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Armada Hoffler Properties Inc. (NYSE:AHH)

Q4 2013 Earnings Call

February 20, 2014 8:30 am ET

Executives

Louis Haddad – President, Chief Executive Officer

Michael O’Hara – Chief Financial Officer

Julie Trudell – Vice President, Investor Relations

Analysts

Dave Rodgers – Robert W. Baird

John Guinee – Stifel Nicolaus

RJ Milligan – Raymond James

Michael Gorman – Janney Capital Markets

Craig Kucera – Wunderlich Securities

Operator

Greetings and welcome to the Armada Hoffler’s Fourth Quarter 2013 Earnings conference call. At this time, all participants are in a listen-only mode. After management’s prepared remarks, you’ll be invited to participate in a question and answer session. At that time, if you have a question, please press star, one on your telephone. As a reminder, this conference call is being recorded today, Thursday, February 20, 2014.

I’ll now turn the conference over to Julie Trudell, Vice President of Investor Relations for Armada Hoffler. Please go ahead.

Julie Trudell

Good morning and thank you for joining Armada Hoffler’s Fourth Quarter 2013 Earnings conference call and webcast. With me this morning are Lou Haddad, CEO, and Mike O’Hara, CFO. In addition, Eric Smith, our Vice President of Operations will be available for questions.

The press release announcing our fourth quarter earnings along with our quarterly supplemental package was distributed this morning. A replay of this call will be available shortly after the conclusion of the call through March 20, 2014. The numbers to access the replay are provided in the earnings press release. For those who listen to a rebroadcast of this presentation, we remind you that the remarks are made herein as of today, February 20, 2014 and have not been updated subsequent to this initial earnings call.

During this call, we will make forward-looking statements including statements relating to the current and future performance of our portfolio, our identified pipeline and future pipeline, our construction business, our portfolio performance and financing activities, as well as comments on our outlook. We will discuss certain non-GAAP financial measures including but not limited to FFO, core FFO, and core EBITDA. Definitions of these non-GAAP measures as well as reconciliations to the most comparable GAAP measures are included in the quarterly supplemental package which is available on our website at www.armadahoffler.com.

Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond our control. These risks and uncertainties can cause actual results to differ materially from our current expectations and we advise listeners to review the risk factors discussed in our press release this morning and in documents that we have filed with or furnished to the SEC.

I would now like to turn the call over to our Chief Executive Officer, Lou Haddad. Lou?

Louis Haddad

Thank you, Julie, and good morning. This morning I will touch on a few of the metrics from our fourth quarter earnings release. Next I’ll provide you with an update on our company with highlights from the year. Following that, I will take a few minutes to review the additional information we have included again this quarter in the appendix of our supplemental package titled, Understanding AHH. Our goal is to assist in fully understanding our markets, product mix and business model to enable a richer and deeper understanding of our company, value and future prospects. Before I turn the call over to Mike O’Hara, our CFO, I will provide you with some insight on 2014.

We were pleased with the quarter and excited about the trend of our business. Fourth quarter, our core FFO was $0.22 per share, which was slightly better than our expectations. The fourth quarter historically has been our strongest quarter and this year is no exception. The quarter was positively impacted by lower expenses in our stabilized properties due to seasonality as well as additional gross profit from the third party construction business. Cash same store NOI increased slightly on a year-over-year basis despite a year-over-year drop in occupancy mostly due to restaurant vacancies and a temporary dip in occupancy at the Cosmopolitan that we previously disclosed.

We executed leases totaling approximately 105,000 square feet in the fourth quarter. Occupancy increased to 94.4%, up from 93.3% as of September 30, 2013. In November, we were selected as a developer for a new office and manufacturing building for Oceaneering International.

I’d like to spend a few minutes on our recent investments. In January, we closed on the previously announced acquisition of Liberty Apartments in Newport News, Virginia. Liberty Apartments is part of a $70 million public-private mixed use development project with the Newport News Shipbuilding division of Huntington Ingalls Inc., the Commonwealth of Virginia, and the Industrial Development Authority of the City of Newport News, Virginia. This is another example in our longstanding track record of executing large, complex public-private partnerships. We believe this specialized expertise will continue to be a growth driver in the coming years.

We acquired Liberty Apartments for $30.7 million, comprised of a combination of operating partnership units, cash and the assumption of debt. The initial rollout at Liberty Apartments was strong with some 15 units rented and nearly half of the retail space either leased, under letter of intent, or in negotiations. This performance confirms the decision by the previous owners, all of whom are Armada Hoffler officers, to delay the acquisition to coincide with the opening of the apprentice school which also resulted in lower carrying costs for the REIT during initial lease-up.

The total consideration for this acquisition was $1.2 million less than originally anticipated in our prospectus due to the value of the OP units issued as a part of the consideration. I should also mention that the project was completed on time in September 2013.

Next, let me spend a few minutes updating you on our Town Center complex, including the two restaurant closings from earlier this year. Those current vacancies when coupled with 20,000 square feet of retail coming online in 4525 Main Street, the new office tower, gives us the ability to accommodate a block of strong retailers who require retailers as co-tenants. We believe that holding this space while concurrently working with these prospective tenants is the desired strategy as these retailers would bring yet another element to Town Center that would be unique to the area. We are in negotiations for all this space at Town Center.

While we are excited about these prospects, the length of lease negotiations is increasing as caution continues to dominate space requirements at these companies. Since we are working with national chains with multiple co-tenant requirements, our expectation is that these leases will not be finalized until late in 2014. Should this strategy prove to be ultimately unsuccessful, we intend to fill the space with other uses complementary to the existing tenants.

This strategic, methodical approach to leasing continues to show in our occupancy numbers as we continue to enjoy occupancy in the mid-90% range. We don’t get overly excited when our occupancy reaches 97 or 98%, nor do we get overly concerned when it dips into the low 90’s. Our focus is long-term growth and stability across our operating property portfolio.

The $175 million development pipeline which we announced at the time of our IPO is on budget and progressing as expected. The first wave of projects will be completed in the back half of 2014 with the remainder in 2015. We believe these projects will ultimately generate NOI of 13 to $14 million on an annual basis. This would represent NOI growth in excess of 30%.

We also began to enjoy the culmination of pre-development work on the next generation pipeline with the Oceaneering engagement. In the fourth quarter, we began construction on this 155,000 square foot build-to-suit project on 18 acres in Chesapeake, Virginia. We expect to complete the facility in early 2015. We facilitated this public-private transaction among the City of Chesapeake, the Commonwealth of Virginia, and Oceaneering International. This build-to-suit development project is 100% preleased.

The Johns Hopkins University development project continues to progress with the program now defined and strong interest from retailers for the ground floor commercial space. This mixed use development will include student housing, retail space, restaurants and parking. The goal of the completed project will be to complement the main campus and nearby Charles Village neighborhood and provide a catalyst for future development in the area. We expect to break ground on the project in late 2014.

Generally, I am extremely pleased with the attractive array of opportunities in the pipeline with more announcements forthcoming in the first half of 2014. We’re seeing a high number of opportunities that are 100% occupied build-to-suit with high credit quality tenants that are wholly stabilized upon completion, as well as grocery-anchored shopping centers that have historically been the foundation of our stable cash flow. Those projects are expected to increase our development spread as we are developing these at attractive return on cost metrics and these types of assets command lower market cap rates once completed.

We believe the net operating income from the next generation pipeline will begin materializing in 2015. This is slightly faster than our original expectation of a new generation of development projects in the range of 150 to $175 million every 18 to 24 months.

We continue to employ all the tools at our disposal to maintain the wholesale to retail spread on our development projects. These levers include structuring land acquisitions, managing the design process, acquiring municipal support through public-private partnerships, construction management, and managing the timing and terms of the leasing process.

We executed $6.8 million of new construction contract work in the quarter and $64.7 million for the full year. Construction segment gross profit was $3.7 million for the full year of 2013. To remind everyone, beyond the consistent cash flow generated by our third party construction business, having our own captive general contractor enables us to better assess opportunities, control costs, and ensure timely delivery of the properties we develop. These efforts go a long way toward mitigating the risk of the development process and protecting the wholesale to retail spreads that create value for our shareholders.

Finally, I’d like to draw your attention to the appendix in our supplemental, the section titled, Understanding AHH. We’ve provided additional information on the various parts of our business to help with valuation efforts. Stable portfolio NOI information is broken down in a way that provides the ability to apply cap rates at a more detailed level and with specificity. Identified and next generation pipeline are summarized to show the NOI and equity creation as we execute on these projects. We’ve also provided data on the third party construction business to aid in the valuation of this smaller but positive income stream.

This also provides insight as to how we think about balance sheet management as well as how we mitigate external market risks that are beyond our control. For example, there is a great benefit to our model in a rising interest rate environment. Many REITs may find it difficult to add accretive properties due to the upward pressure on borrowing costs and reduced spreads. We believe our built-in wholesale to retail spreads provide a substantial growth buffer in a tightening environment. Our business model includes multiple options to manage our balance sheet. This could include equity raises, asset sales, development pre-sales, and joint ventures. The value creation model provides us with the ability to absorb higher capital costs in the short run and still provide stable or growing FFO and asset value per share.

We view 2013 as a year in which we lay the solid foundation for sustained future net operating income and asset value growth. We accomplished what we set out to do this year, including transitioning to a publicly traded company, executing on development opportunities, identifying attractive opportunities for the next generation pipeline, and positioning our income portfolio for further growth, but there is much work yet to be done. Execution will remain our focus in 2014 and 2015.

I’ll now turn my attention to how we are thinking about the current year. Our success in 2014 will be based on our ability to execute on a number of fronts: maintain occupancy in the mid-90% range, execute new leases in both the operating properties and development pipeline projects coming online, build upon the leasing momentum at Liberty Apartments, deliver our development pipeline projects on time, including 4525 Main Street and Encore Apartments in Town Center, as well as Greentree Shopping Center and Whetstone Apartments, execute on strategic and opportunistic acquisitions, manage the balance sheet to ensure appropriate leverage metrics, and position the company for continued FFO and FFO per share growth, execute contracts for third party construction work with a consistent segment profit. We look forward to updating you on these goals as well as the rest of our progress in the coming year.

With that, I’ll ask Mike to walk you through some of the key financial and portfolio metrics contained in the fourth quarter supplemental package, and then we will take questions you may have about this discussion during Q&A. Mike?

Michael O’Hara

Thank you Lou, and good morning. In my comments today, I will first review the highlights from the fourth quarter, next discuss our recent financing activity, and update you on our balance sheet strategy, and finally provide you with some thoughts on 2014. Let me start with our fourth quarter results.

We believe that core FFO is a useful supplemental performance measure as it excludes certain items, including but not limited to losses on debt extinguishments, non-cash compensation expense, and effects from non-stabilized development projects. Core funds from operations were $7.1 million or $0.22 per diluted share, which was slightly better than our expectations. The core was positively impacted by lower rental expenses due to the seasonality as well as a higher net profit in the construction business.

During the fourth quarter, we executed four new office leases and five office lease renewals totaling 64,000 square feet, and two new retail leases along with seven retail lease renewals totaling 41,000 square feet. Since the IPO in May, we have leased 227,000 square feet and have renewed 100% of our expiring leases. We’ve outlined in our supplemental package that the office releasing spreads were higher by $1.47 per square foot on a GAAP basis and lower by $4.39 on a cash basis.

As we discussed during last quarter’s call, these leasing spreads reflect the renewal and expansion of the 30,000 square foot tenant at Town Center. This tenant renewed their lease and expanded by approximately 10,000 square feet for 15 years. This lease also required substantial TI and leasing commissions, as you can see in the supplemental package. We decided in the investment in TI and leasing commissions along with the lower current rental rate for a 15-year lease, including leasing additional sub-optimal space, was best for the long term. The retail releasing spreads were higher by $0.33 per square foot on a GAAP basis and lower by $0.33 per square foot on a cash basis.

Same store NOI for the year ended 2013 was negative $1.2 million on a GAAP basis but overall positive $0.1 million on a cash basis. Office same store NOI increased $0.4 million for the year, retail same store cash NOI was virtually unchanged, and multi-family decreased $0.2 million. The portfolio had positive cash same store NOI for the year despite the drop in occupancy at the Cosmopolitan and the Town Center restaurant vacancies that we have discussed in the past. For 2013, our portfolio occupancy was between 93.3% and 94.4% but still below our expectation of 95%.

On the construction front, we reported segment gross profit in the fourth quarter of $1.4 million on revenue of $19.4 million. We executed approximately $6.8 million of new contracts. At the end of the fourth quarter, the company had total construction backlog of approximately $46 million. We continue to expect approximately $4 million in annual segment profit from the third party construction business.

Now turning to our balance sheet, we continue to execute on our balance sheet strategy to provide the flexibility to fund our growth objectives in the most efficient and cost-effective manner while managing upcoming loan maturities. In October, we increased the borrowing capacity of our credit facility by $55 million by adding six properties to the borrowing base. The borrowing capacity of the credit facility now stands at $155 million. We have in place a $40 million, 2.5 year LIBOR interest rate cap at 1.5% in the credit facility.

In October, we repaid the loan secured by Bermuda Crossroads, which was scheduled to mature in January 2014. This property is now available to be added to the borrowing base of the credit facility if we choose.

In October, we refinanced six loans with the Bank of America, three of which were scheduled to mature in 2014. We reduced the aggregate loan balances by $1.5 million and removed the recourse component. The fixed new loan terms are the same and are for five years at a rate of LIBOR plus 2.25. The fixed loans include three loans secured by Broad Creek Shopping Center, one loan secured each by Commerce Street Retail, Hanbury Village Note 2, which is the Walgreens, and the Tyre Neck Harris Teeter.

In December, we closed on the Smith’s Landing loan extension with the existing lender. The loan was extended to January 2017 with two 12-month extensions at our option at a rate of LIBOR plus 2.15. There is now only one loan maturity in 2014 – Soft Point (ph) Note 4, which matures in December with a balance of less than $1 million.

Now turning to our development project financings, in October we closed on an $18.5 million loan to fund the Whetstone Apartments in Durham, North Carolina. The term is for 36 months interest only at LIBOR plus 1.90, and we’ve put in place an interest rate cap for this loan. In December, we closed on a $10 million to fund the Harris Teeter Sandbridge Commons project. The loan matures in January 2018 interest only for three years at LIBOR plus 1.85. In addition to these construction loans, we have a term sheet to finance the newly announced Oceaneering project. The expected term is for 48 months, of which 24 months are interest only with a rate of LIBOR plus 1.75. We are utilizing this credit facility to fund our equity requirements for these development projects and for the Oceaneering planned purchase.

At the end of the fourth quarter, we had a total outstanding debt of approximately $278 million, including $70 million on the credit facility. Our core debt to annualized core EBITDA multiple at quarter-end was 6.6 times. Our weighted average interest rate is 3.6% and our average loan term to maturity is 9.2 years. Approximately 56% of our debt was fixed at December 31, but taking into account interest rate caps approximately 66% of our debt was fixed or hedged. We are evaluating entering into swap-offs and/or purchasing additional caps on our variable interest rate loans.

Our goal is to maintain a balance sheet with an appropriate degree of flexibility to fund our growth strategies. Maintaining a balance sheet with adequate capacity and flexibility will allow us over time to facilitate access to a variety of capital sources at the most advantageous terms. That said, we remind you that the relative size of our portfolio and development pipeline, as well as our financing model, may result in the short-term fluctuations of leverage metrics which do not incorporate the upside equity creation in our business.

Now let’s talk about the upcoming year. We have not given any commentary on the full-year 2014, so let me walk you through our initial thoughts. First, in 2014 we expect to see our core business FFO results to be similar to 2013. As I mentioned at the beginning of my comments today, when analyzing our business, we focus on core FFO which excludes, among other things, the impact of non-stabilized development projects. Our core business is comprised of our stable properties and our construction business. This core business is a solid foundation for sustained growth.

As you can see on Page 10 of our supplemental in our FFO to core FFO adjustments, our core 2013 FFO did not reflect the exclusion of non-stabilized development projects as we did not have any in 2013. In 2014, our projects will begin to come online and we will have adjustments from non-stabilized projects. During 2014, we expect to deliver five development projects which will cost approximately $150 million and will be excluded from our core FFO results. The projects consist of one office, one retail and three multi-family projects. They are 4525 Main Street, Greentree Shopping Center, Encore Apartments, Whetstone Apartments, and Liberty Apartments.

Using history as our guide, we anticipate an 18-month stabilization period from multi-family, and therefore these three multi-family projects will have a negative impact on 2014 FFO results. We expect a negative drag from these non-stabilized multi-family projects in the $1.5 million range for the full year of 2014. Again, the impact from these non-stabilized properties will be excluded from our core FFO.

Conversely, our shopping centers, office and retail properties are immediately accretive on an FFO basis due to the amount of pre-leasing we require as part of our underwriting criteria. Because these project completions are back-ended in 2014, they are only mildly accretive in 2014. Again, the impact from these non-stable properties will be excluded from our core FFO.

As we mentioned earlier, we purchased Liberty Apartments on January 17 for $30.7 million. The purchase price consisted of issuing 695,653 OP units, the retainment of a $3 million mezzanine loan, and the assumption of approximately $20.9 million of debt secured interest at 5.66% with 30-year amortization and maturity of 2042. Consistent with my previous multi-family commentary, this non-stabilized property is in its lease-up phase and will therefore have a negative impact on 2014 FFO. We expect the Liberty Apartments impact on the first quarter to be approximately $300,000, which will be excluded from core FFO.

Now turning to G&A, let me give you some insight into our 2014 G&A. We expect G&A for the full year of 2014 to be in the $7.8 million range, which includes $1.3 million of non-cash comp. We expect the first quarter G&A to be in the $2.7 million range, which is higher than a typical quarter as it is negatively impacted by restricted stock grants to employees, year-end audit, and tax fees. First quarter G&A includes approximately $26 million of non-cash comp. In early March, we expect to grant approximately 110,000 shares of restricted stock grants to employees and officers of the company.

And now construction. As you would expect, the weather we are experiencing on the east coast is impacting our construction schedules and expected to adversely influence the first quarter results; however, we expect the construction company to continue with annual segment profits in the $4 million range.

Finally, our dividend. We announced this morning that the board of directors declared a cash dividend of $0.16 per share for the first quarter of 2014. The dividend will be payable in cash on April 10, 2014 to stockholders of record on April 1, 2014.

I’ll now turn the call back to Lou.

Louis Haddad

Thank you Mike. The market is clearly taking a wait and see approach to our story, and consequently we have underperformed the REIT index since our IPO. We believe the current stock price reflects a number of factors: a lack of appreciation for the strength of our diversified portfolio along with little to no value assigned to the development pipeline, a thinly traded stock, the misperception that a substantial portion of our assets are dependent on a military presence in our primary market, and lastly expectations about possible capital market activity. We believe this has created an opportunity for investors to enjoy an attractive dividend while the market absorbs our story. We believe that Armada Hoffler’s current entry point is even more attractive considering our NAV, FFO, multiple discount, above-average dividend yield, and our in-hand forward value creation.

This is our transitional year, a prove-it period, if you will, and we intend to do just that. Thank you for your time this morning and your interest in Armada Hoffler. Operator, we would like to begin the question and answer session.

Question and Answer Session

Operator

Thank you. Ladies and gentlemen, if you have a question at this time, please press star, one on your telephone. If your question has been answered and you wish to withdraw it, you may do so by pressing star, two. If you’re using a speakerphone today, please pick up your handset before entering your request. Once again, that’s star, one to be placed in the question queue.

Our first question today is coming from Dave Rodgers from Robert W. Baird. Please proceed with your question.

Dave Rodgers – Robert W. Baird

Hey, good morning everybody. Lou, start with you real quick on 4525. Can you talk about kind of where that building is in the process right now and your ability to get potential tenants up there, the traction activity that you see on some of those spaces, and then maybe tie up the ground floor retail into that comment in terms of the timing of when those leases would commence with these kind of multi-national retail companies that you had mentioned, is this late ’14 timing, is this kind of a 2015, mid-2015 event in terms of cash flow?

Louis Haddad

Thanks David and good morning. Great question. Let me see if I can frame an answer and stay somewhat brief, because I could talk forever about these new projects that are coming online here. 4525 Main continues to progress towards completion. We are almost closed in at this stage, and I tell you, I wish you guys could see this building – it’s absolutely beautiful. We’re already getting a number of comments out in the marketplace of basically bringing the whole level of office space up for the region, so we’re very excited about it.

That said, we’re not ready yet to tour people through. We’re pleased with the activity, with tenant interest in the facility. This is much a kick the tires type of market where once you get past your anchors, which are firmly in place, the rest of the lease-up is going to be dependent upon getting people up in the building and getting them excited. Like I said, that excitement is already starting and we’re pleased with the activity, but I want you all to keep in mind that this is—this office building will have the highest rents in the region, even higher than the building that we’re sitting in, our headquarters building. It’s designed so that we could have some space available for the next couple of years. It is in keeping with the absorption rate that we saw in our first premier high rise here, and this one’s not going to be any exception.

So in our minds, there will be a couple more leases that get signed in 2014. That will leave—I don’t know, I would expect or at least my hope – this is counterintuitive – but my hope is that we’ll have a couple of floors empty at least into 2015. There’s some really nice rollover coming with people that I know want to be here that will be much more in play in 2015.

With regard to the retail, David, these negotiations continue to drag. Every quarter I say to myself, well, next quarter we’re going to be able to announce all of this, and yet here we are and we’re still negotiating. My expectation, for what it’s worth, is that leases will be finalized and construction at least commenced in 2014. There may be—we’ll have an opportunity to get some people in for the Christmas season, but it all depends on how it comes together. Like I said in my comments, all of this is dependent on one another, so just getting everybody to agree to the (indiscernible) co-tenancy requirement in a lease is a pretty lengthy process, but we set out to do it this way. The opportunity arose with the restaurant vacancies. We told you that we weren’t going to simply build them with another restaurant, and our leasing people delivered this opportunity and we seized on it.

Now that said, and as I said before, it may not prove to be successful and if it’s not, then towards the end of 2014 we will start marketing and build the space in due course to complement our existing mix.

Dave Rodgers – Robert W. Baird

Okay, thanks for that color, and then maybe go onto something that you touched on late in your prepared comments with regard to the stock price. Can you maybe run through the total liquidity profile again, Mike, and give us a sense to kind of what sources and uses should be this year? In a (indiscernible) year, is there kind of an imminent capital offering in the market that you’re worried about?

Michael O’Hara

Yeah, good morning, Dave. As we’ve been saying, we believe we’ve got the balance sheet in place to handle the search generation of the pipeline without any issues. We’ve managed to continue our program of going out and getting construction loans just to fund the development of these projects, and we continue to get some really attractive terms from our lenders, and we’ll continue on that process going forward.

One thing I’d like to point out is just to let you know that I misspoke in my opening remarks. Our fixed debt before caps in Hanbury is 46%.

Dave Rodgers – Robert W. Baird

And maybe just a clarification – the Liberty Apartments, the 300,000 in your comments, I think that was a negative number. If you could confirm that for the first quarter impact of Liberty, and can you give us any clarity on kind of what the incremental contribution from the Cosmo will be going into 2014? If you did mention that, I apologize.

Louis Haddad

Mike?

Michael O’Hara

Yes, correct – it’s a negative FFO impact from the Liberty Apartments of 300,000.

Louis Haddad

David, as I think you’ve noted or we noted, the occupancy has recovered, has gotten back into the 90% range at the Cosmo. I’m expecting that 2014 is going to be somewhat lumpy. Between the weather that we’re having now – let’s hope it will break in the not-too-distant future – and the new projects coming online this summer, I could see that having its ups and downs, but again on a temporary basis until that noise moves out. It’s funny – it’s been our experience when we open a new multi-family, there’s a number of people that move across the street because it’s new, and of course you have to let them do that. So I could see some lumpiness there, but I think what you’re seeing now occupancy-wise is reasonable for where ’14 would end up.

Dave Rodgers – Robert W. Baird

Okay, great. Thanks for the color, guys.

Louis Haddad

Thank you, David.

Operator

Thank you. Our next question is coming from John Guinee from Stifel. Please proceed with your question.

John Guinee – Stifel Nicolaus

Great, thank you guys. Nice job. I apologize for the cold here. What was the yield on cost stabilized for Liberty again? Could you—I don’t think I caught that.

Michael O’Hara

John, our pro forma has that in the high 6’s, close to 7%.

John Guinee – Stifel Nicolaus

And why did you buy it at CMO versus stabilization and incur all the drag? Why didn’t you just wait a few quarters so that you wouldn’t be dealing with all the lease-up drag?

Louis Haddad

Well as you know, we contributed all of our development pipeline at cost in the IPO. That was an incredible value to the shareholders. With Liberty Apartments, that was something that started in 2009. The project was nearly complete. We didn’t have the ability to contribute it as a part of the pipeline because everything needed to be delivered in the public-private partnership before the deed could be arranged where it could be acquired. But it was always the plan from Day 1 within the prospectus that it would be acquired at opening.

John Guinee – Stifel Nicolaus

Okay, and then you’ve got about a $600 million company. You imply that you think you can start or deliver about $75 million of development per year, so that’s a 10 to 15% growth number, and then you also talk about acquisitions. Is there actually room in the business plan for acquisitions?

Louis Haddad

Yes there is, John. Again, if I haven’t made it clear before, it’s something we’re equally excited about as our development pipeline. The same sources that bring us off-market development deals—as you guys may have noticed, we don’t compete for deals. We basically take orders and we pick and choose which ones we want to act upon. Those same sources bring us acquisition opportunities, and we intend on executing those as well. The business model affords us that, and ultimately I think the implication of your question is what happens when our financing, our current financings do hit the wall, which isn’t any time soon. Obviously equity will need to come into the company. As I said earlier, we’ve got a number of different levers to pull in that regard. To be honest with you, as we speak we’ve had people approach us about—approach us seeing some of our development pipeline as a source of equity that is obviously completely off-market. We’ve also done a number of institutional and joint ventures over the years – Illinois Teachers Fund, Union Carbide, Carlisle. That gives us that opportunity as well.

But ultimately, this company is going to grow and it’s going to grow in a measured way by doing what we’ve been doing for 30 years as well as acting on acquisitions that complement our existing portfolio.

John Guinee – Stifel Nicolaus

Great, thank you.

Operator

Thank you. Our next question is coming from RJ Milligan from Raymond James and Associates. Please proceed with your question.

RJ Milligan – Raymond James

Hey, good morning guys. Lou, I was wondering if you could give us a little bit more color on the second generation development pipeline. What types of deals are you seeing in there? Are you seeing an increased number of opportunities, and is there any particular property sector where there’s a lot of interest in terms of development?

Louis Haddad

Sure – thanks, RJ. Well, a big chunk of the next generation is what we’re already talking about. The Oceaneering project is a $25 million engagement; the Johns Hopkins project is going to be on the order of 60 to $70 million in and of itself. The remainder, we’re very excited about. I think we’ve told you guys what we think of neighborhood grocery-anchored shopping centers, and there’s a number of those opportunities aligning which we hope to, as I’ve mentioned, start announcing in the next quarter or two, as well as build-to-suits. We are fortunate enough to be in the final stages of negotiation for a couple of build-to-suits with high quality, high credit tenants on a long-term basis, and obviously those things are immediately accretive.

It’s important to note, if I can take a second to expand on something Mike said earlier, in our property types, our office buildings are immediately accretive and that’s because we only do 100% build-to-suit projects or projects that are substantially pre-leased in markets where there’s a high barrier to entry, i.e. Town Center. Same thing with retail – we don’t do unanchored retail of any size, and so you can expect that kind of project to be immediately accretive as we announce it.

With multi-family, there isn’t any opportunity to have them be immediately accretive. If you’re in this business, you understand that the best multi-family projects, you can only move people in so far, the absorption is only so much, and so as Mike said, that 18 months is going to happen. Sometimes we’re a little bit better than that, sometimes a little bit worse, but basically we put them in the right place with a high barrier to entry, they lease up and they’re extremely profitable.

So we don’t—we’re trying to get used to the whole public company thing. We never really focused on what came online first and what was dragging for six months or what was immediately accretive, because we made the right decision to do the right deal so that it would stabilize and we’d be able to get cash flow over a long-term, consistent basis. In our 2014 results for instance, and this is why we strip this out for our core FFO, if for example the office tower and the grocery story came online early in the year and the multi-family late in the year, well then you’d have a positive impact from non-stabilized properties which would again (indiscernible) our results, and we still would exclude them. In this case, you have three multi-family projects coming online before the accretive stuff hits, and so we’ll be excluding that.

RJ Milligan – Raymond James

Okay, thanks Lou. Mike, I was wondering if—I know you guys didn’t really necessarily provide formal guidance for next year, but just as you think about some of the components – occupancy and same store NOI – can you give some comments as to whether or not you think they’re going to be slightly positive, slightly negative, or flat to where we ended up the year?

Michael O’Hara

Okay. Yeah, you must be a little excited this morning (indiscernible).

RJ Milligan – Raymond James

Yeah, it was a big win for Boston College.

Michael O’Hara

Yeah RJ, just the way we look at our business and where we think we’re going next year, our expectations would be in that 95% leased (indiscernible), and that’s certainly what we’re shooting for to take some of these vacancies – you know, these restaurants and some of the distress we see in our small shops, if some of our centers can get those leased up and get those leased here hopefully before long. And when it does, when we get those things in place, we’ll start seeing our same store NOI start to go back positive.

RJ Milligan – Raymond James

All right, guys. Thank you.

Louis Haddad

Thank you.

Operator

Thank you. Our next question today is coming from Michael Gorman from Janney Capital Markets. Please proceed with your question.

Michael Gorman – Janney Capital Markets

Yeah, thanks. Good morning. Lou, I was wondering if you could go back and talk a little bit more about the retail tenants. I’m curious at Town Center, have you had discussions already? Obviously the co-tenancy is going to be a complicated issue, but in terms of economics, are you and the tenants sort of on the same page in terms of what that’s going to look like, and then maybe give us a little bit more color from that perspective.

Louis Haddad

Sure, thanks for the question, Mike. Again, if you guys let me, I’m going to talk all day on this because it seems to be swallowing up my life. We are completely on the same page financially, and the naïve part of myself would have told me six months ago, well heck, we’ve got a deal. And now the savvy part of myself tells me that we’re still some distance away, and basically if you can think about it in terms of location, term and rate, we’ve got all that worked out but the co-tenancy is the remaining issue and we actually have a couple of leases in hand but we can’t execute them because they don’t show the required co-tenancy. That’s another couple leases that we have to get.

So I would tell you—and I don’t want to lead you guys astray. I would tell you that we are very close and that the vast majority of these leases are worked out. But I can also say that we’re far away in that if one or two of these dominoes don’t fall, then the whole thing goes away.

We’re really excited about it because, remember, Town Center here in Virginia Beach commands rents 20% above the market, and that’s something that is a huge duty for us to continue. This type of operation will let us continue to enjoy that spread, and that’s why we’re excited about it and that’s why we’ve decided to take this time. That’s why we’re passing up on the income we could have in simply filling the space, because as these tenants roll over—someone asked the question about leasing spreads. Our top-tier tenants in Town Center that came here 10 years ago at $22 are renewing at $29, $30. We’ve got to keep that going, and so that’s why we’re taking this time.

We’re close and yet we’re far. I’m hoping we can give you a further update at the next quarter, but in the long run our back-up plan works just fine as well. I hope you guys will be patient with us while we try and do something a little bit out of the norm.

Michael Gorman – Janney Capital Markets

Sure, I appreciate the color. Obviously you can’t talk about the specific tenants at this point, but can you just maybe give a little bit of color on what this particular group is going to bring to the Center that kind of factored into your decision to—your long-term thinking about how this positions the Center versus the shorter term backfill, kind of what they provide?

Louis Haddad

Sure. This will be a collection of primarily soft goods retailers that will not have another presence in the region. Remember, it’s MSA – 1.7 million people. We’re talking about strong names with strong followings that don’t have a presence in southeastern Virginia.

Michael Gorman – Janney Capital Markets

Got you, great. And then I’m sorry if I missed this – you’re just about to close a building at 4525 Main. Can you give an update on kind of what the leasing trends look like at the Cosmopolitan as that construction has progressed and maybe gotten a little less heavy?

Louis Haddad

Sure. Well, as we reported earlier, we suffered a drop in occupancy this past summer when we were coming out of the ground with the building. It caused a drop of 3 or 4% in occupancy. What we’re seeing now is that it’s performing consistent with the market. We haven’t upped incentives in terms of getting people back in. Again, we think it’s going to be somewhat lumpy over 2014 because we just don’t know the full effect of the new property coming online. We’re trying to—it’s really interesting and it’s a great opportunity for us. When you’re sitting here at Town Center, you basically have the ability to set the market, and while that sounds very positive, it also can be negative if you get carried away with yourself. We’re trying to position Encore as a different price point and a different style, and we’ll see how successful that is. At the same time, we’re expecting there will be some crossover despite our efforts to differentiate the project.

So I think what we’ll be looking at in the long term is more that we have 600 units here at Town Center and what’s the best way to keep it full and provide the most upward pressure on rents.

Michael Gorman – Janney Capital Markets

Great, thanks guys.

Operator

Thank you. Our next question is coming from Craig Kucera from Wunderlich Securities. Please proceed with your question.

Craig Kucera – Wunderlich Securities

Yes hi, good morning guys. I may have missed this, but is the Oceaneering build-to-suit, is the expected return on cost on that in the 8.25 range?

Louis Haddad

Closer to 8. Again, you’re talking about an $8 billion company, international company, long-term lease on triple-net rent, so that spread is—obviously were we to sell that, the number would start with a 6, so we’re estimating close to 8%.

Craig Kucera – Wunderlich Securities

Got it. And as far as leasing terms go with the build-to-suits and the next generation pipeline, are those pretty typical with what you’re looking at, sort of your 10-year triple-net lease type of projects?

Louis Haddad

We’re looking at 15-year leases. We’re really suspect about a 10-year lease with a build-to-suit, particularly for something like Oceaneering which has some specialization to it from a manufacturing component. So what’s coming through the pipeline is similar, smaller—it will be smaller build-to-suits, but the same kind of metrics – very high credit. I think one of them that we’re working on is a 10-year lease, but that’s basically (indiscernible) over a shopping center and we’ve been pretty vanilla, so we’ll be okay there.

Craig Kucera – Wunderlich Securities

Okay. Outside of the Johns Hopkins project, do you see much in the way of diversification outside of sort of the Virginia Beach-Norfolk area, or are the opportunities you’re looking at going a little deeper in market?

Louis Haddad

That’s a great question. We’re working very hard to expand our presence both in Baltimore and in the Raleigh-Durham area. We’ve got great entrees, as I think everybody on the phone knows. We’ve (indiscernible) some (indiscernible) hours worth of construction at the Inner Harbor in Baltimore. Our name is well known and well respected up there. The Johns Hopkins opportunity came out of that presence. We’re looking—the president of our development company is regularly there on a weekly basis, working a number of opportunities to expand our presence there. And as I mentioned earlier or on an earlier call, the Durham engagement with Whetstone Apartments came out of a relationship that we began with Duke University, which has designs on remaking downtown Durham, and we’re looking for more opportunities there.

I’d say we are—we’re much more focused outside of Hampton Roads with new opportunities than we are inside Hampton Roads. Again, we don’t want to mislead you guys – we’ve got wonderful assets in South Hampton Road. We have the best assets in the market, period; however, that air is limited and it’s not something that’s going to sustain us growth-wise over the long term. So if I had my druthers, you wouldn’t see a tremendous amount of growth beyond Town Center and beyond grocery-anchored centers in our region, and more of the ambitious projects will take air in that arc from Baltimore-Washington, northern Virginia or Richmond here, and northern North Carolina.

Craig Kucera – Wunderlich Securities

Okay, great. Thanks a lot.

Operator

Thank you. Our next question is a follow-up from John Guinee from Stifel. Please proceed with your question.

John Guinee – Stifel Nicolaus

Yes, just sort of a clarification. You’ve got about $28 million of construction payables and a liability on your balance sheet. It doesn’t show up on your NAV summary. Is there an accounting reason for that?

Michael O’Hara

Yes John, it’s Mike. I think this was talked about in our construction business. The cost is mainly a (indiscernible). We don’t—we self-perform the work, so it’s self-performed by subs. Those payables is what we owe subs, and our (indiscernible).

John Guinee – Stifel Nicolaus

(Indiscernible) in accounting, you have a corresponding asset to that liability, don’t you?

Michael O’Hara

Correct.

John Guinee – Stifel Nicolaus

What’s the asset now?

Michael O’Hara

So the asset is less than the liability, and this is because of the elimination of the work that we do for ourselves.

John Guinee – Stifel Nicolaus

Okay, and then what’s the $15 million of other liabilities? What the heck is this stuff?

Michael O’Hara

That’s mainly—the big thing in here is we’ve got—I think we’ve got three ground leases out there and we have to straight line those ground leases, so about $6 million of that is the straight-lining of the ground leases, and we also have the January dividend (indiscernible).

John Guinee – Stifel Nicolaus

Got you, all right. Thank you.

Operator

Thank you. We have reached the end of our question and answer session. I’d like to turn the floor back over to management for any further or closing comments.

Louis Haddad

Guys, we really appreciate your interest in the company. I look forward to updating you on these issues and others, as well as our activities and results in the coming quarter. Thanks very much.

Operator

Thank you. That does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.

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