can get your thoughts regarding what you guys think about, what that type of cap rate means for your portfolio and how your portfolio compares to the California.

Adam Portnoy

That's an interesting question. I don't think the process is ending here. And if something, it's actually something that we continue to look at. But to talk about the cap rates, I'm not sure where those cap rates are going to end up. There's a lot of broker talk about where they've like them end up, but I do agree with you that the cap rates that the people are talking about do seem to be fairly aggressive, especially given the credit of the California – California as a state, it's the lowest rated state in the country.

I will tell you this that properties are good assets. They are very nice assets and the lease structure – it's a very good lease structure, among the best we've actually seen, in some ways, it has all the features, it as good as any GSA lease structure. And in fact, it might be the little better because they are willing to have basically step ups in their rent – annual increases in the rent on top of it, so.

It's a good portfolio, but I think the credit of the tenant is different than the credit of the general U.S. Government – as the U.S. Government is a tenant within our portfolio. But I'm not sure that process is winded, is wind up yet and it will be very interesting to see who actually buys it and what cap rates it ends up with? That process has some lot of contingency. People should be aware, not only that do they have to pick a winner but then the state legislature has to pass a law, the government has to sign it. Everyone has to remember it on Election Year in California this year. So there is a lot of – there are unforeseen contingencies, there are continue to see substrate with that deal that are not normally associated with the sale that who known what happens.

David Blackman

My guess is the process will run until June because there is best in final round and then there will be additional diligence materials provided once they kind of continue to nearly to feel down. So it will be into the third quarter my guess before we understand who the winner is and what the ultimate price will be for the portfolio.

Yanku – Wells Fargo

Okay. Great. Thank you, guys.

David Blackman

Yeah.

Operator

(Operator Instructions) And we will go next to Dave Rodgers with RBC Capital Markets.

Dave Rodgers – RBC Capital Markets

Hi. Good afternoon, guys. With regard, David to the debt that you assumed in the quarter or subsequent quarter-end, what was the rate on that debt?

David Blackman

There is two different loans, the loan from the Lakewood property was $10.4 million at an 8.15% interest rate that’s the longer duration loan it goes to 2021 and fully amortizing loan. So it’s expensive debt but a good asset. The other loan was for the Landover, Maryland property, $24.8 million at a 6.15% interest rate and that matures in 2016. The Lakewood property is subject to yield maintenance provision, so very expensive to prepay today. The Landover property is closed to prepayment until six months prior maturity in 2016.

Dave Rodgers – RBC Capital Markets

Okay. Thank you for that color. You also made comments, I guess, related to G&A and you mentioned I think with the more acquisition to reaching more of the stabilize run rate on the G&A front. That just from a transaction fee perspective or the underlying kind of management fee to turn it through the G&A line, what should that number I guess look like going forward?

David Blackman

Well, as it relates to G&A, I mean the goal is to make sure that it is relatively consistent and that when it increases, it increases its result of acquisitions. We pay a business management fee to RMR, which is equal to 0.5%, actually 0.7% until we get to $250 million acquisition and it goes to 0.5% on the cost of those acquisition. So when I refer to that in my prepared remarks, basically meant increase in G&A was a result of that business management fee, we pay RMR.

Dave Rodgers – RBC Capital Markets

Okay. That’s – I want to make sure understood that, right. And then Adam, you mentioned your opening comment, I think, your opening comments I think $233 million with that what you done year-to-date as you just got me off guard?

Adam Portnoy

That’s since, we went public.

Dave Rodgers – RBC Capital Markets

Okay. Great. Here I just want to make sure I got that right. And then the final question was if you look at broader competition for acquisitions, capital markets coming back a bit better, you made them good new property acquisition on the Build to Suit. What you are seeing in terms of the number of bidders on the property that you are after, is that increasing in the competition rule for underwriting, maybe more growth and some of the rollover and how is that I guess impacting the cap rates for the yield that you are looking at today?

Adam Portnoy

Yes. There are more bidders for properties. The good news is there is still fairly healthy pipeline of opportunities, we’re looking at. I think that it is safe to say the cap rates are creeping in a little bit. You will notice that the two new acquisitions we made in April, were sort of in a mid-to-high eights but I would note that those properties were brand new Build to Suit with long-term leases in place.

I still think we have the opportunity to buy properties, new buildings that are Build to Suits in the eights. And I think properties there might be 5 to 10 years old with still 5 or 10 years left on a lease or new lease or renewal lease with GSA, you can buy those in the nines. I think those opportunities still are out there but it’s safe to say, we are buying properties in the tenths in 2009 at the end of the year and if that’s the stuff, I think its going to be tougher for us to be able to do.

But I still think it’s we are able to buy things between in the eights and then the ninth. And we are still looking a lots of opportunities single assets. And opportunities one offs as well as portfolios.

Dave Rodgers – RBC Capital Markets

Thank you.

Adam Portnoy

Yeah.

Operator

We will go next to Jimmy Feldman with Bank of America/Merrill Lynch.

Jimmy Feldman – Bank of America/Merrill Lynch

Thank you. As you think about the acquisition pipeline, are there a new types of sellers coming into the market that you haven’t seen – since you have been public?

Adam Portnoy

No. I wouldn’t say it is real difference in the type of seller. It’s still a lot of developers that – I mean the part of that – if you think about the capital markets, the private capital market, still is very tough. It is the local and regional developers giving access to credit. And those guys who typically then we capitalized. So they have been the guys that we have typically that’s been I would say half the opportunities we look at had been that characters they should and that’s been like that. Since, we have been public that really hasn’t changed.

We still – we see some institutional sellers coming – maybe that’s little different we are seeing some institutional sellers thinking about selling properties now because they see this is a – I think generally people think that, there is more bidders in the marketplace so some institutional sellers are now entering the market. But I – to what has changed a little bit but again our sweet spots are working with those local and regional players and specifically those developers there then we capitalized. We still have a lot of opportunities with those types of people.

Jimmy Feldman – Bank of America/Merrill Lynch

Okay. So as you see any thinking about cap rates coming in given the conversation and credit market pending up. How are you underwriting, you are underwriting it as some sort of spread to your cost – your rate average cost to capital. I guess how are you guys just thinking about how low you are willing to going on these cap rates?

Adam Portnoy

Well, I mean the settle different ways we look at it. We do it discount cash flow analysis – we do NIO [ph] analysis we do. And we fully obviously look at replacement cost first and foremost. And then we often look at what are cost to capital is in the different ways to look at that. A marginal cost of capital is just a revolver that we never model on acquisition on just buying it on revolver. But, of course, anyone realize is anything we almost buy today would be accretive under the revolver immediately.

But then its higher long-term finance, I think its safe to say that we want a different ways but we certainly are running at it 94% equity and 6% debt, including more. I think as we talked about when we were doing our equity offering earlier this year, we said that the sweet spot where we imagine the company’s leverage will probably get to eventually is between 13% and 14% as we grow.

So when we think about our cost to capital, it’s safe to say we think about things like we do a pretty simple math and so what’s equity between 60%, 70% debt between 30%, 40%. And what do we think our equity cost, what do we think our debt costs are, to get to earlier question. How much can we keep buying in as cap rates compress. Well, I think we can buy safely well – very safely into the eights and it questions to do we ever get down and buying things into the sevens.

Its hard to tough to managing it will be playing in that market where we are playing when cap rates compress that much. But if – I guess it always depends on the asset and what we are buying.

David Blackman

The other things that we look at, it may be a little bit different from other investor’s tools [ph]. We look at the cash rents as well as gap rents and I think one other thing that is attractive so many bidders to the state of California portfolio is the fact that every five years you have 10% rent bumps in those leases.

And so on a 20 year lease, you’ve got pretty attractive gap rents. And so that’s something that is relevant to us as we think about acquisitions that may not be relevant to everybody.

Adam Portnoy

Right. But they get to the earlier question, I think we still have the ability – I think our cost to capital so we still have the ability to continue to make acquisitions certainly in this. I think we are still have – cap rates could compress further still and we still be able to make acquisitions. We are not at the one, yet.

Jimmy Feldman – Bank of America/Merrill Lynch

So when you think about you capital, so you are doing acquisition, lets say what does that give you in terms of the spread?

Adam Portnoy

Well, again if you do it right on the line. Immediately, I mean you could do the math yourself whether you think a cost of equity might be and there is different ways to look at that and you say how much you spend on equity and then how much is debt incrementally, if we decide, well, 5%, 6% leverage today, it safe to assume that, I think leverage will tend to creep up a little bit overtime now.

And as we continue to grow, where we can get that today, I mean, ballpark, 5%, 6%, 6.5%, somewhere in that range. So, just today, if we bought a building, would be that’s (inaudible) it would debt and so we have a lot, we have 200 basis points, let say there of spread.

Adam Portnoy

Jimmy, we could get a three to five-year term loan through the commercial bank market at rate comparable to where our credit facility is priced today. So, 3% to 5%, you can get 10-year fixed rate money secure non-recourse, in the 6%, low 6%.

David Blackman

Low 6%.

Adam Portnoy

So, and, we’ve got, capacity for $150 to $225 million of additional debt at the company based upon where leverage is today. So, I mean, that’s where, we have an opportunity to create some value and accretion for shareholders, as we get through a more normalized leverage.

Jimmy Feldman – Bank of America/Merrill Lynch

Okay. Thank you. And can you talk a little bit about any uptake to your conservation with the IRS and Fresno, and I know, it’s further out, but your D.C. and Colorado role in 2012?

Adam Portnoy

Yeah. In Fresno, we have a good meeting in March with both the GSA and IRS to talk about that renewal. It was good conversation. It’s clear that the IRS intend to stay in the property, at this point, it’s a question of how long they stay, or how long they renew for, and with rental rate is.

So we feel very comfortable that we will renew them in 2011, and my expectation is that we will renew them for no less than five years, potentially longer. But since we’re in the middle of negotiating with them, we probably not saying much about where we think rental rates are or where we ultimately think the duration will be, until we conclude those negotiations.

On 20 Mass Avenue, that is in the latter part of 2012. We really haven’t initiate a conversations yet, with the GSA or with the primary tenant occupants. My guess is, as we get into kind of July, August, we will really begin those conversations.

On Lakewood, Colorado, not a lot at this point that we can stay there either, we do know that the tenant has some expansion need that we’ve been in conversation with them about. Unfortunately their not a 100% sure what those real expansion needs are and there are little bit all over the place right now.

So, I think, as we get into the later part of this year, we’ll have a better idea to what their real estate needs are. Our advantage is HRPT Properties Trust owns a building to, the three buildings we own in this business park. It has capacity to expand these tenants. And it’s more than sufficient space to expand this tenant. So we feel pretty good about where we fit competitively.

Jimmy Feldman – Bank of America/Merrill Lynch

Okay. And then, back to the Fresno in terms of PI, do you have any idea when you think those might come out?

Adam Portnoy

No. But, remember the structure of that lease is not absolute net but it is modified net lease. So most of the tenant improvement dollars they may need or items that we can amortize into the lease, so if we spend a dollar and sign a seven year lease we’ll get that dollar back over seven years with a return. So that’s a pretty good position to be in right now.

Jimmy Feldman – Bank of America/Merrill Lynch

Right. But in terms of your actual cash spend next year that will be real cash outlay?

Adam Portnoy

It will be a cash outlay. But, given that that’s our only real material lease, we certainly got capacity to deal with that and if we can get that money back at a reasonable return its money we are spending.

Jimmy Feldman – Bank of America/Merrill Lynch

Okay. Thank you.

Adam Portnoy

Thanks Jimmy.

Operator

We will go next to Tayo Okusanya with Jefferies.

Tayo Okusanya – Jefferies

Yeah. Good afternoon. In regards to the California bidding process, could you give us an information on just, how involve you with that at this point, are you guys still bidding for properties, are you out of the process and just watching what will ultimately happen or what’s your level of involvement in that at this point?

Adam Portnoy

I think it’s, I don’t want to talk too much about it because it is – because it’s a process that’s ongoing, but safe to say that we are still involve in evaluating, that evaluating it. That’s probably the best answer to give you.

Tayo Okusanya – Jefferies

Does anything changed with, I mean, most of the people were saying California is look for someone to bid on the entire portfolio. Does that actually enhance or discreet your position in regards to the ability to come out on top?

Adam Portnoy

Again the press may not have everything correct. But I think fair to that their preference is that they would like to do a portfolio deal. But again we’re evaluating it when the mix of – we are still evaluating it again. We will see what.

Tayo Okusanya – Jefferies

And reverse to acquisition outlook, I mean there is also some other news clippings about to deal with average we simply did. Currently, there is also something during our invest site Maryland, are you involve in any of those types of deals or would you like to look at any of those deals too?

Adam Portnoy

I guess I missed the recent press on Arizona. You may had put out a portfolio I guess in the third quarter of 2009. We took a hard look at it. There were number of assets in there that we’re interesting to us. But before we were able to formulate a bid we were told that the state was going to do a municipal bond offering to continue to own the assets. Has there been that’s come out recently to change it privacy.

Tayo Okusanya – Jefferies

It did a deal for 235 million of asset, most of it went to Fidelity and Vanguard and then planning to do another small round of real estate sales this coming June.

Adam Portnoy

Well, what they did was they sold the assets into a special proposed entity. They pledged for this collateral probably the Fidelity and Vanguard to issue in this format. That would be my guess. I maybe wrong, Tayo, but let me look into that because mainly we got better advice on that but what was in that portfolio, were an administrative building, the legislature that we have an interest, there was a VA property that would have been interesting to us. But then there was a bunch of prisons in there and there was a state parking. And those think that you (inaudible) result for the Convention Center in Phoenix. So majority of that were properties that really work for our vehicle.

Tayo Okusanya – Jefferies

What about Connecticut and then it sounds like they are conducting some sales up there too?

Adam Portnoy

Well, nothing has as while as –- as far as we understand there is not just Connecticut, there are several stage that we read about that are thinking about the mistake, taking relief from the press that you saw Arizona months ago as well as California. There are all at different stages and it’s safe to say when they come – when they formally come to market we will evaluate it. I think we absolutely will evaluate it. But they haven’t come before – they haven’t formally to market yet.

Tayo Okusanya – Jefferies

Got it. Appreciate it. Thank you.

Adam Portnoy

Welcome.

Operator

We will go next to Brendan Maiorana with Wells Fargo.

Yanku – Wells Fargo

Hi. This is Yanku again for Brendan. Just have a quick follow-up regarding your acquisition discussion earlier. Maybe this is just different for government assets, but a number of our competitors have been saying that they are looking at value, at opportunities – just leased up opportunities. Do you guys have any of that, some type of multi-tenant assets to different agencies that, you guys might be able to acquire?

Adam Portnoy

That's not particularly in our suite spot. This company is primarily focused on 100% leased assets, principally to the GSA. Are there opportunities to buy, let's say a vacant building and then to go lease it to the GSA, we looked at opportunities like that. Those opportunities like that we could engage in, and that was I think – characterizes value add.

We don't have many multi-tenant buildings. We have one large buildings, Sacramento that does have some private tenants in that, but doesn't have much in the way of any vacancy as you know, we are 100% leased. There are opportunities to buy buildings that are majority leased to the government, and then to try leased up the risk. But again, it's probably not something we would be focused on and that gets to the point of the – government tenants typically like to lease the entire building, principally security reasons.

And they like to have the entire building. So if you leased the GSA, yeah, there are opportunities to buy buildings that partially leased the GSA and they have to comfortable that they are going to stay there for long time, even though they don't leased the whole thing or you get comfortable that you might be able to lease remainder of the building to them.

That's not really – it's safe to say that's not where we are focused on trying to add value for the company. I think we are still primarily focused on buying 100% leased buildings, 100% leased buildings from the U.S. Government and state governments.

Yanku – Wells Fargo

Okay. So, I mean you guys are still targeting 8 to 10 type yields, if the cap rates come in a little bit in further, then would you guys just prefer top sit on sidelines then or – I mean it sounds like you guys still have a couple of deals of the Harper, but I was just wondering what the volume might be going towards the end of 2010 and maybe into 2011.

Adam Portnoy

Well, it depends – Your question is speculating on where cap rates might go, and if they compress with tremendous amount, us and a lot of players in the industry will have a difficult time acquiring properties that are attractive. It pauses spread investing, but you still got room in our business plan. Cap rates could compress more than they have already, and we still have room to buy and we can still do at a positive spread. Remember, we have 94% of our capitals equity, only 6% debt. And I think we are going to go lever up, tomorrow, but we have capacity to add modest amounts of leverage and leverage is cheaper than our equity. So I think we can – I think we are going to be able to grow for the foreseeable future. Now, regard this question a lot. We did our IPO, in what we did our secondary. At some point, if cap rates get back to the way they were in 2007 or 2006 and see the CMBS market comes back to the way it was and banks open up their lending and these types of asset trade at 5% or 6% cap rates where they have historically even 4% some trades happen back end. I think you’re right. We have difficult time competing but I think we’re a long way from being to the point where we wont be able to compete effectively. I think we still have a lot of run way left, either with cap rates impressing.

Yanku – Wells Fargo

Okay. That’s helpful. And do you guys – would you guys catch you put out some type of the acquisition, guidance out there for say 2011 or 2012, why is it little too early for that?

David Blackman

We will be acquiring property in 2011 – 2010, ‘11 and ‘12.

Adam Portnoy

Sorry. We just – it’s too tough. We don’t give any formal guidance and – yes, we are actively buying – it just unfortunately it’s tough to giving any sort of guidance on the amount. It’s very especially on acquisition, it’s very difficult. Because you can look at $200 million opportunity one day in the following day, you can look at $20 million opportunity and in it’s a pricing maybe differently. You don’t know which ones you are going to win.

Yanku – Wells Fargo

Yes, sir. Thank you.

Adam Portnoy

Yeah.

Operator

We will go next to Tayo Okusanya with Jefferies.

Tayo Okusanya – Jefferies

Hi, guys. Just a quick follow-up question. If you do end up in the world where it’s either taking longer to make acquisitions or, our acquisition volumes are slowing. Is there any opportunity on the cost side in your opinion to lower cost. So you still – generally meaningful FFO growth on a going forward basis?

David Blackman

We run a relatively lean organization. And we are very thoughtful about how we bid out third-party services for cleaning, landscaping and things like that. So in less, there its kind of build the generally within the economy to create savings in bidding out for cleaning and landscaping and things like that. I think there is not significant savings opportunities at the property level.

I think we will continue to try to do things as effectively as possible on non-property expenses but I think what help system most is continuing to gain scale. And so that’s why we are still very focused on growing the company is because we believe that continuing to gain scale will help us with our cost of capital, will help spread fix overhead over a larger base and all of that will improve our access to capital long-term.

Tayo Okusanya – Jefferies

Okay. That’s helpful. And could you just remind us again which of the operating expenses you can pass through to the government?

Adam Portnoy

A 100% real estate taxes typically and basically increases in all other operating cost up to rate of inflation for CPI.

Tayo Okusanya – Jefferies

Got it. Thank you.

Adam Portnoy

You welcome.

Operator

That does conclude today’s question-and-answer session. I would now like to turn the call back to Mr. Adam Portnoy for any additional or closing remarks.

Adam Portnoy

Thank you all for joining us on our first quarter conference call. We will be at NAREIT in June in Chicago. And we look forward to see many of you there, speaking with you on our Q2 call in early August. Thank you and good afternoon.

Operator

That concludes today’s conference. Thank you for your participation.

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Source: Government Properties Income Trust Q1 2010 Earnings Call Transcript
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